Habits of a Losing Trader – Loss Aversion (27 Apr 2021)

[NIC] Hi guys, welcome to another episode of life of a trader Today, we’re going to start a new series called Habits of a Losing Trader. We’re going to talk about why loss aversion is one of the key traits that leads to trading ruin. How are you, Vee?

[VEE] Hi, Nick. Yes, let’s talk about that, right. So, we all know there are winning habits and there are losing habits and one key losing habit is the inability of traders to take losses or the reluctance to take losses, right? So, it’s loss aversion. Well, there’s a lot of research written on this and it’s a well-established fact that many people are averse to locking it in losses. For some reason, they believe that as long as they do not take the losses, it is unrealised and hence it is something that will come back around. In their mind, they think these are not real losses, these are just paper losses and eventually I have a chance to come back. So, it falls on many levels. A loss is a loss regardless of whether you cut or you don’t cut, it’s still a loss it if it’s in your trading account. Yes, there’s a number that says unrealized loss but you know, it’s essentially the value of your account.

And one of the things that prevent them from taking the losses is that they feel that once they are out of position, then there’s no chance for them to come back. What they are most afraid of is that, let’s just say they bought something at $100, now it’s at $90 and they’ve lost 10 bucks on it. They believe that if they sell at $90 now and it starts to bounce, it goes to 93, 94, goes back to a hundred, then they will be left behind and then they will miss out. They always have this of fear of missing out and that is one psychological weakness, right? It is a weakness that the trader who wants to be a winning trader need to get rid of. Because the first thing that you always learn when you start to trade, you always learn from successful traders, who have, you know, achieved consistent success before they would say, you know, the first thing is you need to do is to learn how to take your losses. And that’s very important because by taking losses, it allows you to free your capital from losing trades, from trades that have not been working – going the wrong way. Then, you have the capital to utilize on other possible trades that have better risk-reward. Of course, it’s no use trying to tell you to take losses and then don’t give you a method to how to become better right?

So, the way that I do it, say if I have a sizable position that I have a lot of conviction for and it’s going against me. (I’ve been there,  feel the pain of taking the loss.) Then, I will not have just one level to stop out a hundred percent, right? Because that is the mental hurdle – to take a big loss of a trade that you truly believe in at one time, right? So, I will break it up into several parts, maybe, say twenty five percent each at different levels. So as it trades against me, I start to take some losses and you’ll find that this psychological trick stops yourself from freezing. It stops me from freezing, from being frozen in fear or hope. One other thing that I find that when I have a position that is going against me is that I find that I’m hoping and making deals with a higher authority that it comes back – “just give me a chance to let it come my way for a little bit…. and I’ll stop/reduce my position” – Then this is the first sign that I really have no more leg to stand on, right? Since it really comes down to hope and just hoping and praying that it will start to work well. So, it’s the other thing that I console myself with is that fact that if the first trade to stop out, the first 25%, it is actually a relief. You will find that it’s always easier to then reduce further, right? And the other thing that we must always remember, is that the markets are open all the time, right? Of course, barring the closing hours of the weekend, but other than that, you have some markets even opened for 24 hours, for example, crypto markets. But the fact is the markets will be there longer than you will. It will always be there. If you stop out and then you find that it was the wrong thing to do. Because then the market starts to perform better, you still like the trade. You can always get back in. So, it’s not about crystallizing the losses and then, that’s it, right? It’s not about that. You always have to understand that losses are losses and it’s imperative to take the loss when things are going against you, right? So, what’s your take on that Nic?

[NIC] Right, I think it’s a very relevant discussion because coming of the back of the higher than usual volatility that we’ve witnessed in the past few days or last week and not only in stock markets but in crypto markets we hear a lot of stories of people getting washed out of very leveraged positions. And to us, it is just a normal dip in the eventual trend – we actually think Bitcoin is even going to 600,000, right? So, what I always believe is that you need to size your trades so that you can stay at the table long enough for your positions, to play out. But Leverage is good, right? I mean it amplifies your gains, but it also amplifies your emotions, right? So, I think that is something that we need to keep in check whenever we use leveraged trading. We have to be very cognizant of how it affects our emotional makeup. And I think that is something that I have learned over the years and something I am more cognizant of each time I use margin to do my trades.

[VEE] Yes, that’s a good point. So, that will be a topic we’ll touch on later on in the series. But of course, it’s very important to be able to take losses first before you start to do a lot of leverage trading, right? Because if you cannot take losses, cannot find yourself to be strong enough to bite the bullet and take a hit and take the loss. Then when you start to trade on leverage, you have amplified emotions and amplified losses and it could lead you to financial ruin. Okay, so to summarize, taking losses is imperative, it’s important for trading success. There’s never been a trader that did not learn how to take losses and managed to achieve great success and build a fortune for himself. Okay, thank you very much Nick with that. As always stay true to the process and profitability is eventual. Okay, just like all right cheers.

[NIC] Thanks Vee. Bye bye.