-The Brain Has a Tough Time with Trading
-You Can’t Out Analyze Poor Money Management
-What You Can Do About It
“When you develop your opinions on the basis of weak evidence, you will have difficulty interpreting subsequent information that contradicts these opinions, even if this new information is obviously more accurate.”
― Nassim Nicholas Taleb, The Black Swan: The Impact of the Highly Improbable
Most personal finance books have a common theme. They tell you that you cannot out earn reckless or irresponsible spending. Put another way, regardless of your income be it 50,000, 500,000 or 5,000,000, if you’re unable to tame your spending, you’ll have a hard time building a net worth that you can rely on down the road.
Trading FX has a very clean correlation to this lesson from personal finance. Regardless of your trading balance, you cannot out analyze poor money management. Here’s a few ways break down and overcome this obstacle that causes many traders to lose money.
The Brain Has a Tough Time with Trading
First off, it’s not necessarily your fault that trading is so hard. It just is. As you can imagine, trading aligns two common fears of all humans, losing money and being wrong. What’s more, the reason why traders get out of the business is important for you to understand if you’re going to make a respectable run in trading.
The reason traders get out of the business happens for one of two reasons. One reason is big losses and the second is really big losses. That’s it! That means that if you find a way to prevent losses big and really big, you’ll be way ahead of the curve.
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One pit trader in Chicago put it this way, “you have to love to lose and hate to win”. What he meant by this odd saying is that you have to recognize and be comfortable being wrong so that you can exit the trade as early as possible. However, an important note is that being wrong doesn’t mean that the trade won’t eventually move in your direction but that you’re “spending” too much at this point to see if the trade will work out.
You Can’t Out Analyze Poor Money Management
This is easily one of the largest problems in world of trading. Traders of all account balances large and small, attempt to out -analyze their balance. This brings about a vicious cycle that is article is aiming to help you avoid.
The cycle plays out in this familiar manner, a trader correctly analyzes multiple trades and in so doing, grows her or his account. As confidence builds, the trader decides to increase their trade size and in so doing, grow their account faster. When a trade goes against them (oh, the horror), they decide to fight the market and hold onto the trade waiting for the market to eventually prove them right.
I’m sure you remember the opening comparison of personal finance, you cannot out-earn reckless spending, and you’re now learning its trading equivalent. If you start with the mindset that you spend a portion of your balance every time you open a trade, you can see that you’re recklessly spending your account balance by trying to wait for the market to turn in your direction. Armed with this new mindset, it’s time to make a change.
What You Can Do About It
The first thing you can do about reversing this vicious cycle is to change your mind set about a Win Ratio. Doing this is not easy because it goes hand-in-hand with the statement earlier that your brain is set-up to not favor trading well. In other words, you’re brain often goes for the direct approach to growing your account as opposed to the non-direct route of taking many small losses to avoid the big loss while always keeping your eye out for the trade that works right away and therefore has less risk.
Traders lose money more commonly due to large losses than the number of losses. The risk: reward ratio that many traders focus on is to ensure that the winners pay for the losers. By keeping your losses small, you can easily pay for the losing trades and even more importantly, work on growing your account.