turn the Fear of Losing Money into a Winning Mindset
The cave you fear to enter holds the treasure you seek. JOSEPH CAMPBELL In the case of the trader, money should be just a means of keeping score. It s a chicken or egg kinda thing. You want to build wealth because wealth is important to you. So, you take your hard earned cash and risk it by investing in your ability to define the direction and distance a financial asset will move. No matter what software, education or whatever special talents a trader might have, there is always the probability that the trader will be wrong. After all, the random walk is just that. So, building wealth through investing can become a dance with the devil. It s exciting because of the potential gain but at the same time it is a bit scary because of the potential pain. Pain caused by losing a valuable asset and pain caused by being wrong; a double whammy that carries a significant impact. The paradox for most traders is that making money is an important factor in the motivation of becoming a trader but at the same time money used for trading should have no emotional importance to the trader. We are told that trading capital should be expendable. That doesn t mean that you are so wealthy money means nothing to you but it does mean that losing much of you trading capital will have little or no impact on your ability to continue to live your life normally. In the case of the trader, money should be just a means of keeping score. But for most of us, money is a very powerful symbol and is easily tied up with our self image and ego. Contrary to popular rationalization, you are probably a better person with it (money) than without it. If you didn t believe that, you wouldn t be trading. So, at some point in every trader s career, losing money is usually a painful experience. It s all a matter of scale. What does that mean? If you are a very wealthy person, going out to an expensive restaurant is no big deal. You probably do it all the time. But to an average person, an expensive restaurant is only for special occasions (unless it s all-you-can-eat).
For the average person, if they have $20,000 in savings, losing even 10% can be devastating. For the wealthy person, losing $2,000 is nothing. However, losing $100,000, even for a wealthy person, can cause some real pain. It s all a matter of scale. If a trader is afraid of losing his capital, the constant fear makes trading exciting because there is something to lose. But when actual losing takes place, fear and guilt raise their ugly heads. Fear is caused by the loss of a valuable assets and guilt because those assets were lost directly due to the incompetence ( this is the subconscious interpretation of bad luck ) of the trader. In cultures that value wealth, power and being correct, There is no escape because every losing is for losers. And nobody wants to be a loser. The obvious paradox is that most traders have been winners in some form or the other. Otherwise, they wouldn t have the capital to trade. So, trader loses and traders have a daunting task: face their own fallibilities and financial fears. There is no escape because every trader loses and on a on a fairly regular basis. Guaranteed fairly regular basis. Guaranteed. So how does the normal person with the confidence and capital arm themselves to do battle with these grim phantoms within ourselves? They are there, waiting and they will find you. It just comes with the trading territory. The following are some suggestions to prepare for the internal battle all traders must fight: 1) Determine what level of trading capital can be completely lost and not affect your lifestyle as you like to live it. How do you do that? First, determine your monthly budget for all your normal activates and debt payments. Second, make sure you have enough assets in savings or assets easily converted to cash to meet living expenses for at least six months. Third, assess if you have adequate insurance coverage for you and your family. Unfortunately, in today s world (at least in the U.S.), having medical insurance can be a major factor in determining the six month emergency cash requirements. Fourth, if you have a balance of cash after the first three considerations, decide on your priorities of what you want to do with the remaining financial assets. Consider your short and long term goals such as funding your children s education, long term care for
2) your aging parents, etc. Once those factors have been considered, consider what portion of the remaining capital will be your investing capital. Now, once you have an idea of how much those leftover funds are available for investing, imagine losing it all (not that you will you ll be out of trading long before that happens). If you say to yourself no problem, you re there. Determine your trading account drawdown limit. Take a look at the chart below: % Drawdown % Gain required to recoup loses 10 11.11 20 25.00 30 42.85 40 66.66 50 100 60 150 70 233 80 400 90 900 100 busted As you can see, once the reduction in account balance reaches about 40%, recovering lost capital becomes a rather Herculean task. (maybe its all 6 s for some biblical reason). So, as a basic benchmark, a trader might be well advised to limit the trading account drawdown to 40%. What if the account does come down to drawdown? Usually, at this point either the trader has hit one of those rare but very possible losing streaks. Or, the trader s system might be flawed or the trader might be flawed. Either way, the best course of action is to pull out of any trading activities and take inventory of what is happening and what might be the remedies. Once solutions have been found, the trader should do some paper trad-
Remember, trading is not about hitting home runs but about hitting for average and staying in the game. ing to build back confidence before replenishing the account balance or re-establishing a new drawdown limit. Sometimes, traders decide that trading is just not for them. Others take hitting the drawdown limit as a time to seek more education or find a mentor to fight the good fight. Remember, trading is not about hitting home runs but about hitting for average and staying in the game. 3) 4) 5) Establish a maximum trade amount. As has been said, staying in the game to allow probabilities to work in the trader s favor, capital must be conserved. As a general rule of thumb, most traders will limit the maximum amount of capital per trade to about 1-2%. If you have a trading account of $100,000, the maximum amount that could be used in any one trade would be $1,000. This is more appropriate for larger accounts such as institutions or investment managers. For retail traders, perhaps a more realistic amount would be around 10% of the trading account balance. If the retail trader has $20,000 in their retail account, then $2,000 would be the maximum for any one trade. Even this amount is probably a bit high. Remember, it s a numbers game and the more you play, the better chance that probabilities will work in your favor-over the long run. What do you do with profits? There are many options on how to take profits. Many traders will let the account balance grow and allow the trade limit to increase and trade in higher volume. Other traders may allow the account balance to rise to a certain level and then take the excess and move it into another account to make tracking profits an easier chore. Further, they might put the profits from trading into more conservative investments like bonds or long term investments. I know several traders who trade to build up a vacation savings account. If you don t have a plan of what you will do with profits, you probably don t believe you will have any. Not a good sign. Trading rules. Many traders will establish trading rules to help limit loses. For example, if a trader loses more than three trades in a row, the trader must stop trading for a period of time-maybe a week or so. Some
It [money management] begins with having specific policies and procedures. traders will only trade a certain amount of trades per week to help avoid over trading. Other traders may not trade if they are tired or ill. The main thing is to have documented rules to follow to help make the decision of when and what to do when things aren t going right. Just like any business, you need specific policies and procedures. Money management is essential in becoming a successful trader. It begins with having specific policies and procedures. The objective is to conserve enough capital to stay in the game. I know it s easy to establish administrative procedures when it comes to money management but it s not so easy to establish procedures for how to handle the emotional impact of losing. And because losing is part of trading, it s essential to have a way to deal with the built in negatives that come with losing. And a trader will lose. First, a trader must accept that taking loses will be a problem. Once that is accepted, a trader needs to incorporate some form of training the conscious and subconscious mind to handle the problem. It begins with fully under-standing and internalizing the philosophy of trading: it s a numbers game. Your system of trading will provide you-if it s followed to the letter every-time-with an opportunity to win a higher than chance opportunity to have profitable trades. Consider the fact that even if a trader has a system which will produce a 75% win-loss ratio, the best traders will lose 25% of the time. Nobody but nobody wins em all. Believe it. Accept in. Internalize it. If your stop loss gets hit, so be it. It s on to the next trade. Think with a long view. Having a system and a mechanical way of trading helps to separate emotion and judgment from the facts as represented by market information. Your system should be as much plug and chug as possible. If your stop loss gets hit, so be it. It s on to the next trade. Think with a long view. But what if my system isn t that good? you might ask. To have confidence in your system and that it can produce profitable results over a period of time, you need to paper trade. Paper trading does several
important things. First, it allows the trader to practice implementing their system on a regular basis. Second, the system will have a chance to demonstrate its ability to produce positive results. Third, paper trading will allow the trader to tweak the system to best fit the trader s preferences. Fourth, it allows the trader to gain comfort with the fact that losing does happen but it is more a matter of probability than a flaw in the system or the trader. Fifth and lastly, it allows the trader to do all these things at no cost. There is none of the emotion and stress that real money produces. But even with this preparation, it s still hard to handle those internal voices that chastise you when you lose. It should be part of the trader s trading plan to work regularly on how to handle loss so it won t spread negativity and affect trading system. So, once a system has demonstrated its feasibility to make money, the next step is to incorporate a strategy to deal with the psychological effects of losing. There are tons of literature out there in the form of how to books, spiritual philosophies, hypnotism and other ways to focus on ways to help establish the proper mindset. It should be part of the trader s trading plan to work regularly on how to handle loss so it won t spread negativity and affect trading system. We want to develop a philosophy of it is what it is and how do we work with it. Too much emphasis is given to the technical side of trading and not enough to the psychological aspects. Having a trader s mentality is essential to becoming successful. As a result, it is up to the trader to be aware of this important fact and seek the best plan of action to address these concerns. As a matter of fact, finding ways to accept things we can t control is a big lesson not only in trading but in life, as well.
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