Why Losses are the Best Teacher

Failure is prevalent. No matter how well organizations are managed, some mistakes are inevitable and even seemingly ubiquitous.

Nobody sets out to lose money, however many traders will suffer a severe and sometimes a total financial loss within the first 6 months of trading. You may have seen these reports on the web. As traders we need to learn how to deal with loss. Looking at the human emotions of fear, greed and regret can help.

It’s often said that how you deal with your first major loss will define you as a trader. It’s reckoned that:

· 90% will give up

· 5% will become gamblers

· 5% will go on to become successful traders

Which route you end up on will largely depend on your personality type. Though, if you read this and put it into practice, you may be able to change which direction you take or even prevent a major loss in the first place.

Trading Personality Types

The enthusiastic-trader – first 90%

After a major loss, most new traders give up. This is a fact of life. People in this group start trading with a rush of enthusiasm but a big deficit of experience. The first big loss is a major hurdle that most won’t have the willpower to overcome. It’s usually at this point it dawns on them that trading is far more difficult than they first thought. Sensibly, they decide they don’t have the time or commitment to follow it any further. There’s no shame in this.

The gambler-trader – next 5%

The sign of the gambler-trader is that that they don’t see the error of their ways. The gambler won’t sit back and evaluate what went wrong or try to figure out what caused the loss in the first place. The gambler will just attack the market with more gusto. He’ll start taking bigger and more dangerous trades in order to try and win back what he’s lost. This is a destructive cycle and can lead to serious financial problems. If you recognize this in yourself or someone else it’s important to get professional help straight away.

The committed-trader – last 5%

After a major loss, this personality type will take time and take stock of what went wrong. This may take a few weeks or months of soul searching, learning and careful reflection. The result is that this person will come out the other side with a new and more realistic perspective. They will have learned a valuable lesson from the experience. Most of these people go on to succeed.

Examining the Reasons for a Loss

If you experience a major loss, it’s important not to get into the mindset of blaming the market or other external factors. When a trader makes their first significant loss it’s almost always to do with their own trading behavior.

" Most professional money managers look to make small, incremental gains."

If you find yourself in this position, the best thing to do is take a time out. Stop trading to clear your mind. With a serious loss, this may take several months. This time out will give you space to evaluate what went wrong and how to avoid the same thing happening in the future.

Look at your trading plan

Ask yourself this question. Are you finding that your trading losses are causing a significant emotional shock? If the answer is yes, then the problem is not with your trading it’s with your trading plan. With a sound trading plan, a few losses on individual trades should never cause pain or even come as a surprise. Losses are the cost of being invested in the market. There isn’t a way to avoid them so it’s better to get used to them early on.

No doubt you’ll have heard of the warning “never trade with money you can’t afford to lose.” Not only is this sound practical advice but obeying this rule will also make you a better trader. Ironically the more emotionally attached you are to “having to win” the more clouded and biased your trading judgement will become.

Are your expectations realistic?

One part of a valid trading plan is having an achievable goal. That means aiming for a realistic rate of return. Aim for single digit or low double-digit percentage return per annum. That’s on your invested capital – before leverage. Anything higher than that isn’t trading – it’s gambling.

" The more emotionally attached you are to “having to win” the more clouded and biased your trading judgement will become."

By Suren Subramaniam | 1 September 2020

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