Everyone takes trading losses some of the time. ¬†All of the great wealthy traders have had draw down periods. ¬†Nothing wrong with taking losses. ¬†It is a part of the trader process. ¬†George Soros took a $600 million dollar loss during the St Valentines Day Massacre.
George Soros said:
It’s not how many trades you win or lose, it’s how much you win or lose on each trade that counts
One of the many fears that traders have when they enter a draw down period is that they will not be able to make the money back. ¬†And the only reason they do not believe they will make the money back is if they do not have confidence in themselves and their system. ¬†Or they have not broken their system down into a process that they can follow day after day that can find the great trades. ¬†It is that fear of not being able to find the great trades and make the money back that can cause a vicious death spiral for the traders account.
The death spiral can occur because when many traders take losses, they believe they should leverage up more and risk more per trade in order to get the money back. ¬†Not only that, they believe that they should get the money back today. ¬†So they go and force a highly leveraged position at the worst possible market times, typically after 12pm EST, when the markets major identifiable movements for the day can be over and done with.
For example, if a trader risks 1% per trade and has just had a series of losses and they are down 10%, what do they do?
The trader who is worried about getting the money back right away has a very bright idea! ¬†That trader sees that they are down 10%, and decides to tell themselves that the next trade they will place will be 10% risk per trade, and they only need to make a 1:1 reward risk ratio to get their account back to full value.
This trader has just gone from risking 1% per trade to risking 10% per trade in order to recover a trading loss quickly and within just a single trade. ¬†The trader has visions of a glorious trade in their mind where they can risk 10%. ¬†They rationalize it by saying, well they only need to make 1:1 reward risk then they will take profit. ¬†If they use a 50 pip stop, then they think that if the market just moves 50 pips in their favor they will have made all the money back that they lost.
As the story goes, just when the trader decides to ratchet up their risk per trade from 1% to 10%, they take another loss. ¬†Now instead of being down 10%, they are down close to 20% of their initial account value.
That can cause the vicious death spiral to continue. ¬†The trader may say to themselves, that in the next trade they are going to risk 20% per trade in order to get the money back. ¬†Of course, that trades tend to lose as well and now they are down close to 40%.
They wonder how they could let this happen to their trading account. ¬†After all, they were only down 10% before, now they are starting at a 40% draw down.
They took a much bigger draw down because they deviated from their system and their money management rules. ¬†If they were used to going for 1% risk per trade and have a high reward risk ratio, then that this their system. ¬†But if they deviate and attempt to change it into a 10% risk per trade system with 1:1 reward risk ratio, then they are setting themselves up for disaster. ¬†Their trading system wasn’t designed for such high leverage. ¬†It wasn’t designed for the high win rates that a high risk per trade system needs in order to be viable. ¬†But the trader converted their system into a highly leveraged system in order to recover from the trading losses and getting that money back quickly.
That is the exact wrong approach to take.
Correct Approach to Recovering from Trading Losses
The correct approach is not to leverage up and risk far more than you normally wood.
The safe, conservative approach is to keep risking small amounts per trade as you previously were, or to actually reduce the risk per trade and cut back on risk. ¬†Then you need to search for an extremely good trade or series of trades that have an extremely high reward risk ratio.
The reward risk ratio is key. ¬†Because if you suffered 2 losses in a row, that is 2R of losses. ¬†If you use the same % risk on the third trade and nail a 6R winner, then you just made your losses back and a big profit on top of it. ¬†If you only make a 2:1 reward risk ratio trade winner, then you are back to breaking even.
And obviously, the 6R winners don’t happen every day, it is impossible for them to occur every day in the forex markets. ¬†Which is you if you have to put some time between your recent losses and your next trade, then you do it. ¬†If you need to search for a few days or a week or two for the next 6R winner, then you take the time to do it.
Richard Dennis said:
I learned to avoid trying to catch up or double up to recoup losses. ¬†I also learned that a certain amount of loss will affect your judgement, so you have to put some time between that loss and the next trade.
If you have taken losses, having a few down days, weeks, etc. ¬†Then you need to get back in harmony with the market. ¬†Stronger order flow research. ¬†Capturing an explosion in volatility in order to have that huge winner that brings back your confidence.
Sometimes to get out of a rut, you just need to place a few trades with very low risk, just to get a feel for the markets or the trends. ¬†To get a feel for how the market responds to news, etc. ¬†Sometimes taking a small loss or losses is the best way to get back into the markets momentum and learn a few new tricks.
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