Trading seems like an easy way to make a living – that is, until the market moves against you. Unlike your current job, it’s possible to lose money trading. In fact, you should expect to lose a good portion of the time – all traders have down days.
If you’re going to trade full-time, there’s no escaping it – sometimes, you’re going to lose. What matters is how you respond when you get punched in the face. Learn how to prepare yourself before investing.
In today’s blog, we’re going to talk about the mindset and its importance to the professional trader. How do you cultivate a mental approach that maximizes profits and minimizes losses? We’ll discuss everything you’ll need to know below.
Maintain a healthy bankroll for your level of risk
Some traders treat trading as a game. They take whatever spare cash they have, open a TD Ameritrade account, and begin firing away. Often, they’ll give no thought to how dangerous leveraged trades can be – all they see is dollar signs.
“A 100 USD to buy 10,000 USD worth of EUR? Sign me up!”, they think. However, if their per-pip cost is 10 USD, a ten pip movement is all it would take to wipe out their initial investment. As it stands, a significant downward market movement can take a pairing like USD/EUR far lower than that.
In this arrangement, a pip is 0.0001EUR. Let’s say USD/EUR is at 0.89235 and drops by 1% to 0.88343. That 0.00892 drop is equivalent to more than 89 pips. Not only will our hapless trader lose their initial stake, but they’d owe 790 USD. Let’s assume they had 500 USD in your account to start; their remaining 400 USD would be wiped out, plus they would owe their broker an additional 390 USD.
Trading should make you money – it shouldn’t leave you in debt. Never risk more than 1% of your account on a trade – if you want to make 100 USD investments, ensure you have at least 10,000 USD behind.
What if you don’t have 10,000 USD? Save up 2,000 USD and begin your career making 20 USD investments. Your early returns won’t be mind-blowing, but this strategy will keep you out of serious trouble when bear markets rear their ugly head.
Don’t trade stocks on tilt
Like poker, markets can be a fickle mistress. A reversal leading to a loss can leave you shocked in the same way a two-outer on the river can. Suddenly down money when you expected to be in profit, you double down and open new positions, desperate to get back to even.
This mental state is known as tilt in the poker community. Despite its origins, it applies just as readily to trading as it does to America’s favorite card game. When you make decisions in a state of anger, you miss subtle cues that would indicate a bad trade. In an attempt to make back your losses, you may end up deepening them further.
When deploying hundreds or thousands of dollars, you need to make decisions with a clear head. If you’re upset over a trade, walk away from your desk until you settle down.
Study your trades relentlessly
Michael Jordan wasn’t born with the talent which helped him lead the Bulls to six NBA championships. After being cut from his high school’s team as a freshman, he practiced like an unrelenting machine.
If you want to become a professional trader, you must embrace the same work ethic. Every day, after you close down your active positions, identify trades where you won and lost the most money.
Did you give in to the temptation of buying unvetted penny stocks? Did you over-leverage yourself and wipe out half your account? Did you close a winning position too early so that you could ‘book a win’ for the day?
Go through each significant trade and extract lessons that you can use going forward. This way, you’ll get stronger with each passing day.
Understand and embrace variance
On an episode of Star Trek: The Next Generation, Patrick Stewart, playing Jean-Luc Picard, said the following: “It is possible to commit no mistakes and still lose. That is not a weakness. That is life.”
And so it is with trading. You can employ a technically perfect strategy, making all the right decisions with the demeanor of an emotionless robot. And yet, you’ll still lose a shocking number of trades.
Don’t gaslight yourself – if you’re analyzing your trades and struggling to find anything wrong, it’s likely variance is having its way with you.
What is variance and what does it have to do with trading? Statistical variance posits that, in a small sample size, results with vary from the long-term expected trend. Let’s say your system claims you’ll win 70% of your trades. If you’ve followed it for a month and you’re below 50%, the system might not wrong – it could be that the market is moving against you more than usual.
Don’t get hung up on ‘win rates’
Want to learn something shocking? If you’re drinking something right now, swallow before reading further. Are you ready?
Okay, here it is – did you know some of the best traders out there have win rates of less than 50%?
You can take two lessons from this. First, it is nigh impossible to predict individual market movements. Even automated trading algorithms have down days – if they get it wrong half the time, what chance do you have?
Second, despite losing half the time, the best traders make gobs of money by maximizing winning positions. They don’t let losses bother them because they know when the market moves their way, they’ll be rolling in dough.
Stop-losses: learn about them, love them, use them
Why doesn’t losing bother professional traders? Because they know that if the market tanks, they have a safety net beneath them. If you don’t know what a stop-loss is, don’t put another cent at risk until you do. Here we have talked in detail about them.
In short, a stop-loss is an order to sell a holding when it reaches a given price. If you buy into GBP/EUR at 1.14625 and don’t want to lose more than 0.25%, set your stop-loss at 1.14350. This way, if Theresa May loses her 8th Brexit vote in a row and GBP/EUR slides, you’ll be covered.
Don’t let your fears master you
The most airtight system in the world won’t produce results if you don’t commit money when you’re supposed to. We get it – losing hundreds or thousands of dollars for the first time will shake anyone up.
However, if you have a healthy bankroll, avoid trading when upset, and study your deals, losses shouldn’t matter. Tomorrow will come, and with it, another opportunity to make a killing. Keep a cool head, and you’ll avoid disaster and be able to capitalize on whatever the future holds.
You can read our article and learn how to master your ego, admit that you’re wrong, take the loss and move on. This is a must-read for any investor, novice or experienced.