The Woodchuck and the Possum
The woodchuck circles the trap many times, and from all angles before deciding how he is going to get the fruit. Sometimes he will wait till another animal is in the trap, then pick the fruit through the wire cage. Woodchucks know their capabilities. They pal around with others in their den and know when one does not come home.
They search for the scent of their own, and hear the cry of the one that is trapped. The big, old woodchucks learn from others mistakes and do not make the same mistake themselves. They are not paralyzed in fear, but cautiously optimistic, ever searching for the food they want, but holding onto true principles that have kept them alive. Big, old woodchucks will at times walk away from a trap because the lure of the fruit is not worth the work it will take to get out of the trap before the hunter kills him.
- Terry Larsen, Neigborhood Pest Control Expert
This is why many forex traders, although they have learned true principles, are still losing money as fast as they can trade. They want to chase the mystery of the market. They enter the cage to get the fruit because that’s more exciting. It’s also more dangerous. Even fatal.
4. Know your limits
One mistake Possums make is that they never set limits. They’ll waltz into the cage and go for the fruit with reckless abandon. You might attribute this to stupidity, and
you may be right. But it also might be due to their over-exuberance. Their inability to contain their excitement over finding some fruit.
You will be tempted to snatch the fruit as soon as you can see it. You might be tempted to violate your principles when you see the market take a big swing, or after Bernanke says something on television, or the latest job report comes out. Sometimes, you’ll be tempted to set your stop-loss very widely (thus risking the loss of a lot of money) or to not set a stop-loss at all.
In order to succeed, you must set stops. You have to be able to tell yourself that it’s time to get out of the market, that you’ve tried to get the fruit – but that today it’s just not going to work. Perhaps your system works 80% of the time, and this time your system has simply failed.
Getting out of the market at the right time is just as important as getting in at the right time. If your system tends to return 20 pips per trade, then set your stop-loss so that you don’t lose more than you can possibly gain.
If you disobey your principles, and you find that you’re in a big, big losing trade, then look at your trading system: do you really see the market coming back to break-even anytime soon? If not, then get out. If so, then stay in – if you have the usable margin to withstand some heavy losses.
Which brings me to my next point: don’t trade huge chunks of your account. If you have a $1,000 account, then don’t make trades that require you to put up more than $100. Also, don’t make trades that can lose or gain more than $3 per pip. If the market takes a real nosedive against you, you could halve your equity before you realize what you’ve done.
5. Back off when necessary
If you lose a lot of money in one day, or gain a lot of money in one day, back off from the market. These are dangerous times. I talk about Pride, Fear, Greed, and Revenge in my Strategy:10 booklet (free, on my site) but it will help to summarize the main points here too.
Pride is your worst enemy. There is no such thing as “good pride” in the forex market. As soon as you become proud of your success, you’re headed for a fall. When you’re prideful, you leave yourself open to Greed and Revenge. You feel that you deserve more profit, are willing to take more (unwise) risks, and you strike back at the market when it beats you. Being prideful in the forex market is acting the same as the Possum who believes he can go into the cage, get the fruit, and still get out. It won’t work. Keep your pride in check.
Next, watch out for Fear. When you’re afraid, you make poor choices – you’ll exit a trade before it becomes profitable or you’ll enter no trades at all. If you give in to fear, then back off the market. Backtest your system again. Review what made you successful in the past. Take a day off and reset your bearings. You’ll feel better and be ready to trade the next day.
Greed is perhaps the second worst emotion you can ever feel in the forex market. This emotion will convince you to set higher limits and wider stops, leaving you exposed to the wild swings of the market. Greed is what convinces you to leave a position open for one more pip of profit – when the market is about to slide in the opposite direction and take your entire profit with it. Don’t give into greed. If you lose a bunch of money because of greed – or make a bunch of it – then take the next day off. Watch the market. Demo trade for that day. See how you fare. Then get back in the next day when you’re ready to stick to your principles.
Revenge is the most dangerous emotion of all. When you lose money, you will always feel the temptation to strike back at the market (out of pride). You’ll say to yourself that you deserve to get your money back. This might even work temporarily. But this will catch up with you, as you seek out trades for the sake of trading rather than for the sake of making money safely. If you feel revenge coming on, get out of the market. Take a seat. Review your system. Even if you lose almost all of your money, you can gain it back systematically. You will never get it back by seeking revenge on the market. A Possum in a cage might seek revenge against the trapper, but we all know how futile that is.