We tend to remember poignant, emotional events far better than mundane, trivial ones. Think back to your very first kiss (her name was Sandra) or where you were when the space shuttle exploded (college cafeteria). The death of a loved one or the birth of a child are also most likely stored forever for immediate retrieval. The third date or the seventh kiss or the mention of a former classmate’s death who we knew only in passing usually does not elicit much of an emotional response. How about past experiences where we had to make a quick decision to flee, freeze, or fight? Without getting too technical, there is a a part of our brain, the amygdala, that performs the primary role of storing memories of emotional events and, in so doing, give certain emotional memories added recall strength. Take, for instance, one of my first experiences with a neighbor’s dog. This dog would charge after me whenever I rode my bike passed his owner’s home. One day he came so close I fell off my bike. Even today, some 35 years later, my first reaction to a large, approaching dog, is one of fear and doubt. It is stored in my memory: do I flee, freeze, or fight?
Stock traders store memories as well based on the energy given to past experiences. Think about how support and resistance works. Past support is based on past experience where traders found a reason to buy: “if and when this stock gets back to support I am going to buy.” Past resistance is based on past experience where traders found a reason to sell: “if and when this stock hits resistance I am going to sell.” These areas are formed for psychological reasons with the trader reasoning that he is not going to miss the next support/resistance opportunity. Or, better yet, since he did not sell his last long position at what became resistance, he will certainly do so “this time” without hesitation. Eventually the tug of war will end and new support/resistance will be created. In this example, the trader has created a memory and, depending on the time frame used, it could be a long or short-term memory. The energy behind the memory and how it can affect future trade activity…now that is another story. This brings us to the topic at hand.
How do we best take a loss so that it does not adversely affect out next trading experience? To put it another way, how do we keep a bad experience with a dog from affecting how we react to run ins with future dogs, that may or may not be as dangerous?
HOW MOST TRADERS TAKE LOSSES
I believe that most traders lose money. In fact, less than 20% of all traders consistently make money over the long term. It is not for lack of education or information but for lack of understanding how to control losses. Here are some of the ways losers seek to control losses:
1. Ignore the loss. “If I just walk away from the computer screen I am sure the problem will just go away.”
2. Double Up. “It is only a minor pullback, so let’s add to the position.”
3. Take the Opposite Trade. “The trade is going against me so I will take the other side.”
4. Quickly Find Another Trade. “That hurt. I need to recoup these losses NOW.”
5. The Blame Game. “The market is out to get me. I am not trading anymore.”
6. I need a new strategy. “This strategy just does not work. Let’s find another one.”
7. Take It to the bank. “I don’t care what this trade does because I have more money in the bank.”
8. The Lottery ticket. “The next trade will make it all back. What’s a 70% loss when I can make 100% next time?”
Any one of these “solutions” to a losing trade will most likely cause the trader to burn an emotionally charged memory into his brain that will be hard to forget as the initial loss only gets worse, much like putting off getting the car aligned only to have to buy a few new tires with the delay. In my early trading days I learned many hard lessons about stock trading and few stand out more than the lessons I learned when I made the decision to take a big loss. It affected my attitude, my relationships with friends and family, my future trading decisions, my memory. Fortunately, I did manage to find the solution early enough to rectify the problem and not simply walk away from the wonderful trading game. The losing traders flee (give up), freeze (make no decisions), or fight (by adding to losers). The successful traders?
HOW THE SUCCESSFUL FEW TAKE LOSSES
Here is the one thing I learned about taking a trading loss and this one thing has made all the difference in my trading, in my life, and in the memories stored in my amygdala: make sure that your losses ARE VERY SMALL. I know. It is real simple isn’t it? But are not most of the really important things we learn in life based on simple, yet profound principles? By taking SMALL LOSSES we are able to do the following:
1. VERY EASILY FORGET ABOUT IT. A small loss is much easier to hide among many gains than a big loss among a few small winners.
2. MOVE ON TO THE NEXT ONE. Once the small loss is taken the next trade is…well…the only trade that matters.
3. REMOVE AN OBSTACLE OF FUTURE GROWTH. I big loss held on to can prematurely stunt our future growth.
4. HANG ON TO FOND MEMORIES. Even a blind squirrel finds a nut once in a while but the nuts carefully stored, recalled, and retrieved for future use are what keep us around during the cold winters of our discontent.
The successful traders flee (stay away from big losses), freeze (know when to say when), and fight (to trade another day).
CONCLUSION
That dog that I was so scared of? He lost his life chasing one too many cars. He may be gone but his memory is still with me. I have little control over that now. What I do have control over is my initial reaction to any dog I now see and any trade I decide to keep.
Great Post i had learned a lesson from this blog post.