1) Risk Management - I'm convinced that one of the great advantages of trading at a hedge fund, prop firm, etc. is the presence of external risk management. A good risk manager will not only hold you to loss limits, but can catch you in the process of losing too much. Even better, a risk manager can play a proactive role by letting you know when you might be vulnerable, perhaps by holding multiple correlated positions or by holding a large position going into a major news event. As I've mentioned in the past, no baseball pitcher is expected to take himself off the mound. That is the job of the pitching coach. Sometimes it's not your day, but that can be tough to recognize in the heat of battle. The risk manager is your pitching coach.
So what do you do if you don't have a dedicated risk manager?
Substituting for the risk manager, as Bella notes, are hard and fast rules for how much you can lose in a single position; how much you can lose in a day/week/month; how much you can lose across positions. It is important to make these rules explicit--written down and in front of you--and it is important to size all positions so that, if they are stopped out, they will not exceed the limits you set.
For portfolio managers, that means knowing your risk per position and acceptable risk across the portfolio. For day traders, it means knowing your risk per trade as well as your risk per day. For active day traders, I like the idea of having separate risk limits for the morning trade and then again for the afternoon, effectively breaking the day into two trading days. For active portfolio managers, I like having risk limits for each month or quarter.
The idea is to never lose so much in one period that you can't come back in the next one.
2) Psychological Management - The big losing days are typically the result of snowballing. One loss leads to another leads to frustration leads to imprudent trading. Or, overconfidence and directional bias leads to oversizing trades, which leads to vulnerability and frustration. At such points, the problem is not just the shift of mindset, but the lack of awareness of this shift.
Look, we expect competitive people to not like losing, to have periods of frustration. And, for all of us, the ego can sometimes get in the way of doing the right things. We are fallible; that we can't control. What we can do is become better and better at *recognizing* our fallibility. This is why preparation before we begin trading is so important, allowing us to identify in advance what would tell us our positions are the wrong ones. On my trading screens, overlaid on charts are various indicators, including short-term RSI, moving averages, regression lines, etc. Do I think those are predictive? Not really. They are there because, if I'm trading directionally, those weather vanes should be pointed in my direction. If we dip below a key moving average while I'm long, I want to mentally rehearse my stop scenario. The idea is to anticipate loss and cement in your mind what you'll do about that loss.
Why is that effective? It is difficult to become frustrated about an outcome you've rehearsed many times. It's difficult to go on tilt and trade poorly if you've clearly laid out your plans for a losing position. This is why, when a position is on, I want to rehearse my exits in detail. I want to know where to take profits, where to get out. That becomes a kind of mantra while the trade is unfolding.
I generally find that, if I start the day flexible and open-minded, rehearsing a variety of trading scenarios, I don't get too caught up in any one idea. Excitement is just as much of a risk factor as pessimism and negativity. I recently went in for routine surgery. The surgeon was all business, clearly planning out the procedure with the team. Do I want a surgeon who is excited about the procedure? Do I want a surgeon who is full of "conviction" over his plan for the procedure? Hell no. As it turns out, the surgery discovered a couple of unexpected growths--fortunately nothing dangerous--that needed to be removed. That's why they call it exploratory surgery. All trading should be exploratory trading.
If you have firm risk limits and a process that keeps you aware of your thought processes and the unfolding of your trades, you'll have plenty of losses--but none that have to be debilitating to you or your account!
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