What to do after a big loss?
How to deal with losses driven by mistakes.
One of the questions I get a lot is:
“I’ve just had a massive loss, what do I do?”
First thing you do is not panic.
Panic often leads you to make even worse financial decisions.
Stop for a second, take a deep breath, go outside, turn off the computer and approach it from a logical framework.
This is an important topic, because it definitely affects you personally.
On top of that, your confidence gets shattered.
So we need to ensure that if it happens, it never happens again.
The most important thing to do, when we do a mistake, is to define it, record it, and make a plan to fix it.
If you don’t document every single mistake you make, how can you develop a plan to improve from those mistakes?
Look at mistakes as lessons you paid for. Would you waste something you paid money for?
My guess is not.
Let’s dive in!
Index
Introduction
Index
Documenting Your Mistakes
Defining the Reason Behind my Big Loss
Fixing the Problem
Documenting Your Mistakes
Take my personal story, when I had to deal with a massive loss.
It was May 2019.
I had been trading for almost 2 years by now.
I was having a decent couple of months trading, and I was gaining confidence that I could do this as a job.
I arrive at my desk, at my old job, turn up the computers, and begin scanning the market.
Normal morning routine.
I see this small-cap stock gapping up on news.
It was a massive gap up.
In the micro-cap world, that means a higher likelihood that the stock will fade later in the day.
So I reserve some shares during premarket, so that I can short the stock when the market opens.
When you’re trading these micro caps, you have to buy shares and reserve them, because there’s not an infinite amount, and usually by 9:30 am, the brokers run out of shares.
On the more extreme gappers, by 7 am, some brokers are already running out of shares to borrow, because everyone is waiting to get them.
It’s 9:30 and the market opens.
As planned, I get my shorts in, I short into the initial open move, and I build a decent average.
Then the stock dumps as expected, and I cover my position.
As the day unfolds, the stock starts to move higher and higher. Breakout after breakout.
My day was already done at this point. I had made a decent chunk of cash, and I didn’t have any business to be shorting this stock later in the day.
But what do I do?
My greed kicks in, and I start shorting more and more.
As I lose more money, the less I care about losing a bit more, expecting that the stock would fade, and make me whole.
This mistake, almost cost me my account.
Defining the Reason Behind my Big Loss
After we’re calm, stepped outside away from the computer, we take a pen and paper, and write about what went wrong on that day.
Our job as both capital managers and business owners, is to define the inefficiency in our business that led us to take that massive cost.
Do it as if you were explaining to a board of directors, why you took that loss.
Let’s define my own inefficiencies.
1) Lack of a systematized approach
By not having a systematic approach, I treated trading mostly as a way for me to extract money from markets, whenever I wanted.
Just like a game.
When I wanted to play the game, I’d just turn out the computer and start playing.
Markets are not like that.
You either have an edge to trade, or you don’t.
When you don’t have an edge to trade, you shouldn’t be trading.
That edge is found through a systematic process. Knowing exactly when to execute trades and when to be out of the market.
If I had a defined entry signal, exit signal, stop loss, trailing stop loss, the basic stuff, I wouldn’t have that story to tell today.
Because I would have known better.
I wouldn’t have had to be guessing, whether to enter a trade again, or if it was a bad idea to be taking more trades.
I would have known exactly, the expected value of the positions, I was about to take.
I am a business. I am here to make a profit. If I don’t know if my actions lead me to a profit, why am I wasting time and money on it?
It doesn’t make sense in any business!!!
If you don’t have a defined method, don’t know where to start, and want to speed that up in the next 3-months:
2) Lack of a well defined risk management plan
Taking so many positions, with such individual risk, would have been avoided had I built my model thinking about risk first.
Even if I hadn’t have a proper systematic process, I should have known that risking so much on every trade, is a negative expected value decision to make over the long run.
Even if I had made money on this trade, by fighting the stock, eventually, my luck would run out and I would have destroyed my portfolio.
Always build your portfolio to ensure it survives.
Don’t build it thinking how much money you’re going to make, or how fast you can get out of your job.
No!
That only leads to disaster. Markets are dangerous and volatile.
Build your model with survival in mind. Given the worst conditions, the worst market environments, does my portfolio still survive?
This is how you build robust plans.
3) Lack of future vision
One of the things I see most newer traders struggle with, is a lack of vision.
What do I mean by that?
They take random trades, they over-size, don’t follow rules, all because they can’t see what’s ahead.
Take the example of my portfolio.
I am currently going through a normal drawdown. But how do I keep trading, despite losing money for long periods of time?
How do I keep myself from breaking the rules, tinker with my models, whilst going through the pains of financial loss?
Because I know what’s the expected value of my decisions.
I know that historically, my methods tend to work, not only for a few months or years, but over decades and decades of data.
Not only data, now multiple years of live performance with my own money, but also, live performance from other funds that employ the same methods as I do.
When you stack all of that evidence on your mind, and keep it close all the time, you don’t question your decisions any more.
It’s not bullet proof, of course.
Things change in markets, and we must be constantly vigilant.
But if you study what the performance and expectancy of your models are, given the past 10, 20, 40, years, you can relax, knowing that you probably made a good decision.
Fixing the Problem
After you’ve identified your problem, or at least have a thesis for why you keep making these mistakes, you can now fix it.
Take this framework that I’ve built for myself:
Define your systematic approach
What is it, that I am exposed to in the market, that should provide me with returns over the long-term?
What are the exact rules of my trading system? (Leave nothing undefined)
Entry
Exit
Stop Loss (if applicable)
Take Profit (if applicable)
Trailing Stop Loss (if applicable)
Define your approach to risk
Fixed % of portfolio per position
Fixed % risk of total portfolio, per position
Allocation based on target volatility
Have a clear vision where you’re headed to
Have a report of the performance of your model, over the past few years/decades (the more the better):
Maximum drawdown
Average drawdown
Length of the drawdown
Average volatility
Make comparisons of your current performance, versus historical performance.
Analyze the comparison reports on a regular basis, so that you know whether you are in line with what’s expected or not.
Project forward, based on that historical data, what can be expected if you follow the plan.
This is how I fixed my own problem.
By looking at it like a business instead of a hobby.
I was no longer playing around with money, I was managing a business where I had to explain why I was taking decisions.
This shift in framework, changed everything for me.
Since then, I’ve never looked back.
To help you really speed up your learning curve, I’ve decided to open a few spots to one-on-one coaching, to share my knowledge and passion for trading, with you. I’ll show you exactly how you can go from unprofitable, to profitable trading, as I did.
If you’re an individual or enterprise, feel free to book a call:
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