It surprises me how quickly after a few losses my whole psychology has the potential to turn to smoosh. I stop and listen to myself think, sometimes, and have no choice but to come to the conclusion that I can be really quite screwed up. Trading-wise, that is.
But that’s to be expected. Traders, especially traders who are still in the ‘getting everything bedded down’ phase, have to go out of their way to wrestle with their mind pretty much every time they put on a trade.
Sometimes the interaction is easy – you’re in the zone, you know what needs doing and can do it without too much internal push.
But other times when you’re slightly off kilter, the internal push is so strong that you have a hard time just thinking straight.
Never does this become more obvious than after a run of losses.
I’ve just come off a run of 10 straight losses. To define that for you, that included eight 1R losses, one 0.5R loss and 1 break even. Quite a patch, huh?
I’m not a good loser. I don’t like to be wrong and it’s probably the biggest hurdle I have to deal with in regard to my own trading psychology.
So when I get to around 10 losses in a row, I’m starting to feel like I suck. I’m starting to feel scared about losing any more money. I’m starting to worry that all the profits from my last good patch will be decimated if I keep trading.
At least if I stop trading right now, my equity curve will continue to look pretty – kind of like Snow White frozen for eternity in her glass case – but unless I’m ready to quit forever, placing another trade is inevitable.
Common trading wisdom suggests that if you’re losing, cut back your size.
Cutting back trade size when you’re losing makes sense on many levels, because if you’re trading like a junkie or the market isn’t right for your style you don’t want to be flinging around huge positions. It also makes sense to our hurt feelings – it feels much better to have a go with a teensy position because the damage will be minimal if you continue to be wrong.
I have a problem with this ‘wisdom’. In fact I think it’s flat out wrong. It might be good for the big guys – money managers and the like – but not for average retail traders.
The big guys generally don’t have the flexibility to pull the pin and sit out. They are expected to trade no matter what.
But think about it from a retail traders perspective. Generally, those of us who know what we’re doing already limit our risk through position sizing, and keep the risk in each position below the 2% mark. We already have that in place to prevent blowing ourselves up. Reducing our size has the potential to make our positions so insignificant as to be pointless.
While cutting our size does make us feel safer and helps to sooth our battered souls, it can actually be detrimental to our profitability – I realise this sounds like crazy-talk, but let me explain.
Look at the following graph, which shows a run of 10 1R losses, followed by a great equity rally. Notice that after panicking at loss 10, the risk has been halved.
Put yourself in the picture here. You’ve just had 10 losses in a row, and are feeling hideous so you’ve cut your risk back to make sure you don’t lose too much. You feel happier knowing that the damage is going to be limited from here on in, and continue trading.
You start to win again, which feels fabulous until you check your equity curve. Even after all those wins, you’ve only just poked your head above water. You’re not feeling quite so happy now, so given your recent good luck you go back to full risk. And promptly start losing again, with full 1R losses.
Compare to this, which shows the same data without the cut to risk levels.
By not cutting back risk you can now afford to host another run of losses, should the market decide to serve them up. You never know what’s hiding just around the corner, but by cutting your risk after a bad run you are guaranteeing that you won’t be in a position to profit from good conditions.
If you feel out of touch and like you can’t catch a break, it’s time to back off – not from risk, but from trading. Give yourself a couple of sessions to get your head straight, read something inspirational and just chill for a bit. You’re not going to miss anything in a couple of days.
That doesn’t mean switch off, necessarily, in fact continuing your usual routine is a good thing. Watch the market, journal your thoughts and get your confidence back.
And then, when you’re rested and certain a loss straight off the bat isn’t going to make you cry, you’ll be in a much better position to take on whatever the market throws your way.
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