If
you’re going to be a trader, you’re going to lose money at some point,
and in case you are still in the phase of trying to avoid all losing
trades and searching for a “Holy-grail” trading system with a 75% strike
rate, you should forget about all that right now. As cliché as it may
sound, losing really is part of winning as a trader; the two are
inseparable. If you don’t learn how to lose properly you will never make
consistent money as a trader.
Some of the key reasons why traders become fearful about losing their money include the following:
1. They don’t understand that
mathematically, over a series of trades, a trader can lose a majority of
their trades and still be widely profitable, simple math proves this.
2. They are simply fearful of losing money in general.
3.
They are trading positions that are too big (risking more than they
really should be), causing fear, sleepless nights and huge emotional
swings.
In the rest of this lesson I’m going to provide you with
some insight into the fear of losing money in the markets and how to
conquer it. This is some pretty powerful stuff so make sure you actually
read the whole article and re-read it if you have to. What you learn
here should give you the power to eliminate your fear of losing money in
the markets and will help you develop into a confident and emotionally
collected trader.Fear of losing money can be a good, natural emotion, but we need to transform its focus.
Fear of losing money is a good emotion to have in many areas of life, if
we did not have it there would be even more chaos in the world and in
the markets. Humans are protective of their acquired wealth and
property, and rightly so; they worked hard for it.
Instead of being fearful of losing your money when trading, embrace the control you have on each trade; a trader has complete control over the risk management of every trade via stop losses and position sizing, [and for more advanced traders, derivatives and hedging mechanisms (not discussed here)]. These risk management tools are your way of being in control of your money/funds, and instead of being “fearful” about losing money, you should feel empowered and confident because you can predetermine how much you are comfortable with potentially losing BEFORE you enter a trade by using these tools.
Ask yourself some serious questions
1. Do I really have the knowledge and confidence to be trading with real money in the first place?If you’re trading your hard-earned money in the markets but you don’t know what your trading edge is and you don’t have 100% confidence in your ability to analyze and trade the markets…you probably should not be trading. One of the biggest reasons traders become afraid to lose their money is because they aren’t confident in their own ability to trade! It seems silly I know, but it’s very true; many traders simply don’t have a trading strategy mastered, they don’t have a trading plan, trading journal, etc…they simply aren’t prepared to risk real money in the markets yet…thus they feel fear when they trade.
2. Am I trading a position size that’s too large for my personal risk profile / per-trade risk tolerance?
If you don’t know what your per-trade risk tolerance is, then you need to figure that out first. It’s basically just the dollar amount that you feel like you are 100% comfortable with potentially losing on any trade; because you CAN lose on any trade…remember that. You have to take into account your overall financial situation and then determine how much money you should realistically and honestly have at risk in the market on any one trade…be honest with yourself here. You’ve got to think of yourself as a risk manager and as someone who is managing funds, rather than just a small-time guy trying to get lucky; your trading mindset will directly influence your trading results.
3. Do I truly understand the math’s behind trading?
When I say the “maths behind trading” I am mainly referring to risk reward and how it relates to your overall winning percentage. For example, on a series of 20 trades, you are likely to lose at least 35 to 45% of the trades, and most traders who are successful lose anywhere from 40 to 50% of the time, some even up to 60% of the time. But, through the power of risk reward you can lose more than you win and still come out very profitable. We will expand on this below.
Embrace the belief that losing is OK
Losing is good if you’re cutting your losses quickly and understand that by doing so you’re simply preserving capital and that your winning trades will pay for your losing trades with profit left over. This is the power of your average risk reward ratio over a series of trades coming into play; we will see this in action below…Even very profitable traders typically lose more than they win, to prove this point let’s take a look at a case study showing 14 trades with a just a 43% win rate. To be clear, that means you are losing 57% of the time and winning just 43% of the time. It can be hard to associate “losing” the majority of your trades with making money, but as I discussed in one of my recent articles.
Trust your strategy and Trust the maths
As we can see in the hypothetical track record above, the math shows us
that even while losing 57% of our trades, if we let our winners run to
around 2 to 1 or better and cut our losses at -1R or less, the profits
will take care of themselves. It’s worth noting we included a couple of
1.5R winners, because sometimes it will make more sense to take a reward
of slightly less than 2R, depending on market conditions. The average
risk reward in this example was 1:1.75, and if you can aim for an
average risk reward of around 1:1.5 or 1:2, over the long run you should
come out ahead. The “secret” is keeping ALL your losers at 1R or less and ONLY trading when our price action trading edge is truly present.
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