The fastest way to go broke is to bet it al —al the time. Most traders don’t learn this lesson until they have had at least one blow-out; by that I mean they have lost al their equity quickly and have had to start over.
For some reason, there is a tendency for traders of al age and experience levels to trade too
large for the actual cash in their account. This is a symptom of a larger problem and unless you
are wil ing to consider that you personal y might have this problem already you most likely will
be trading too large for your account right now today.
What is this larger problem?
GREED, BABY—GREED
It is unrealistic for you to believe you are going to make a kil ing on THIS ONE TRADE RIGHT
NOW. Sure, you might be on the right side of a large move but that wil take time and evidence
to see. For this moment, any trade you have on has the potential to run the other way against
you and if you are trading too large, your potential to lose a lot on only a few trades is huge. No matter your age, education, skil or experience level you are not going to make 100% winning
trades. Therefore a certain percentage of your trades will simply not work. Those trades cannot
be so large that you lose a significant portion of your equity in the process.
To beat the greed habit you need to make a few changes to both your equity management and
more importantly to your thinking.
First, trading is a business. You need to treat it like one. There are certain things every business needs to run effectively and the first thing is liquidity. Simply put, if you run out of cash to play you can’t remain open.
Second, if you had a reasonable plan in place already then it is a good guess that your plan
cal s for only a reasonable amount of percent gain on your equity regularly. If you were to use
some basic mathematics while creating a sound trading approach one of the things you would
be looking for was a realistic “risk-to-reward” ratio. That means for every dol ar you lose you
expect to make a certain number of dol ars and out of every 100 trades a certain percent wil be
winners and some wil be losers.
If you put this al together and asked the “what-if?” questions you get this base-line number that statistical y wil be a winning set of results:
42% winning trades out of 100 taken
Two dol ars out for every dol ar you give back
This is not my opinion, this is the Probability of Ruin Matrix and you can research it yourself
if you have time. Of course, if you have higher percentages of winners and take more out on
those winners you make money a lot faster but the point is if your results are at least this good consistently you are on your way to success. I teach more about that in Trading Rules that
Work and in my Psychology of Trading course.
It’s great to be on the high side of the matrix but most of us didn’t start there and that is why you have to TRADE SMALL at first. To protect yourself from being greedy about your trading and to help you stay focused on long-term success it is important to make your trade size smal
enough so that it won’t leave you in a position of not being able to play at al should you have a string of losses al at once. I found that limiting your risk/reward ratio to a factor of about 1.5% on any one trade is a great way to stay focused and not get greedy.
This means that for any one trade you take, no matter how you think of the trade or how certain
you are of a win; you wil not risk more than 1.5% of your account balance at any one time. This
means that if you are trading so that your average loss is 3-5% of your account balance at any
one time—you are trading TWO to THREE TIMES TOO LARGE for your account size. In that
case, the Probability of Ruin Matrix wil work against you and you wil likely run out of capital
before you make money with your approach.
If you are the greedy trader right now and you are guilty of making this mistake; If this means
you have to drop your trading size down a few notches then you had better cal your broker
today and fix it—because if you don’t you are an accident waiting to happen. It only takes
making this mistake THREE TIMES IN A ROW to drop your account balance 15% or more in a
heartbeat; especially if you are day trading!
HOW TO MAKE THIS MISTAKE WORSE:
Convince yourself you are so good at trading that
this couldn’t possibly happen to you, convince yourself that your analysis is good enough to help
you find 80-90% winning trades all the time, trade without a stop-loss order “just this once”,
double-up on the next trade after taking a large loss.
SOLUTION:
Immediately reduce your account balance; take 20-30% of your cash home. Trade
position sizes that are no more than 300% as valuable as your account balance. In other words,
if your account size is $10,000, don’t trade anything that has a total contract value larger than
around $30,000. If that means trading mini’s instead of big-board you had better do it.
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We hope you’ve enjoyed the first few mistakes that traders make, and that it opens up your
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