Forex Walkthrough

AAA

Trading Rules - No Excuses, Ever

by Boris Schlossberg and Kathy Lien

Our boss once invited us into his office to discuss a trading program that he wanted to set up. "I have one rule only," he noted. Looking us straight in the eye, he said, "no excuses."

Instantly we understood what he meant. Our boss wasn't concerned about traders booking losses. Losses are a given part of trading and anyone who engages in this enterprise understands and accepts that fact. What our boss wanted to avoid were the mistakes made by traders who deviated from their trading plans. It was perfectly acceptable to sustain a drawdown of 10% if it was the result of five consecutive losing trades that were stopped out at a 2% loss each. However, it was inexcusable to lose 10% on one trade because the trader refused to cut his losses, or worse yet, added to a position beyond his risk limits. Our boss knew that the first scenario was just a regular part of business, while the second one could ultimately blow up of the entire account.

The Need For Rationalization
In the quintessential '80s movie, "The Big Chill", Jeff Goldblum's character tells Kevin Kline's that "rationalization is the most powerful thing on earth. As human beings we can go for a long time without food or water, but we can't go a day without a rationalization."

This quote has strikes a chord with us because it captures the ethos behind the "no excuses" rule. As traders, we must take responsibility for our mistakes. In a business where you either adapt or die, the refusal to acknowledge and correct your shortcomings will ultimately lead to disaster.

Case In Point
Markets can and will do anything. Witness the blowup of Long Term Capital Management (LTCM). At one time, it was one of the most prestigious hedge funds in the world, whose partners included several Nobel Prize winners. In 1998, LTCM went bankrupt, nearly bringing the global financial markets to its knees when a series of complicated interest rate plays generated billions of dollars worth of losses in a matter of days. Instead of accepting the fact that they were wrong, LTCM traders continued to double up on their positions, believing that the markets would eventually turn their way.

It took the Federal Reserve Bank of New York and a series of top-tier investment banks to step in and stem the tide of losses until the portfolio positions could be unwound without further damage. In post-debacle interviews, most LTCM traders refused to acknowledge their mistakes, stating that the LTCM blowup was the result of extremely unusual circumstances unlikely to ever happen again. LTCM traders never learned the "no excuses" rule, and it cost them their capital. (To find out more, see Massive Hedge Fund Failures.)

No Excuses
The "no excuses" rule is most applicable to those times when the trader does not understand the price action of the markets. If, for example, you are short a currency because you anticipate negative fundamental news and that news occurs, but the currency rallies instead, you must get out right away. If you do not understand what is going on in the market, it is always better to step aside and not trade. That way, you will not have to come up with excuses for why you blew up your account. No excuses. Ever. That's the rule professional traders live by.

USD-JPY Pair


Related Articles
  1. Options & Futures

    Massive Hedge Fund Failures

    Flying high one day but not the next - see the stories behind some spectacular meltdowns.
  2. Investing Basics

    4 Things Investment Managers Say To Justify Losses

    While reputable managers will speak candidly about their performance, investors should be on the lookout for excuses.
  3. Forex Education

    Forex Trading Rules: Never Risk More Than 2% Per Trade

    by Boris Schlossberg and Kathy LienNever risk more than 2% per trade. This is the most common - and yet also the most violated - rule in trading and goes a long way toward explaining why most ...
  4. Active Trading

    10 Steps To Building A Winning Trading Plan

    It's impossible to avoid disaster without trading rules - make sure you know how to devise them for yourself.
  5. Trading Strategies

    How Elite Traders Learn From Their Mistakes

    What distinguishes a good trader from a mediocre one is his or her ability to learn from mistakes and use the experience to avoid making the same errors again.
  6. Active Trading

    Top 4 Mistakes That Cause Futures Traders To Fail

    Learn to keep your losses to a minimum and consistently produce positive results.
  7. Professionals

    A Day In The Life Of A Day Trader

    Day trading has many advantages and, while we often hear about these perks, it's important to realize that day trading is hard work.
  8. Forex Education

    Forex: Money Management Matters

    Currency trading offers far more flexibility than other markets, but long-term success requires discipline in money management.
  9. Personal Finance

    Government Bailouts Around The World

    The U.S. isn't the only country that had to bail itself out. We'll look at other bailout nations and how they're doing now.
  10. Active Trading Fundamentals

    Beginner Trading Fundamentals: Limiting Risk

    Managing risk is the most important thing you do as a trader. Here we discuss probability and strategies for limiting trading risk.
RELATED TERMS
  1. Blow Up

    A slang term used to describe the complete and abject failure ...
  2. Position Trader

    A type of stock trader who holds a position for the long term ...
  3. Right Of First Refusal

    A contractual right of an entity to be given the opportunity ...
  4. Day Trader

    A investor who attempts to profit by making rapid trades intraday. ...
  5. Superiority Trap

    A psychological or behavioral trap that leads people to believe ...
  6. Forex Hedge

    A transaction implemented by a forex trader to protect an existing ...
RELATED FAQS
  1. What trading strategies help investors withstand a drawdown?

    Understand the concept of drawdown and the importance for traders of having a trading strategy that takes temporary drawdown ... Read Answer >>
  2. Is it better practice to use a stop order or a limit order?

    Discover whether it is considered best practice to use stop losses or limit orders. Both options have their advantages and ... Read Answer >>
  3. What are some ways to reduce downside risk when holding a long position?

    Learn about the various methods a trader can use to minimize risk of loss or protect a portion of profits in an existing ... Read Answer >>
  4. How do traders use out-of-the-money options to hedge?

    Learn a couple of simple option trading strategies that traders can use to hedge an existing market position and protect ... Read Answer >>
  5. What is the difference between the rule of 70 and the rule of 72?

    Find out more about the rule of 70 and the rule of 72, what the two rules measure and the main difference between them. Read Answer >>
  6. How do you lose money in the Forex market?

    All trades made in the forex market are made in pairs. In other words, one currency is always quoted against another currency, ... Read Answer >>
Hot Definitions
  1. Demand Curve

    The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity ...
  2. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  3. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  4. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  5. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  6. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
Trading Center