Previously, I have written a post on how to minimize losses in trading through position sizing and stop loss limit. There is something that needs to be addressed further to ensure you can survive the unforgiving market. Stop loss limit is to prevent you from losing too much on a single trade and position sizing protects you from risking too much capital. The issue to be addressed is, “what if you have a string of losses?”
The most effective answer to the question is to stop trading. Yes, stop trading. It is harder to stop when you are losing. This is because you want to get “revenge” from the market. This is where the trader makes his/her deadly move as he/she is likely to lose even more. Worse, the trader may even resort to overtrading, taking large leverage to recover the previous string of losses. Instead of earning profits, the trader ended up losing all the capital and even land himself in debt.
The problem with most investors who started to get involved in the markets always have the “profits perspective”. They will be thinking like, “it is a place where my money can earn even more money”, or “If I can win consistently, I will be rich!” They participate in the market with excitement over the potential profits. This is natural as everyone wants to gain something out of it, if not, why invest in the first place?
However, the market is a double edged sword. If you look at the market for potential profits, you must also look into the possible losses. How many investors think of the probability of loss just before they invest their money in the market? How many have decided how much they are willing and able to lose before they invest? And when the loss realized, how many are able to take the loss that they set prior to the trade?
If traders only care about the profits, and neglect the losses, they will not know what to do when the latter happens. It’s like an investor getting a good deal on a row of houses makes him excited about the lucrative rental yields. He decorated the houses to increase rent further, but he did not really care about the bad things that may happen, lest to say taking precautions. One day, a fire break out, without any fire system in place, and a fire insurance, his entire row of houses was destroyed. The message I want to bring across is that a trader can be winning, but if he/she does not take care of potential losses, a mismanagement of that one loss can wipe out the capital.
Dr Alexander Elder recommends the 6% rule. He mentioned that traders do better when trading for institutions than for themselves. Although there may be a myriad of reasons, one of the reason he said is because of the institution manager’s presence. He looks over the group of traders and ensure no one trader bust his/her trading limit. Trading privately, you would need to have the discipline to do so consistently.
The 6% rule is to tell you that you should stop trading whenever your trading account decreases by 6% from the capital brought over from previous month.
This means that if your trading capital is $10,000 carried over from the last month, you can only afford to keep your losses within $600. By doing this and coupled with postition sizing and stop loss limit, your capital will never be wiped out. The challenge is whether you are able to execute all these rules.
Another advantage of this rule is that you can trade bigger as your capital grows. The contrary is true, as your capital reduces, you can only trade smaller contracts.
Think about surviving first. If you cannot even stay in the game, how are you going to take profits?
{ 1 trackback }
{ 0 comments… add one now }