Trading After A Blow Up and Knowing Your Psychological Capital

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05 Jul Trading After A Blow Up and Knowing Your Psychological Capital

I blew up my options trading account in Jan 14.

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.

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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.

Leverage and Blow Up

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.

Psychological Capital

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?



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5 Comments
  • My 15HWW
    Posted at 22:16h, 05 July Reply

    Hi Alvin,

    It’s not easy to admit a mistake and even harder to learn effectively from one. But looking at your recent results and the consistency of your profits, it seems that you might have.

    Trying to chase back the lost amount could have led to an even bigger disaster (gambler’s mindset) and it’s good that you did not try to do that. Your episode is a sobering reminder to readers like me that one should be humble of his/her own abilities in the market. Thanks for sharing!

    Regards,
    My 15HWW

    • Alvin Chow
      Posted at 05:53h, 06 July Reply

      15HWW, thanks for the support :)

      I did have the intention to put in more capital but I managed to talk myself out.

  • Xeo Lye
    Posted at 10:52h, 08 July Reply

    opps, forget to add this line. Was distracted by something. Here is the amended comment.

    Hi Alvin,

    I suffered the same fate as you back in 2005 – 2007 when I blew up my options account 3 times. The main reason for my downfall is my Hubris. I was making good money and in fact tripled my capital for within 6 months thanks to beginners luck. I got so confident that I my trades will be spot on everytime and focused my entire capital on a few positions. These positions got wiped of course. My subsequent top-up fell into the gambler’s fallacy. I believe that I have started afresh but the aim of trying to recoup my principle ASAP is still at the back of my mine, which lead to me blowing up my later 2 top ups. I took a long break to realign my psychology (and to work hard to make back my capital :( )

    I see that you are making 10-15% a month using $10k worth of capital. That’s quite a high risk position you are taking in my opinion and the US stock market has been doing well since Jan. Take care!

    • Alvin Chow
      Posted at 11:47h, 08 July Reply

      Xeo Lye, thanks for sharing your personal story. I don trade US stocks options but mainly commodities futures and commodities have taken a beating in recent weeks. I have a string of losses. I am still able to keep losses small and trade within rules.

      Nonetheless, we are as good as our next trade.

      It is nice of you to remind me of the risks. We need grounding once in a while. Appreciate that.

  • Why I Stopped Trading
    Posted at 09:38h, 08 October Reply

    […] way to reduce the emotional swings is to trade a small capital. I talked about knowing your Psychological Capital (PC) previously. You should be trading a capital that you have no problems cutting losses. The art […]

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