7 Worst Trading Mistakes #2: Failure to take quick, small losses

You are going to face failure in life. So fail fast, learn from it, and try not to fail the same way again.

Failing fast and well is one of the keys to success.

Failure-as-learning-opportunityTrading works the same. Losses are a part of any successful trading strategy. The question is, how will you take your losses? Take them fast, take them as lessons, and take them with detachment.

Failure to profit comes from failure to take quick, small losses.

There are two ways to take losses badly in the markets.┬áThe first way is to hold on to a trade that’s going against you, long past any mental or actual stops that you had in your plan. You’re stealing money from your own account and handing it over to someone else. All because you can’t stand the idea that you might have been wrong.

You hate that idea so much you’ll pay money not to face it. You hate being wrong more than you love making money.

Well, that just doesn’t make sense. And yet we all have done it. Such is the power of an unchecked ego.

The second way is to overtrade. Keep jumping in and getting stopped out. You lose money and your broker collects commission. A good broker will stop you. Mine will, because in the long run, he makes money only if I prosper.

I wish there was a fancy, mystical cure I could offer you to cure yourself of this. But the cure is simple: just be aware that it’s happening.

Focus on how it feels in your body, the battle between the voice that says, “Just hold on a little longer, it’ll turn around, you’ll make it all back plus more,” and the voice that says, “We can’t afford this! We should have gotten out three points ago. But it’s too late now. I guess it can’t get much worse.”

Except, of course, that it can get worse. Lucky for us, there are other questions besides “Can’t we just hold on a little more and be proven right?” and “Can we afford it?”

Your mind will focus on whatever you put in front of it. So ask your mind a more useful question.

When a market starts going against you, ask yourself, “Would I do the same trade at this point?” Keep asking at every tick. If the answer remains yes, stay in the trade. The minute the answer is “No, I wouldn’t enter the trade here,” get out. Quickly. Run away and live to fight another day. There is no shame in taking a small, quick loss.

There is no shame in taking a small, quick loss. Make that your mantra.

Or at least remember that it is embarrassingly stupid to take a large loss after a long period of hoping and praying. Pray for guidance before the trade. Pray out of gratitude afterwards. But don’t pray while you’re holding on to a losing trade, unless it’s to ask God to forgive your stupidity.

OK, what if you have deep pockets and can take a large drawdown? If that works for you, great. But let’s say you’re long and the market has a huge drop. Wouldn’t it be better to short that drop? Again, ask yourself, “Would I enter into a long position at this point?” If your mind answers, “Of course not, I’d short this move,” then why aren’t you short?

Even if you’re strictly a buy-and-hold investor, it still makes sense to get out, wait, and then buy at the lower price once the trend is clearly upward again. More money, less heartburn.

Finally, don’t just make your stop a dollar amount. At first, you have to give the trade room to breathe and develop a trend. Then you can tighten up your stops. In your plan, before you enter the trade, find a level of support or resistance or a tested trendline and use that as your stop. Why? The market doesn’t know or care about the size of your account or your risk tolerance. It does remember and care about its own price levels.

Once you’ve found that price level, one which is significant to the market and affordable to your account, then honor your promise to yourself to stick to your plan.

Do it quickly. Do it ruthlessly. Do it before your ego has time to get a word in edgewise. Take the small, quick loss. You can always get back in, but only if you still have money.

It is your ability to take small losses quickly and without emotion, and not your ability to find insanely profitable trades, that will make you rich. It’s the only thing that ever has.

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