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Thursday, December 4, 2008

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Coping with Losses (Overcoming The Fear of Losing Money)

In modern society, money seems to be taking on the specter of the major motivating force for human actions.
Without money, a person's quality of life can be stunted and leave a person standing on the outside of society.
Money-and the successful pursuit of it- may be the new religion.

The paradox of being a trader is that you do it to build wealth, but to really enter into the game, you need to already have some wealth.
Not only that, for money to not ruin the chances of making your trading capital grow, you need to not need it......
Say what? Let me explain.

To be able to trade effectively, a trader can't be afraid to lose money. You see, you will have losing trades and you will go through periods when you will see your trading account dwindling. It comes with the territory. Losing is just part of the reality of trading on probability.
Over time, even the best prepared and most favored fall victim to probability. Just as the New England Patriots.
And trading is all about probabilities.

The fundamental concept of trading is that a trader, over time, will have more winning trades than losing trades and that the margins on the winning trades are higher than the margins on losing trades.
Over a set of trades, top traders expect about a 65-75% win to loss ratio. That means that at least 25% of the time, even the best traders have losing trades.
So, the first thing to accept is that there will be losses.

Most people who are aggressive enough to be attracted to trading have been successful in other aspects of their lives. This may often mean that they are used to winning or at least normally not failing.
From our earliest days, we are taught that losing is equivalent to failure. That you have done something wrong. Losing becomes a deeply ingrained negative symbol.
Often times, it is accompanied with some sort of negative consequence and negative emotions amplify the impact of the concept of losing.
Unfortunately, not many people learn to see a losing situation as an opportunity to learn and improve.
But in trading, you not only have the deep seated connotations of losing but also the emotional impact of the tangible loss of something valuable-money.

Because money has such power, traders must apportion an amount to trading that won't make a significant impact on the life style, financial obligations or future plans of the trader.
That is to say, the trading account should be monies that can be lost without adding any stress to the economic situation of the trader.
If the total trading account were lost, it would have little to no impact on the economic well being of the trader. And thus, little emotional impact.

Because trading is a long haul proposition, traders need to be conscious of the fact that capital conservation is part of the strategy of keeping in the game and exposed to the probabilities.
As a result, most traders are very conservative with the money they don't really need. (the trading account).
It's common to hear that most traders have a drawdown limit of 20-30%. This means that if the account balance decreases 20-30%, a trader will stop trading and return to the drawing board.

Normally, the trader will need to tweak the trading system or take a hard look at how the trader is implementing the system.
Not only do traders use drawdown limits on the trading account, but also they have limits on how much money can be traded on any one trade.

For example, most traders won't trade more than 1-5% of the trading account on any one trade. This allows a trader to absorb the inevitable losses and still have resources to continue trading. Remember, trading is about being correct most of the time, not all of the time.
Losses will happen but they are quickly closed out to minimize impact on the cumulative number of trades.
To sum it up, traders need to totally negate as much as possible the emotional impact of losing money. Proper training of the subconscious mind to put losses in the right perspective can be extremely helpful.
In addition, traders need to set up rules and procedures to limit the effects of the inevitable losses and play to stay in the game.
To use the baseball analogy, being a trader is about hitting for average and not about hitting home runs.

[by Norman Hallett, CEO of Subconscious Training Corporation, Makers of TradingMind Software]

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