Thursday, November 08, 2007

When Good Traders Lose

Good traders lose money. They also go through slumps. I've seen it with people who have made millions for multiple years running. What makes them good traders is, in part, how they lose. Here are three qualities I've seen in good traders who go through rocky periods:

1) They're quick to identify when their ideas aren't working - They don't fight the market, and they don't become threatened or defensive. Rather, they quickly enter a mode where they look at what's working, what isn't, and what they can do about it. They accept that there will be periods when they see things well and periods when they don't.

2) They're quick to de-lever - They get smaller when they realize their trading isn't working. They avoid digging large holes for themselves, but they also don't stop trading. By trading smallest when they're having the most trouble and largest when they're seeing things clearly, they leverage their strengths.

3) They're patient in regaining their feel - They keep trading small until they have a good understanding and feel for what's going on. They don't press to catch up and make money; they ride out the storm and take minimum damage. Because they've been through this before, they know that their time will come--and that helps them sustain patience.

The traders who are most at risk are those that fight markets, trade larger or more often to recapture lost money, and can't stay out of the water when conditions are unfavorable. All traders lose money; it's how you trade when you're down that makes all the difference.


Ten Lessons I've Learned From Traders

Blueprint for an Uncompromised Life


robin said...

Great post Brett.
Very timely post. As we tread through the markets during these difficult times it becomes easy to lose focus. Thank you for keeping us (me) on target. As I get deeper into my trading, position size and money management have become keys to staying above water. These three steps above will help as I wade through the shallow end of my trading.

heywally said...

Consider also taking a longer (than intra-day) time frame approach, painting the market with broader strokes, slowly scaling in to positions on weakness that has 'apparently' washed out, accepting the occasional under-waterness (with not unreasonably large positions) that reasonable risk necessitates.

Adam said...

Brett ~~~

Thank you for a particularly lucid and timely post. We are experiencing an interesting market phase, indeed. Your three points speak directly to positive behaviors we as traders can adopt to both survive and thrive in the days to come.

As a lifelong baseball addict, I find it helpful to think of each trade as an “at bat.” For a hitter, each at bat is a new game. Results achieved in each individual at bat, much like a coin flip, are not predictive of results the next time a player comes up. Grounding into a double play doesn’t affect the odds of hitting a home run on the next trade.

In a past post, you brilliantly described a cash management method as “losing money scientifically.” This great truth is especially relevant in today’s market. Calculating degrees of leverage and position size are keys to avoiding ruin, especially when things get choppy.

For those mathematically inclined, I suggest looking at the Kelly Criterion aspect of probability theory, a method of determining bet size in a given expectation of positive return, thus preventing losing one’s whole bankroll. Even partial application of this idea adds a bit of science to losing money.

Thank you again for many inspiring posts.


Colin said...

I think it should be mandatory for every trader to keep a punching bag adjacent to their trading set up. Punching the market is not good for your wallet, but punching a bag is great for your health and wellbeing.


Brett Steenbarger, Ph.D. said...

Great comments on the post; many thanks! I like the idea of trading days as "at bats" in baseball. Thanks also, Adam, for the mention of the Kelly criterion, underscoring the importance of position sizing--