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The Importance of Financial Market Traders Not Adding to Losing Positions

InvestorEducation / Learn to Trade Oct 02, 2009 - 04:29 PM GMT

By: Dr_Janice_Dorn

InvestorEducation

Best Financial Markets Analysis ArticleThe day was more or less like any other trading day...full of thrills, chills, panic, elation, some "high-fiving" and some "what is happening here?"
 
Then he appeared.  It was the first time I had seen him, but the look in his eyes was familiar.  It was not sad, not happy--- just empty.


What could I say? His face and the way he held his head and quietly handed me the notebook said it all.

The first words he spoke to me were: "I made one trade last year and I am in trouble."

That got my attention very quickly. One trade in 12 months and in trouble was quite a different story from the one I usually hear. This was not the typical tale of a trader who laments over the hundreds of trades made each year and the inability to understand why they did not work and his accounts were now in significant drawdown. 

“Why are you here about one trade?” 

He looked at me for a long time without speaking. 
 
“Well, it wasn't exactly one trade.  It kind of was one trade but I kept adding to it, so the trade just got larger and larger.  I kept doing options on the SPY until I had hundreds of them.  Hundreds of options on the SPY.” 

“So what happened?”

“Well, I knew what was going to happen.  I read my newsletters, followed the pundits and what they were saying and I had this trading system which I bought at a big seminar that kept telling me that things were about to turn around and if I just hung on, it would be OK.”

So, I said: “You were in a losing position and you kept adding?  Is that what happened?”

“Yes”, he mumbled quietly.
 
“And then what?”

“Well, after three months of adding and averaging down I was down so much that I couldn't take the loss, so I kept adding.”

“And then what?”  

“Well…finally, after I couldn't take it anymore, I closed everything out for a loss.”
 
“And how much loss would that be?”

His voice went very, very quiet. “It was 80% of my trading capital.”
 
“80% of your trading capital?”

“Yes.”
 
“And?”

“It was the worst thing that ever happened to me because I lost hundreds of thousands of dollars and now I am totally afraid to make a trade. “
 
“I have not traded for six months and I am absolutely gripped with fear.  Can you help me?”

“Well, I don't know if I can help you unless you are able to tell me what you did wrong?”

“What I did wrong?”

“Yes...what you did wrong?”

“I didn't get out when I SHOULD have?”

“Why not?”

“Because I didn't want to take the loss and I KNEW it would turn around, so I not only hung on but I kept adding.   I was absolutely convinced that I was right, and all of my indicators and the main guy I follow kept telling me that it was only a matter of time before the turnaround would come, and that I really wasn't at a loss unless I took it.  In other words, it was only on paper.”
 
“Only on paper?”

“Yes, it wasn't real because I didn't take it.”
 
“And then, when you finally took it?   Was it real then?”

“Well, yes.  Good Lord!   It was so real that my wife threatened to leave me, called me a reckless gambler and threw me out of the house for a week.”
 
“Not a good thing.” 
 
“No, not a good thing.”
 
“And then, what did you decide to do?”

“Well, at first I thought I could get even, you know, get back into the game and make back everything I lost.”

“And then?”

“I was in total paralysis, total fear and unable to trade. I still am.  I can't eat, don't sleep well, my marriage is on the rocks, I have no faith in myself and I think I am becoming paranoid about people in the market being out to get me.”
 
Needless to say, this individual was in major trading tilt.  What does that mean?  He was and is out of control.  He was blinded by his own belief that he was right and the market was wrong.  Despite glaring evidence to the contrary, he was unable to cut his losses.  Worse than that, he kept adding to a losing position.  He was trading on hope and belief and was blinded completely to the reality of price, which was staring him in the face every day.  With each passing day, his accounts were in increasing drawdown and he became more and more crippled with fear.  Additionally, his self-esteem was failing and he entered a phase of shame that then progressed to toxic shame.    He was paralyzed with fear and remains so to this day.
 
There are so many trading lessons here, the least of which is: no matter what one thinks, believes, hopes or prays, the markets can remain "irrational" longer than you can remain solvent.  This is among the most difficult lessons to learn, but it is now--and has been since the inception of trade--an eternal truth.
 
What happened here to put this man into tilt?   Market opinions held in the face of glaring evidence to the contrary are among the largest sources of trading gone wild.

I have seen this over and over again- the inability to change quickly from bullish to bearish is not rewarded.  Just as in life, inflexibility and resistance to change is not rewarded in the markets.  The most successful traders are those who can adjust quickly between bullish and bearish trends, and who are prepared to do this within the course of minutes to hours.

Adding to a losing position is another lesson learned here.  Unless your pockets are deeper than the ocean, you must cut losses short (and, of course, let winners run).  Not cutting losses short is a major root of tilt.  Why?  Because the trader becomes absolutely worn out by daily watching the weak position get weaker.  In the markets, as in life, the weak get weaker and the strong get stronger.  The daily demise of a losing position is among the most debilitating of all things that a trader faces.

What else went wrong here?   If there was a trading plan, it was not adhered to.  All the planning went out the window when the position did not "cooperate."

Why have a trading plan when you are unable or unwilling to follow it?   What's the point anyway?  Trading is a business and a trading plan is like a business plan.  If you deviate from it, you better have a really good fall-back position or your business will go bust.

A few of the many lessons to be learned from this story:

The market is always right--except at significant tops and significant bottoms.

Keep and open and flexible mind.  When in doubt, get out.

If you must have a guru, take him or her with many grains of salt

Do not add to losing positions.

Try every day to make yourself stronger, better and more integrated as a person.

Stay true to yourself.  Lying to yourself and others, and trading on hope and prayer do not work

Most importantly, accept and recognize that you are not perfect. You are human and are going to make mistakes.  Trading is the only profession where losing is actually winning.  BUT--- unless you accept mistakes as mistakes and learn from them, you will not progress and be upside down.  Unless you are able to get your trading brain out of the cave you will not accumulate regret.  It is only through the true acceptance of a mistake as a mistake that we accumulate regret. This is how we learn and grow as traders and human beings.

Until Next Time,
Good Trading and Brain On!

By Dr. Janice Dorn, MD, PhD
Prescriptions for Profits
www.thetradingdoctor.com

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© Copyright 2006-09 -- Janice Dorn, M.D., Ph.D. -- Ocean Ivory LLC

Dr. Janice Dorn is a graduate of the Albert Einstein College of Medicine, where she received her Ph.D. in Neuroanatomy. She did her postdoctoral work in Neurophysiology at the New York Medical College. She received her M.D. from La Universidad Autonoma de Ciudad Juarez, did one year of clinical clerkships in Phoenix, Arizona. and then completed a Neurology Internship at The University of New Mexico in Albuquerque. For the past twelve years, Dr. Dorn has focused her attention on trading, mentoring and commentary in the financial markets, with emphasis on Behavioral NeuroFinance, Mass NeuroPsychology, Trading NeuroPsychology, Futurism and Life Extension. A graduate of Coach University, she is a full time futures trader and trading coach.  Dr. Dorn is the author of over 300 publications, relating to Trading and Investing Neurouropsychology, Market Mass Neuropsychology, Behavioral Neurofinance, and Holistic Wellness and Longevity. 

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