Do I Have to Accept some Big Losses in the Beginning?

This is a discussion on Do I Have to Accept some Big Losses in the Beginning? within the New to Trade2Win forums, part of the Reception category; SHORT ANSWER Losses yes. Big losses - no you don’t This assumes you’re trading a live account, funded with your ...

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Old Apr 5, 2008, 12:42pm   #1
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Do I Have to Accept some Big Losses in the Beginning?

SHORT ANSWER

Losses yes. Big losses - no you don’t
This assumes you’re trading a live account, funded with your own money or, possibly, your broker’s money. Some spread betting companies in the U.K. have introductory offers whereby they will fund your account to the tune of £100 or so.

Paper trade for free
The even better news is that you don’t have to accept any losses at all if you start by paper trading on a simulated trading platform. (Most brokers offer this facility.) As a rule of thumb, if you can’t make a paper profit, then you’ve got less than no chance of making a real profit trading a live account. Only switch to trading live when you’re able to make a consistent paper profit and you’re comfortable with both your trading platform and your trading methodology.

Beware of paper profits
There is a flip side to all this good news though which explains - in part at least - why some traders experience heavy losses early on. While paper trading, few of us can resist the temptation to fantasize that we’ve got the pockets of George Soros along with his Midas touch. The result is that we might make 500% profit or more in a single day. This is entirely doable when paper trading. The mistake would be to think you can repeat such a feat trading live with real money. You might do it once. You might even do several times after that. But sooner or later – your luck WILL run out – and you’ll blow your entire account. The moral of the tale is to only paper trade with the same position size (i.e. same number of shares or contracts) using the same stops as you would do if you were trading a live account, funded with your own hard earned cash.

Last edited by timsk; Sep 26, 2010 at 10:39am. Reason: Updating
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Old Apr 5, 2008, 12:42pm   #2
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Do I Have to Accept some Big Losses in the Beginning?

T2W Bot started this thread LONG ANSWER

There IS a Holy Grail – and I’ve found it!
On T2W, there are a few threads with attention grabbing titles like this or ‘100% Winners Guaranteed’, ‘Never Lose Again’ and ‘Profit on Every Trade’ etc. In many cases, the title is not meant to be taken too literally. However, occasionally, the thread starter – or opening poster (OP) - is not only serious, but intent on convincing the rest of the membership of it as well.

Collectively, these threads come under the umbrella of ‘Searching for the Holy Grail’. Secretly, most traders admit to having done this at one time or another. Every once in a while, one or two of them claim to have found it. Almost always, they utilise the same techniques – or combinations of techniques – to achieve their jaw dropping results. Needless to say, at the heart of them lies a flaw so serious that, sooner or later, catastrophic loss is inevitable. The detail of these flaws is (nearly) always exposed by those members who know what they’re talking about on the threads concerned, so there’s no need to go into specifics here. However, at the heart of many Holy Grail strategies lie two deadly sins of trading: not using any kind of stop loss and adding exponentially to losing trades; a practice known as ‘averaging down’. The idea is that eventually, price will reverse, permitting the trader to at least get out at break even and possibly with a profit. It’s the same as betting on black with each spin of the ball at a Roulette table. Each time the ball lands on white, you increase the size of your next bet to cover the loss on previous bet(s) and still make a profit on the ensuing one. Sooner or later, one of two things will happen: either you’ll run out of money or you’ll reach the house limit set by the casino. (See the link to ‘Martingale Strategy’ in the next post.)

The house limit for traders is governed by the size of their accounts. Their pockets aren’t infinitely deep and, eventually, there WILL be an unprecedented move in the market that catches them out. The oft’ quoted axiom by John Maynard Keynes sums this up perfectly: “The markets can remain irrational longer than you can remain solvent”. Etch these wise words on your mind, or ignore them at your peril!

No Holy Grail – just calculated risks
So, while you might do quite well for quite a long time, the day will dawn when you will lose your entire account. Guaranteed. So, be very wary of any trader who claims not to use a stop loss of any kind – ever – and of those who average down with increased size in order to bring the point at which they break even ever closer to where the market is currently trading. Having said all of the above, experienced traders can manage their positions in such a way that they work areas of price by adding to - or taking off - part of their trade. However, this practice is not recommended for new traders, especially those with small accounts.

Trading is all about taking calculated risks in which a favourable outcome is more probable than an unfavourable one. When a sales person makes a cold call, they have no idea what the outcome of that individual call will be. However, their records tell them that for every ten calls they make, they secure three appointments which results in one sale. The same principle applies to many sportsmen and women. Roger Federer doesn’t know whether or not he will win the next game, let alone the next point. However, his records indicate that the probability of him winning the match is usually very high and ranges from excellent (against a low ranking player) to perhaps only 50:50 (against one of the world’s top five). One thing is absolutely certain, even against very poor opposition, Roger Federer will lose points. Equally, all sales people the world over make calls that don’t even result in appointments– let alone actual sales. Trading is exactly the same. Being a consistently profitable trader does not mean that every trade taken is a winning one.

Embrace risk and accept (small) losses
All traders have losing trades; some more than others. A handful of traders have strategies with a success rate of 80% or better. Some have a success rate of only 40% or less but, quite possibly; they’ll be more profitable overall than the trader with an 80% success rate. Regardless of which camp you fall into or, more likely, if you’re somewhere in between, one thing is certain: losses are inevitable. By definition, the mythical trader that never experiences a loss – never takes a risk. And the only way to completely eradicate risk is to know the future. This negates the natural law of physics. This is the realm of fiction writers and Hollywood producers; it’s completely divorced from reality. No trader can know the future, therefore they cannot eradicate risk. It’s impossible. Risk is to traders what ornithology is to birds. If you can’t embrace risk and all that it involves, then trading is not the business for you.

Hopefully, you accept and are comfortable with the idea that, as a trader, you’re going to take calculated risks with a probable favourable outcome and that some of your trades will lose. This leaves two variables to work with:

Success Ratio.
This is the number of trades that you close out with a profit, relative to the number of trades that you close out with a loss. For the majority of consistently profitable traders, this will usually be somewhere between 40% and 80%.

Profit Ratio.
This is the size of the average loss on the losing trades, relative to the size of the average gain on winning ones.

Self evidently, if your strategy only wins 40% of the time, the average gain made on winning trades needs to be 1.5 times that of the average loss on losing trades - just to break even. After commissions and expenses, realistically, such a strategy needs to return gains that are at least twice as big as the losses. The reverse is true on an 80% system. In theory, you could lose twice as much on losing trades that you make on winning ones and still remain profitable.

Big losses – what causes them and how to prevent them
So, let’s try and put all this together and answer the central part of the FAQ which is: does the new trader have to accept BIG losses when they start out? The simple answer is an emphatic NO! However, the reality is that a great many of them do. The best way to ensure that you’re not one of them is to look at the reasons why big losses occur and to take the necessary steps to ensure you don’t repeat these same mistakes. The list below of seven potentially fatal errors is by no means comprehensive, but it does cover the main reasons why traders tend to incur big losses early on . . .

1. Risk per Trade
New traders tend not to have a good understanding of risk management principles and risk too much of their account equity on any one trade. This often occurs after a string of early successes. They then look at their meagre profits and bash away on a calculator to work out what their account size would have been had they bet £10.00 or £20.00 per point instead of only £1.00 per point. So, they drastically increase the amount risked on the next trade and that’s when disaster strikes.

2. Setting a Stop loss
Most experienced traders agree that novices should set a hard stop loss to protect them from trades that go against them. Not setting a stop loss of the correct size and in the correct place can lead to heavy losses. Not setting one at all is highly likely to result in a sudden and premature end to a new trader’s career.

3. Moving a Stop Loss
Moving a stop loss further away from price to give the trade more room to ‘breathe’ is so tempting that even very experienced traders do it. Every trader the world over has had the frustrating experience of being taken out by a stop loss at the high/low of a move before price then goes in their intended direction. On the next trade, the temptation to move the stop as price gets closer to it is huge. Stick to the rule that stop losses should only ever be moved in the direction of the trade – and never against it. Ever!

4. Beginners Luck
Many new traders are seduced by what they see on the TV and the internet. Trading is portrayed as being glamorous and – above all - easy. Who doesn’t want to earn shed loads of wonga by spending ten minutes a day on their laptop while sipping Martini’s by the pool? This view is then endorsed by some early successes which leads to complacency and bad habits. In turn, this leads to heartache and a severely depleted trading account. Be under no illusion that making consistent profits over time is no easy task and will require dedication, discipline and persistence.

5. Poor Preparation
Many activities rely on the ‘6 Ps Rule’- none more so than trading. Proper Planning Prevents pi$$ Poor Performance. At the heart of this is a poor understanding of the market itself and the tools used to trade it - e.g. the trading platform. One of the most common clichés written on forums like this one is ‘plan the trade and trade the plan’. It’s also the one least adhered to. Make sure you have a proper trading plan and stick to it at all times.

6. No Methodology
Part and parcel of any trading plan is to have a well thought out methodology. Once this is established, it’s a good idea to paper trade it first to see how it performs in a simulated environment. Many traders don’t like paper trading on simulated platforms because it doesn’t help them when it comes to trading real money. This is a valid point. However, one thing is for certain: if you can’t make paper money with your strategy, you definitely won’t make any real money either! When you are ready to trade real money, start with small amounts and build up to larger size slowly and only when you have a consistent record of success. Wading into the markets and trading large size with an unproven strategy is a recipe for disaster.

7. Know your Ratios
Don’t trade with real money until you’ve established your Success Ratio and your Profit Ratio. Almost certainly, this will save you a lot of money. These are expanded upon in the Essentials Of First Steps Sticky, along with some other cornerstones of any successful trading methodology. Once you know these ratios, keep monitoring them on an ongoing basis. There are three possible outcomes:

1. The ratios remain fairly constant over time and this will be reflected in a steadily rising equity curve.

2. The ratios will fluctuate wildly from week to week or month to month. This is indicative of a trader who hasn’t got a thorough plan in place or, if they have, they’re unable to stick to it. Their equity curve is likely to be up and down like a yoyo. However, over the longer term, it’s virtually certain to head south.

3. The ratios remain fairly steady and consistent for a long time but then change. The change can be very sudden or it can be very gradual over an extended period of time. The former tends to indicate a one off event; e.g. a radical departure from your trading plan such as a gamble that didn’t pay off. Or it could be a ‘Black Swan’ event like 9/11. If you were long that day, even with stops in place, price waterfalled so fast and so far that your stops might not have been triggered, resulting in a big loss. A gradual change is indicative of a change in the market. For example, a moving average cross over system will work well in a strong bull market, but it won’t work in a market drifting sideways. In this scenario, you must look at the principles that underpin the strategy and ensure that they are aligned to the market(s) being traded.

The good news is that all of the above are all totally preventable. So, while a certain number of losses are inevitable, they don’t have to be big. Not only that, but you can have a lot of losing trades – 60% or more – and still be profitable over all. However, if you’re experiencing a lot of losing trades and you have a poor profit ratio, your equity curve will slope down and you have a problem. To solve it, you will either have to reduce the number of losing trades, increase the profit on winning trades (relative to the loss on losing ones) – or a combination of the two. Slice ‘n dice it any way you want, the key to success lies in balancing these two ratios.

Last edited by timsk; Oct 15, 2010 at 9:52am. Reason: Updating
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Old Apr 5, 2008, 12:42pm   #3
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Do I Have to Accept some Big Losses in the Beginning?

T2W Bot started this thread USEFUL LINKS

If you find other threads, Articles or sites on your travels around the net that are relevant to this FAQ, please add a link to them in this thread, outlining what it is that you like about them. Thanks!

T2W THREADS
None here? If you find a good one, let us know and we’ll add it!

T2W ARTICLES
The Power of Now by Woodruff Johnson
This article explains how easy it is to end up losing your shirt in the markets by making basic errors. Read, mark, learn and inwardly digest!
Paper Trading and the Transition to Real Money Trading by Barry Lutz
This article explains the importance of paper trading and the steps you can take to ensure that it is as 'real' as possible - before starting to trade with actual money.

EXTERNAL LINKS
Martingale Strategy
The exponential nature of increasing your position size after every losing trade can be so ruinous to traders that not even billionaires like George Soros or Warren Buffett would use such a stragey. Not convinced that it won't work for you? That's fine, read what Michael Shackleford, (a.k.a. 'Wizard of Odds') has to say on the subject. He's a professional actuary who has made a career of analyzing casino games and is an Adjunct Professor of Casino Math at the University of Nevada, Las Vegas.
Gambler's Fallacy
Closely allied to the Martingale Strategy is the 'Gambler's Falacy'. Many new traders try and apply this flawed logic to the markets in much the same way as gamblers try and apply it to fruit machines and Roulette. This link is also to the excellent 'Wizard Of Odds' website.

Last edited by timsk; Apr 11, 2012 at 5:29pm. Reason: updating
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Old Apr 5, 2008, 1:35pm   #4
 
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Surely this is debatable. In the past, you had to take a big wad of cash to the market, once you've paper traded, to see how your strategy works in the real world. Nowadays, esp if you go down the spreadbetting route or use sites such as Oanda, you can trade in tiny sums so you while you're losing thousands of pips, in reality it might only cost £10.
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Old Apr 5, 2008, 1:50pm   #5
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This is an easy one. The answer is no.

Do your research before you trade and start to trade with small amounts.

Having properly researched a profitable method and learnt to trade it consistently, you can then increase your trade size.

Common sense.
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Old Apr 5, 2008, 3:22pm   #6
 
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Big losses to some would be peanuts to others.

But., losses probably are necessary to get a handle on the emotional side. Without losses how can you trade successfully in the future, not knowing of the down side.

Traders I feel sorry for are the ones that appear to immediaitely hit a winning formula and then lose big style because they were not aware of the downside, and open positions have been far greater that would otherwise have neen the case.

Tbh actually its quite funny!
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Old Apr 5, 2008, 5:38pm   #7
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Yes and No

Quote:
Originally Posted by timm View Post
This is an easy one. The answer is no.

Do your research before you trade and start to trade with small amounts.

Having properly researched a profitable method and learnt to trade it consistently, you can then increase your trade size.

Common sense.
Hi timm

arrrrrrrrr common sense, not that common in the real world

Yes I see no reason if rules are followed why anyone should need to lose big even once or injure themselves riding a motor bike

simple answer is = most do I think, most fell off bikes in their youth even after good advice from their tutors, and most ended up better riders for it.

Some died when they made their first error of judgement, harsh but just is

We all make many mistakes imho in our normal working jobs and lives, all we can do is try to mitigate them and learn from them. It will break some and make them worse and more at risk of repeating the error and others will be much better for their mistake and never once repeat it, some will repeat it a few times.

Glass half full or half empty = The person who makes an error as the choice how they deal with it and what they learn from it, if infact there is something after post examination that needs learning.

How many buy a car, find out its not what they thought and marry it for the next 3 years and never try to rectify their error. Repair it over and over again. Ends up a complete nightmare costing them a small fortune requiring constant attention and letting them down just when they needed it most.

The cars a pup out it !! easy but hard to do for many in the real world because every one will ask ....... you bought a pup then

A car dealer makes the same error of judgement, and some can be pretty expensive ones regards buying his or her stock = shrugg = sell it ASAP at cost or as smaller loss as possible = learnt a bit more today so not that bad, the loss comes back without any real effort on the traders part in a few months if he just keeps doing his job well.

They do not invest any time and money in repairing it, just get shut fast and move on to the next deal the majority of the time. Try not to repeat it again.

If you have the perfect make up to start with and you increase size slow I guess its possible, I just don"t think its all that common.

Some lessons need learning and pain helps that learning imo, its important for anybody to be able to cope and just do their job as per normal following an un-expected error of judgement.

No one nows what their next lesson will be imho, obviously everybody else does.

In fact I think thats what makes a pro a pro. A part timer taking part in any activity can just walk away and cobble together some excuse for a poor show imo he or she is not investing much emotionally in the first place so..........learn nothing of any value, might at best learn it in theory but never deep within.

They come back and try again ......... O well I will have another go some time later, I am ok nothing to learn from this, to much like hard work, I did it right I am sure of that, it was not me it was .................

A pro gets on with the job and grinds out the result if thats whats required, looks to take his or her chances and opportunities as per normal.


Show me a man who as not made a mistake, and I will show you a man who as made nothing.

From my own experience I would just say mitigate your total exposure to the market (bank) and assume you have plenty still to learn at all times and just get on with it to the best of your ability.

Make the mistakes you make and learn from each one and try not to make the same one twice because my grandad told me that really is a real mistake.

Last edited by black bear; Apr 5, 2008 at 5:43pm. Reason: typo
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Old Apr 5, 2008, 5:53pm   #8
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Addition to above post


From my own experience I would just say mitigate your total exposure to the market (bank) and assume you have plenty still to learn at all times and just get on with it to the best of your ability.

addition, I new one guy who did not make a mistake for 4 years when he stated trading

He made one mistake in the dot com bubble crash

= all gone = THE LOT HOUSE EVERYTHING

He had no experience, he had not made any mistakes in the actual moment he had just read about them and thought that counted for something.

He did not no how to act. By this time he had an account size most would die for = very very expensive at this stage to start making basic errors. When the emotion hit him it blew him out of the game the figures were that large.

No imho some errors and an odd large loss in the early days are best done and dealt with
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