Control your losses, trading rule number 6

27 9 2014 - No comment

One of the most important rules in trading is to know how to control your losses and not allowing yourself to be overtaken by events. This is usually what will differentiate a losing trader from a winning trader in the short, medium and especially long term.

Not taking your losses on the stock market is condemning yourself

On the forum of my stock market site people tell us almost every week that they have lost everything, their account has dropped to zero because they did not know how to take their losses. They waited for a miraculous turnaround in the market that could save their portfolio. This attitude belies a form of autism, where we cling to anything that might give us some hope; we do not see reality upfront, and there by behave irrationally in the true sense. We can not afford to trade while hoping for an event of this nature; that is not sustainable over time. We can be saved once, twice but we will some day run out of this luck. Chance absolutely has no place in the stock market, there is none, it does not have a role to play; there are only positive or negative trades.

Why we are not able to take our losses in the stock market ?

Many reasons account for this stubbornness of not wanting to take one’s losses: taking a loss is often more painful personally for us than it is for our portfolio. In fact, this is where psychology assumes its importance: trading is perhaps the only activity where we have the consequences of our choices in real time. Trading means to be constantly in front of a mirror that reflects what we really are – there is no way out. In psychoanalysis, personal identity consists of 3 things: that id (simplifying our subconscious), the ego (what we really are at a given time ), the superego (the limits imposed on us by society, our education …). And to add a bit of spice to the delicate balance of opposing forces that make up our personality, we must add the ego ideal – which is what we want to be.

Trading thus brings us, sometimes violently, to what we really are and with every position we take, we are testing the reality of the trader we are. We are testing our ego ideal against our ego. This is why many traders will lose everything by not giving in, by staying rigid in the market since taking their losses would mean being wrong, and being wrong will shatter the image they have of themselves, and this would shatter their ideal self, their ego. This is why we sometimes find people who have been ruined in the stock market and will continue to tell you they were right, that their analysis was correct and that the market was either completely manipulated or only morons are trading. This is simply a defensive reaction to protect their wounded ego, their Ego ideal colliding with reality. They do not want to face reality; they flee the mirror and would want to find a culprit: the broker, the method used, the indicator … which are obviously bad.

How to accept your losses on the stock market ?

As we see, the psychological aspect is crucial in agreeing to take losses when we trade. There is no mystery, you must work on yourself, the loss (symbolic and real) … For this psychoanalysis, psychotherapy can be of great help in identifying the reasons for this narcissistic vulnerability. Beyond trading, it also opens up possibilities for daring to do things. Many people are inhibited by the fear of failure, fear of discovering that they will never achieve their Ego Ideal makes them fear to act … The French society does not value failure, it condemns it meanwhile in the United States of America, for example a person who has experienced many failures is valued; he is a fighter, he had the courage to try, he got up…

We must therefore learn to accept; for a person, it is often the feat of losing, of being wrong. I rarely meet people who can say: I was wrong. Usually the prevailing discourse is: I’m right, the others are wrong. Statistically, a person who can live off his trading is exceptional; only about 5% of traders do. They accepted this reality; they are not perfect and will never be. Hundreds and sometimes even thousands are still deceiving themselves … and this has absolutely no importance. You have to totally overcome the complex of failure and when we get there, accepting your loss in the stock market and respecting your stop-loss and its management … is much easier. Too many people associate their social status, their job, their results in the stock market to what they are. An executive losing his job, a trader making a big loss and we end up with people all washed out, with all their psychological structure a wreck. Let us recall once more that we are more than a job and that what we earn at the end of the month is not our identity. Winning € 10,000 in the stock market at the end of the month does not make me a better or more intelligent man and losing that amount does not make me a loser or a moron. We must stop identifying ourselves…

You will know you have made tremendous progress the day a loss will be just like any other news and will not cast doubts on how you perceive yourself; the same for a profit. A trader must strive for a flawless psychological strength and there is no mystery in doing this; you have to work on yourself. In addition to becoming “rich”, trading may be the way to become a more emotionally stable person and accomplished man. So I went through psychoanalysis; it was my personal route but there are as many of them as people, to understand, learn and try to control my feelings, accept my Ego ideal which will always be flawed and inadequate … and thus take a loss, accept it, know how to recognize my mistake without it being the end of my world.

My technique to take my losses in the stock market

Technically, most of my trading is focused on total control of my losses. As Lacan would say; my earnings will come as a bonus. Therefore, I fix a maximum daily loss. This loss is a fixed monetary value. If in the day, I reach this level of loss, I close my position, turn off my computer and leave my house in order not to be tempted to continue. This is an absolutely extraordinary comfort in my trading because I know in advance the maximum loss that I could have in the next month if I lost for 22 sessions in a row (which has never happened to me :). There are few traders who can tell what their maximum loss will be in January 2014: X% or X Euros. And yet, this is an incredible psychological comfort. I no longer live with uncertainty. I know that I can lose every day, every week, every month. I know that this maximum potential loss will not put me in danger; I’ll still be there next month and the month after…

This technique of taking losses in the stock market has other benefits:

I will not aggravate my daily loss trying to “catch up” with things. 9 times out of 10 when I was trying to catch up with a significant loss, I only multiplied the loss at the end of the day.

I will not stupidly lose energy, stress myself up and be exhausted. I’ll be fresh the next morning in full possession of my faculties. Managing your fatigue and blood pressure is an essential point for traders.

I leave a market I do not understand on my unit of time; I let it go on without me, giving me the opportunity to once again be in sync with it the next day.

This system works with iron discipline, I no longer behave like a child, who does not accept that he has lost or is losing a game. Moreover, I am now no longer a “bad loser” in any game, I am more interested in the game than winning or losing. A bad loser is unlikely to succeed in trading … I feel it in trading, I am satisfied when I make a good trade, regardless of the financial result, I am satisfied by the “gesture”, the aesthetics of the trade. There is beauty in trading.

In conclusion, if you cannot respect your rules, your money management, if you let your losses run you down, you now know that you must find a way to discipline yourself, and especially accept the loss. Losing is a normal and natural thing. We have come across it all our lives, be it a financial loss, losing a loved one, losing a job, losing a social status, losing our favourite pen etc. We must learn to grieve and for a trader to accept personally that he is not perfect, and that a bad trade does not challenge who he is. Accepting that we are wrong makes us adults, better traders and allows us to no longer be children … Trading is the royal highway to becoming an adult.

List of my 10 personal trading rules:

1) Do not lose money, trading rule number 1

2) Trading rule number 2, reread rule number 1

3) Always have a backup solution, trading rule number 3

4) Only trade when in top form, trading rule number 4

5) Think for yourself, trading rule number 5

6) Control your losses, trading rule number 6

7) Do not force yourself to trade, trading rule number 7

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