Thursday, October 30, 2014

How to Take a Loss

A loss never bothers me after I take it. I forget it overnight. But being wrong - not taking the loss - that is what does damage to the pocketbook and to the soul.
Jesse Livermore

Humans are risk averse. No liking losses we will do almost anything to avoid taking them. Losses are painful, and there is a strong human need to seek out pleasure and avoid pain. Traders tend to come up with many ways of denying they have a loss, such as holding on to a losing trade and hoping it will turn around, or keeping losses on paper to avoid acknowledging them. However, you will trade more effectively and profitably if you can take losses as quickly as possible, move on and make a new trade. In his book, "The Disciplined Trader," Mark Douglas suggests that you close out losing trades immediately, the instant you perceive that a trade is a loser. The best way to do this is to have a clearly defined trading plan where you predefine where you will enter and exit a trade. Once you have a clearly defined plan, you can execute the trade without hesitation. There is nothing to consider, weigh, or judge and consequently nothing to tempt you to hesitate and be consumed with self-doubt. 

The best way to take a loss is to anticipate it. If you go into a trade expecting that it may be a loser (and you always should), you won't be as bothered should the trade go against your expectations. If, you try to avoid considering the possibility of a loss, you'll become extremely frustrated when you are in the midst of a losing trade. Accept the fact that losses are the norm and not the exception. 

Define your potential losses before you enter any trade. Define your possible loss, or risk, in comparison to your possible reward, or profit. Don't take losing personally! Traders who put their self-esteem on the line with their money are especially vulnerable to strong, unpleasant emotions when they lose. Take a more carefree approach, and think, "It is not personal; it isn't a big deal in the end," then you will be able to accept a loss and take quick, decisive action. 

Taking a loss is a fact of trading. If you trade to make profits, you will face many more losing trades than winners. Because you lose more than you win, doesn't mean that you won't trade profitably over the long run. The fact that you lose trades is not an issue. The issue is how you cope with losses. If you view them as nothing more than a minor setback, you'll get back up and make trade after trade in order to come out of it. If you are stunned and disappointed, you'll actually give the losing trade more significance than it deserves.. So practice taking losses effortlessly. You'll trade more profitably in the long run.

Reprint from Prudent Trader archives

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