As all traders now, and all traders before, we have all had to trudge through a myriad of internal and external forces that drove us to make very costly decisions in the Stock Market. I am sure by this point in your trading you have discovered problems like over trading, revenge trading, trading outside of your “setup” or strategy, or take my current struggle…….not cutting losses! Follow along on this post and we will deep dive into issues I have discovered in my own trading and will pass on my solutions to you!!
Just recently I took a trade on a stock that fit my strategy really well. I took the trade as usual and sized in heavy based on my overall trade ideas. The stock however, went against my position and did so way outside of my rational stop loss. Now, this isn’t the first time this has happened, nor will it be the last time I take a loss in trading. (all trading strategies will have a reasonable amount of losses) The problem here is that I did not stop the trade after it went outside of bounds! Strange right??
There are many factors that lead up to this kind of inability to emotionally regulate during high stress events, and believe me, in trading they can, will, and do occur. First lets take a look at a winning strategy and get a better understanding of how it actually works mathematically.
Let’s say we have a trader who executes a strategy with a high win rate. His/Her win rate is 80%. This means that out of 100 trades this trader places, 80 of those trades will generate a return. The other side of this, is that 20 trades out of that 100 will incur a loss. One of the trickiest parts about that idea is the randomness. Even though we know 80 out of 100 will win, we do not know which 80. We also know that 20 out of the 100 will lose but we do not know which 20!
To explain this better lets pretend we are wagering on coin flips being heads and tails. We know that the odds are 50/50. Unlike trading there aren’t many variables but lets keep an open mind here. Let’s take this randomness idea and apply it to how many different variations of heads tails we get out of 10 flips.
FLIPS T=Tails H=Heads Both examples are of 10 coin flips
FLIP 1 : T T H T H H T H H H
FLIP 2 : T H H H T H H T H H
We can see just in 2 examples that there are random and unpredictable outcomes. With the combinations generated from flipping a coin 10x, there are 1000 possible outcomes. A coin however, has only two possible outcomes. Trading has more variables when we incorporate a trader who will change his/her bet sizing, entry/exit, external factors changing the heads or tails in real time i.e news releases etc etc. A trader, a person, a person with emotions and a life that has factors other than trading effecting their mental and emotional state i.e relationships, career, things are more complicated than flipping a coin.
Lets look at some of the issues that contribute to NOT cutting losses :
Confidence Bias
This is an issue that can occur after really solid winning streaks. It is the idea that you cannot be wrong because the market has proven your ideas for such a long stint that you completely forget about the loosing 20%. I have had this issue but it gets more complicated especially if there are other external factors putting you in a bad state of mind. This is essentially like you betting heads and it landing heads 40 times in a row!! Tails will come, and they can be painful.
The Fix
Place a stop loss. My fix was to scour all of my collective trading data to identify an average draw-down. After reflecting on this data and coming up with a PnL draw-down I have, posted at my trading desk that number and use that as my cutoff. It is ultimately up to the trader to determine their risk and how they will ensure they follow through at the time things are not working out as they had expected. I have been trading for over 6 years and still struggle with this. (this is actually my current biggest trading flaw) One thing to remember, is that a winning strategy is also a game of longevity so try and think of the big picture not the single trade.
Burnout
This one is tricky especially if you are a newer trader because we want to spend as much time as we can with the market. This is good and bad! I used to trade for over 12 hours every market day, work a swing shift at my job, spend time with my family and………what the hell was I thinking. We can very easily become obsessed with the market and not take necessary breaks. The market is not going anywhere and any trade missed is not that big of a deal. It may help to stay out of social media where you can see what other traders are doing or have done to mitigate that resentment FOMO (fear of missing out). I promise you have not missed the only trade ever!!
Whats The Fix?
I am just now re-approaching these ideas. I have had in two instances,…… times where I was emotionally drained and burned out from the trading grind that I was incapable of making sound decisions on risk (both times were right after incredibly green months, and there were external factors building). I personally schedule times to be available for the market, and to be away from it with purpose. I also will take every other Friday off if the market is slow. I use the other time to be productive in my life in other areas whether that be building my relationships, working on mindfulness, and enjoying the outdoors. It is extremely important that we are capable of removing ourselves from the market and take adequate mental breaks.