Michael Taylor explains why learning to lose well is one of the most important skills a trader can develop. He looks at position sizing, stop losses and the dangers of averaging down, showing how keeping losses small can help traders stay in the market long enough for their winners to count.
My first ever trade was in a company called PeerTV. I put my money in, watched it do some crazy volatility, then watched it do something else – go to zero. A 100% loss on trade number one. Welcome to the markets.
Though in all honesty, this was probably the best thing that could’ve happened to me. It’s true that this happens to some people and they then quit the markets and their wealth-building capabilities forever, but I wanted to learn where I went wrong.
Losing is the part few people want to talk about. Every trading account on Instagram you scroll past is a wall of green screenshots, Lambos and beaches, and you’d be forgiven for thinking that nobody who trades ever actually loses money. The reality is the exact opposite. Losing is the most common thing that happens in this business. Trade for long enough and you will lose regularly, guaranteed, and you’ll do it over and over again.
The fact is that you don’t get to choose whether you lose. You only get to choose how much you lose. And how you lose is, in my experience, the single biggest thing that separates the traders still standing in ten years from the ones who then delete their apps and never mention it again.
Being a good loser is a skill. It’s also the least glamorous skill there is, which is precisely why almost nobody bothers to learn it.
Win rate is the wrong obsession
Ask a new trader what they want and they’ll tell you they want to be right. They want the high win rate.
Being right is overrated. In fact, in the new Market Wizards: The Next Generation Kristjan Kullamägi says he is right far less than half the time.
Every trade you’ll ever take has four possible outcomes. A small win, a big win, a small loss, or a big loss.
You can have a win rate below 50% and still make very good money, as long as your winners are big and your losers are small. And you can have a win rate north of 70% and still blow up, if those three little winners get erased by two losers you let run. This strategy is often known as picking pennies up in front of a steamroller.
The job is to make outcome four (the big loss) as rare as you possibly can. Removing outcome four is the most valuable thing any trader can do, and it has almost nothing to do with stock picking. It’s entirely about what you do once a trade has gone against you.
When I check my P&L, there is no column for “undervalued”. If the price is going down, I’m losing money.
Sometimes the market takes your exit away
You are not always handed the chance to lose gracefully.
On the morning of 10 October 2018, shares in Patisserie Holdings were suspended. The day before, the business was valued at nearly £450 million and the shares last changed hands at 429.5p.
Then a black hole appeared in the accounts, eventually put at £94 million, and the shares simply stopped trading.
If you owned it, you were trapped.
There was no stop loss to rescue you, and the company fell into administration in January 2019 with the business later being sold for £8 million. Shareholders got nothing.
That is the whole argument for deciding your risk before you’re in the trade. Bad news doesn’t knock politely and give you a fortnight to react. You need to position size for 100% loss on every single trade, because unfortunately, one day it will be.
Brent Donnelly said something I’ve always remembered.. If there’s a fat-tailed risk on any trade, cover it and go find a new one.
Averaging down is for losers
If you’re an investor, then averaging down may be a valid strategy for you. I’m not here to say it’s the wrong thing to do, because there are various ways to make money in stocks.
But if you’re a trader, then averaging down is for losers.
Carillion was a FTSE 250 construction giant with something like 450 government contracts to its name doing hospitals, roads, rail links etc. On 10 July 2017 it issued a profit warning and took an £845 million write-down on its contracts. The shares lost roughly 70% over the warning and the two days that followed.
That’s exactly when the trap sprang shut. It’s a household name. It builds hospitals for the government. Surely it’s too big to fail? Surely 70% down is the bargain of the decade?
It wasn’t. The shares fell more than 90% from that warning, and on 15 January 2018 Carillion went into compulsory liquidation. Shareholders were told there was no prospect of any return whatsoever and it was a big fat zero.
Every single person who averaged down on the road to that liquidation was buying more of it because it was cheaper on paper. In reality, the stock had become more expensive. The balance sheet was a wreck and the price was screaming that something was badly wrong.
Average up into your winners. Never, ever average down into your losers. Adding to a losing position is just taking a small, controlled loss and volunteering to turn it into a big, uncontrolled one.
The true cost of losses
A large loss takes two things from you, and only one of them ever shows up on the statement.
The first is physical capital. The second is emotional capital.
After a proper kicking, you don’t trade the same. You either freeze and miss the next good setup, or you go on tilt and start revenge trading to “win it back”.
Emotions wreak havoc on judgement, and nothing floods you with emotion quite like a loss big enough to hurt.
This is the bit people miss about the 1% rule. Risking no more than 1% of your account on any single trade isn’t only about protecting the pounds. It’s about keeping every individual loss small enough that it never reaches your head. If a loss can’t rattle you, you can take the next trade clear-eyed.
Do that a few hundred times and the maths starts to tilt in your favour. One trade is variance. 100 trades is data.
I’d also tell you to log your losers. Write down what you did, why you did it, and what you’d do differently. But the traders who journal tend to be the ones generating positive P&L, and I’ve never thought that was a coincidence.
Decide the loss before you take the trade
Before I enter anything, I want two numbers. Where is my stop (the price that proves the idea wrong) and how many shares can I buy so that hitting that stop costs me only 1% of the account.
The sum is simple. Say the account is £50,000.
1% is £500. If your entry is 200p and your stop sits at 180p, you’re risking 20p a share, so £500 divided by 20p gives you 2,500 shares.
The position sizes itself around the risk, rather than around how much you happen to fancy the stock that morning.
You can use my position size calculator to do this.
Then run a premortem. Assume the trade has already failed and ask yourself why. If the honest answer is “because I bought a stage 4 stock”, or “because I bought a story I never actually checked”, you’ve got your answer before you’ve lost a thing.
Size the trade so that even the worst case, a gap down or a profit warning or even a suspension and zero, is a wound you can survive.
Always position size for zero. Because one day, it will be.
The point of losing well
People hear “be a good loser” and assume it means going soft, or lowering your sights.
Mark Minervini put it best: those who trade without a stop loss eventually stop trading.
He’s right. The entire point of losing small and losing cleanly is that it keeps you at the table long enough for your winners to actually pay you. You can’t compound anything if you’ve been blown up.
Losing is inevitable. Decide your stop and your size before you click buy, keep every loss small enough that it barely registers, refuse to average down into a dog, and log the ones that go wrong so you learn something for the price of admission.
Get good at losing, and the winning has a habit of taking care of itself.
Michael Taylor
Free educational content: https://youtube.com/@shiftingshares
This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.
This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.
