THE LOSER'S SPIRAL - THE DARK SIDE OF TRADING
All of us, as trader's normally sense that trading can become "dangerous", if you let it get out of control when it's not going well. It can indeed be a rather dangerous (risky) endeavor, financially speaking. A friend of mine, after trading marginally successfully for a few months, said to me "man, I sense this is really dangerous - I could get into a lot of trouble here". He was right. There is one basic process that destroys almost everyone that "blows out" of trading; I call it "the loser's spiral". I know all about it, as I went through it myself several times, in the process of really learning how to trade more consistently. Only extreme interest in trading, and perseverance through travails got me through this one! I've never met a good trader who hasn't been through grappling with this, either. As they say, "you must learn how to lose, before you can win". It is "the filter", which keeps most away from full-time, long-term trading success.
It goes something like this (simplified, for brevity). Trader makes a little bit of money. Skills develop. Trader makes a lot of money. Takes bigger risks. Things going well. Then...Wham! Big loss. Wham! Bigger loss. Trader tries to "make back" loss by taking bigger risks... and so on. The spiral is self-perpetuating.
Think that won't happen to you? Well, it happens to 80%+ of beginning traders within six to nine months (mileage varies, depending upon prevailing market conditions). It happens to a lot of intermediate traders, and experienced traders. It happens to world-class traders who run huge hedge funds, and it happens to people that have written scholarly books (Victor N.) and who are geniuses. So don't think it can't happen to you - it will, unless you study the mathematics of money management, and carefully calculate how much you can risk, versus your total tradeable capital. The statistics are overwhelmingly against you, if you violate the cardinal rules (generally, if you are risking more than 1-5% per trade, depending upon your trading style). For those with higher net worth, more tolerance for risk, or a longer time frame, (usually a combination of these factors) the parameters are different. But the basic idea is, if you are trading too "large" (of risk on each trade), sooner or later it will destroy you and blow you out of the game - probably, sooner rather than later.
Picture the trading process as a vortex that you are swimming in. If you trade properly and exercise good money management, you can create enough centrifical momentum to avoid the inevitable "flush down the drain". After a while, it will become a habit, and you will be able to routinely stay out of trouble (see my post on Equity Curve - an "early warning system"). But the forces of the vortex are always there, ready and lurking. This is truly the dark side of trading, which is always there. If you let your greed get the better of you, it will take over. And for any trader who has experienced the "high" of a big trade, the lure is always there to pull you away from your discipline.
What causes a trader to enter into "the loser's spiral"? For most, it can be identified as simply to trading too big relative to their account size, trading without stops, and/or riding positions down. Losses overwhelm gains, then the trader tries to trade his way out, quickly, often while not taking the true market environment into account before taking positions. Good traders are out of the market more than they are in, and they trade selectively.
Only the minority know how to avoid this vortex, in my experience. Think about it, before you commit to a trading (vs. investing) style... investors are less susceptible to this ever-lurking, rarely-discussed problem, which is the biggest potential pitfall traders must face, IMO. The shorter the time frame of your trading, the more difficult the trading process becomes. The rate of return also becomes higher; however the risks become higher as well. So daytraders are particularly susceptible.
Good trading, -Steve |
