05 Jul Trading After A Blow Up and Knowing Your Psychological Capital
How is life after that? Am I still trading? Some friends would ask.
Yes, I am. In fact, I resumed trading within a week. I topped up the account with US$10,000, a far cry from the amount I have lost.
I wasn’t used to the trade size at first and I fully understood how Tom Yuen felt when he resumed trading after his blow up. It was really negligible amount that you do not feel like trading. There is no kick to an alcoholic who could only drink a sip of beer.
But this is a punishment. Because I could not handle a big capital with my emotions acting up, so I must trade small. As the saying goes, “great powers come with great responsibilities”. I can also say, “large capital come with great emotional control”. It is not how much capital you have, but how well can you trade without getting emotionally affected. Let’s call this Psychological Capital.
Leverage Wants to Blow You Up
People are often attracted to trading because the returns are higher over a shorter period of time. And they can often do it with smaller capital.
To do so, the main source of profits have to come from leverage. If the price of a stock or forex pair moves 1-2% daily, you cannot force it to move more. The only way to increase your returns is to take leverage. We need to accept that making higher returns essentially means taking more leverage. Just like property investing, the main source of returns is leverage. Strip out the leverage and property returns looks average.
If you have to take leverage, you stand a chance to blow up. Below is the table to illustrate my point. If you have taken just 2 times leverage, a 50% move against your position would have blew up your account. Hence, you would have less tolerance for volatility going against you. And to make things worse, traders tend to choose instruments that move more – so they do not have to wait that long to see results and technical analysis work better with price movements.
Hence, it is not that trading is risky. It is risky if you have taken leverage.
There are ways to protect you – position sizing and cutting losses. You would have read numerous literature and listened to enough gurus preaching about these two important tenets of trading. They exist because of leverage. Because there is a chance to blow up your account, you need to chop off your limb before the poison gets to your brain and kill you.
Easy to say – position size, cut loss, follow the rules.
To do all these requires big Psychological Capital. I do not believe that discipline is a solution. The key is to find out how much capital you can trade without you panicking when things go wrong.
For example, I know my Psychological Capital is between US$10,000 to US$85,000. The latter is how much I blew up. I can never trade that amount and maintain my sanity. You should have seen how I was procrastinating cutting losses in Jan. I do not know my exact threshold yet, but at least I have established a range. I can tell you that trading US$10,000 was a breeze for me. I had no problems cutting losses for the past week and that is what trading should be. You do not FREEZE when you need to take actions.
Here are my results since the disastrous January (all in USD):
- Jan: -$84,496.25
- Feb: +$1,680
- Mar: +$1,138
- Apr: +$1,460
- May: +$1,732.50
- Jun: -$699.17
Trading is a risky game because of leverage. To execute the cut loss properly, we need to trade below our Psychological Capital.
Have you figured out your Psychological Capital? If yes, are you trading below it?