Don’t Avoid Taking Losses, Embrace It
Taking losses is an integral part of trading. There is no way to avoid it. It doesn’t matter if you are a new trader or a veteran trader.
Understand it this way: taking losses to traders is like taking punches to boxers.
The sooner you understand and truly accept this matter of fact, the sooner you can “embrace” taking losses instead of trying to avoid it. Avoiding taking losses is a stubborn subconscious human propensity; it is detrimental to trading.
The good news is that you CAN bring the unavoidable trading losses under YOUR CONTROL and thus limit them.
In this article I will show you some tried and true methods you can use right away to take control of your losses and limit them to manageable levels.
But first, let’s look at trading losses from some different perspectives.
Two Different Types of Losses
It’s important you understand that there are mainly two different types of losses: the good losses and the bad losses.
The Good Losses – Price Action Driven, Unavoidable but Controllable
You see a potential trade setting up. You can clearly identify a price level on the chart where, if breached, would invalidate the setup. That’s where your stop will be (your predefined risk). With that, you can easily figure out how many shares you want to take with this trade.
So the setup triggered and you took the trade. Well, as it turned out, the setup failed to follow through as it should and the price breached your stop loss level. You took action and cut the loss.
You know you can’t win them all, even the best setups don’t work 100% of the time. It’s just the way trading is. This was recently mentioned in a Motley Fool review that showed how long-term investing success is possible even with losing positions.
It doesn’t really matter if the stock suddenly goes your way and makes a big move without you, you couldn’t care less. Guessing or “imagining” what a stock is going do afterwards has no bearing on your decision to cut the loss.
You cut the loss simply because that was where you were supposed to. Nothing more to it. You cut it and you moved on.
Well done. That was a good loss, and the trade was still a good trade despite the loss. This is what successful traders do day in and day out.
The Bad Losses – Traders Own Behavior Driven, Out of Control but Mostly Avoidable
Behavior driven losses can get out of control very quickly if you are not mindful of such and don’t have the mental tools to stop them in time. Let’s take a look at a few most common behaviors that can lead to runaway losses.
1. Avoiding taking the loss in the first place
Now you are in the same trade. The price has just breached your risk level. You know you should cut it. But your human inclination of avoiding taking losses kicks in and takes over your mind. You find yourself thinking along the lines of
… “I’ll give it more time…it’ll go right back up”…
… “If it goes lower I’ll average down and I’ll get out as soon as I’m breakeven”…
… “Maybe I’ll just hold it as a swing trade”…
While your mind is conjuring up all the excuses to avoid just taking the loss, the price keeps going against you, tick by tick.
2. Averaging down
Eventually, the mounting loss triggers the “fight or flight” response in you. You either panic and get out, or worse, you mindlessly double down hoping for a bounce to break even, only to see the price falling faster. Next thing you know, the loss is out of control.
You have just allowed an initially manageable loss to turn into a runaway loss that can potentially wipe out a big chunk of your trading account.
That was a bad loss, the kind of runaway losses that are very avoidable.
3. Revenge trading (aka “I must make my loss back” mentality)
This is one of the most destructive behaviors in trading.
After a loss, even after a good loss but especially after a bad loss, if you are not careful (about your own mind), even the most experienced traders can be sucked into the “revenge trading” mental black hole.
Market just took your hard earned money from you. It just trashed your ego (so it felt like). You want your money (and your ego) back, you want to feel better, and that’s the only thought dominating your mind right now.
You jump right back into trades. No plans, no rules. You are now no longer a trader but an adrenaline driven gambler. You go all in, hell bent on making all your loss back in one lucky trade.
Revenge trading is the one behavior that’s responsible for causing the biggest one day losses for many traders.
All these “bad losses” are behavior-driven, thus avoidable. We’ll show you how below.
How to Take Control of and Limit Your Trading Losses
1. Make a plan, but make it SERIOUSLY, so that you trust it and take it seriously
Don’t just make a trading plan because every guru on Twitter told you to do so.
Most traders do take time to make plans that include the setup, the entry point and the stop loss level. But many treat the “stop loss” part of the plan as nothing but a “placeholder”. When they plan and enter a trade, they ONLY EXPECT to make a profit.
In other words, they don’t take the “stop loss” part of the plan seriously. Many traders end up throwing their plans out of the window as soon as a trade starts going the wrong way.
You don’t think Muhammad Ali going into fights EXPECTING NOT to take punches, do you?
So from now on, when you are making your trade plans, take the “stop loss” part very seriously. Give it MORE serious thoughts.
And please, while making your trade plans, do NOT “imagine” or calculate how much money you are going to make if the trade works out, instead, calculate how much loss you are going (and willing) to take if the trade does not work out. REALLY think THAT through.
Once you’ve done that, now you can go ahead and fully trust, respect your own plan and take it seriously when the trade is in play. You take care of controlling the risk, profit will take care of itself.
2. Trade small, trade tiny, until you’ve REWIRED your mind’s “auto response system” to losses
This is by far the most underrated and yet the most effective way of taking total control of your trading losses.
Trade small sizes, tiny sizes, trade odd lots if you have to and do so every single trading day. Resist the temptation of increasing the size because you “feel” very good about any given trade. Do not fantasize or imagine the “big profit” you’ll make with a trade if only you just size in big.
Stick to the small, tiny, or odd lot sized trades UNTIL you have trained your own mind to cut losses at the predefined risk levels effortlessly and automatically without any second thought. It may take you 100 trades, 200 trades, or more to get to that, so be it.
Then and only then can you start to increase your size and stair step up from there.
Every time you have a mental slip up and allow a good loss to be turned into an out of control bad loss, fall back to the small size routine.
This “rewiring of mind” will turn you into a bulletproof trading machine that no losses can really hurt you. It will free up your valuable mental energy to work on your setups, improve your entries and many other aspects of your trading. You will start to make meaningful progress.
3. Walk away from your screen after a loss (even after a good loss)
The best way to avoid getting sucked into the revenge trading mental black hole is to just walk away from your screen.
Do not jump right back into a trade after a loss, especially if the loss has affected you more than it should. Maybe it’s a bigger loss than you expected, or maybe it’s a bad loss that you could’ve avoided, and you are mad at yourself.
Whatever it is, just walk away for at least 30 minute.
You won’t miss anything while away. Great trades will continue to set up and come your way. Your chance of making back the loss is far greater later on and/or tomorrow than it is right now.
4. Set your stop loss properly
There are a few ways you can set your stop loss. Many traders use both at the same time.
- Technical stop (chart stop)
This is a stop loss level where, if breached, will invalidate the setup you are trading, thus it is the logical level for you to cut the loss. Some traders use a price zone instead of a specific price level. The idea is the same.
You shall adjust the size of your trade based on how far the stop level is from your entry point so that the total amount of the loss is completely acceptable to you.
- Max dollar stop loss (per trade)
This is the maximum dollar amount you are willing to lose on each trade no matter what. You cut the loss right away as soon as it reaches the max amount. No questions asked.
- Maximum DAILY dollar loss amount
Many traders also set a maximum DAILY dollar loss amount. Once the total loss for the day reaches this amount, they are done for the day.
This is a great practice. It protects you from over trading (most likely revenge trading) so that the total loss of one day will not wipe you out. You get to fight another day tomorrow.
- Should you set a hard stop?
It’s always advisable to put in your stop loss order right after you’ve entered a trade.
But make sure you continue to actively monitor the trade, as stop loss orders may not get filled all the time. Do not enter a trade if you know you have to be away for a while.
For options traders though, it’s not advisable to use hard stops.
5. Be mindful at all times
You must watch out for your own mind and be mindful of potentially dangerous behaviors that may turn a normal day into a very bad day.
- Are you hesitating cutting a loss when the price breached your predefined risk level?
- You just took a loss where you should. Great! But are you still very upset because you lost money?
- Are you getting emotional even though it was a good loss?
- Do you feel the urge to “get back the loss”?
- Or you just made a good trade and a nice profit. Do you start to feel invincible? Maybe you feel you can bend the rules and size in big?
You get the point.
The key is to stay mindful so that you can catch yourself before your own subconscious mind tricks you into doing potentially dangerous things.
6. There is nothing wrong with just sitting out today
- Feel a bit burnt out?
- Don’t feel well today?
- Can’t focus?
- Something bothers you a great deal today?
Well, why not just stay away from trading today and focus on taking care of other things. Market will still be there tomorrow.
There’s no way to sugar coat losses. It is painful to lose money, but losses are the tuition you must pay to the Master Teacher, the MARKET itself.
How you view trading losses and how you handle them in your trading will define how far you can go as a trader.
Embrace taking losses instead of avoiding it, learn from your losses, take what you learnt to heart and constantly work on making less and less of the same mistakes.
With some hard work and persistence, any trader can bring trading losses under total control. And once you can do that, profits will roll in on its own.
The sooner you get this important aspect of trading handled, the sooner you will become a consistently profitable trader.
I have given you some of the most effective, tried and true methods to do so, take them to heart and use them in your trading today.