Recovering From a Big Loss

How To Deal With a Major Setback

I was honored when I was asked to do a guest post for TraderLion. I thought through all the topics I could discuss. 

I could tell you how to find winning stocks and my setups for trading them.

I could share my trading rules, pre-trade checklists. 

Or, I talk just about trading aphorisms that we’ve all heard a thousand times. — Did you know that that the “Big money is in the sitting?” and that you should “Cut your losers and let your winners run?”

Those topics don’t seem right in this environment. 

The market has been increasingly difficult as of late for growth traders.

Everyone has a plan until they get punched in the mouth. – Mike Tyson

I know that many traders just got punched in the mouth.  Many for the very first time.

I’m going to cover a topic that is less fun to talk about. We’re going to talk about losses. And by losses, I don’t mean the ordinary stop-losses that are the cost of doing business. I mean BIG losses—the losses you know you should never have put yourself in the position to have and yet here you are. 

People rarely talk about losses on Twitter.  I guess that losses just don’t sell subscriptions and earn followers like photographs of Lamborghinis do.  Yet,  we’ve all seen the statistics that 95% of aspiring traders will fail. This attrition rate doesn’t come from taking paper cut losses.  It comes from a big loss that they don’t know how to recover from.  In other words, most aspiring traders will never recover from a big loss.

That’s the reality of longevity in trading is that every trader will break their rules at some point.  Most of the time we are rewarded for breaking our rules. For example, you pull your stop to give a stock a bit more room and it works and you make a profit. This creates a feedback loop that encourages us to break the rules again. Eventually, the luck runs out and you’ll find yourself sitting on a loss that is much bigger than what you had ever contemplated when you took the position.  

You are not alone. There have been some well-publicized losses by great traders:

  • Just this year we saw Gabe Plotkin of Melvin Capital, which had a phenomenal record,  lose over 50% of his firm’s capital after his Game Stock short got squeezed to the moon. 
  • George Soros took a 30% hit in a single week when he didn’t see the 1987 crash coming. He tried to ride it out after he theorized that the crash was because of portfolio insurance rather than economic concerns. But when the market started to roll over after a couple of days of bounce Soros capitulated and sold out the entirety of his positions at what would be the lows.
  • Jessie Livermore—the source of many trading aphorisms had tremendous periods of fantastic booms and busts.

If this is your first time getting kicked— embrace it— it’s your chance to prove that you may have what it takes to become a successful trader for the long term.  In the words of Lou Mannheim from the 1987 Classic movie “Wall Street “:

Man looks in the abyss, nothing is staring back at him. At that moment, man finds his character. And that is what keeps him out of the abyss.

Or as Tom Canfield who is one of my favorite Twitter follows, once put it “real trading begins after you break a rule and how quickly you can recover.”

I’ve been there and I’ve recovered. Each time my loss was a bit less severe and my recovery a bit quicker. 

Recovering from a big loss is a process.  This is my process.

big loss

Get to Market Neutral and Step Away from the Market

If you’ve just taken a big loss—or worse—you’re sitting on big unrealized losses your decision-making and discipline sucks. You can’t trust yourself to make the correct decision on your next position.   You need to reset and find balance again or you’ll engage in more account destroying behavior such as revenge trading.

Turn off the screens. Take a walk. Have a drink (have many drinks) if that’s your thing. This is critical. You need some separation from the markets to be able to think clearly.


Get Back to Work

Take a mental inventory of how you feel.  Assess why the loss happened.

We create a lot of rules to keep ourselves safe.  We have rules about liquidity, market exposure, stock selection, setup definitions, position-sizing, whether to take a position through earnings, and the risk we are willing to take on the position.

 Be honest with yourself. 

 Which rules did you break?

Why did you break them?

Why didn’t you correct the error sooner?

After you’ve gone through that process, resolve never to do it again. Review your rules. Take a picture of the chart and put it in your trading notebook. I have a Tab in my trading journal called “F*** Up’s,”  — Paging through these charts reminds me what I’m capable of when I break my rules.


Put the Training Wheels Back On

You need to earn the right to trade size again. You need to prove to yourself that you still have what it takes.  Make your next series of trades a fraction of the size that you would allow yourself to trade. You need to remove the temptation to try to recover the loss on the next few trades.  Focus on your process.


Ramp Up And Be Humble.

After you can demonstrate discipline and that you are in sync with the market you can return to trading the size that your rules permit you to take.  Focus on the process and the results will follow. 

Dr. Alexander Elder’s book Step Into My trading Room instructs “Every morning before trading I suggest saying: “Good morning, my name is so-and-so, and I am a loser. I have it in me to do serious financial damage to my account.”

The funny thing is that when we remind ourselves that we are not brilliant and we are capable of incurring great losses we tend to trade at our best.

– Cheers


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