On Learning to Embrace Your Losses

 | Oct 27, 2013 | 10:30 AM EDT
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When traders post a loss, they'll often conclude that perhaps they, themselves, are losers. After all, the future is uncertain, so it may seem reasonable to question whether you'll ever have another winner again. Of course, if you proceed to plan well, do your due diligence, study and focus -- and make your future bets accordingly -- the odds will be in your favor.

But, in the meantime, how do you deal with a loss?

As we deal with mass unknowns, we move along the risk curve between fear and greed. Sometimes we press and get it right, while other times we'll get it wrong. In trading, therefore, we certainly have our share of gains and losses -- and, with options, these results are magnified. Yet, when we do encounter a loss, our minds can play tricks on us.

This is why I continually maintain a good risk discipline. My self-worth is not my net worth, so I can stomach a loss and not be (too) rattled. Do I feel bad when a trade goes against me? I'd be lying if I said I don't. But I don't feel like a loser, because the next big trade is probably just around the corner. Like you, I want to win every time. But, realistically, it's just impossible.

So I give myself a break. I know and understand that the odds of success are extremely high as I trade, and they go even higher as I trade more. Armed with this information, I can either let the trading gods take over and bring me places -- most likely, the crowded trader's graveyard -- or I can remain in control.

I choose the latter.

Again, I know trading losses will happen. It comes with the territory. I recently had a blowup on some Panera (PNRA) calls after earnings, and the position went down to a loss. These things happen in options trading, and more so if you play earnings.

But it's how we deal with those losses -- more specifically, how we recover from them -- that separates the professionals from the amateurs. In my years of trading, I've known many traders who have feigned discipline, yet they would simply roll the dice in trading. They'd see the exit door eventually -- and not by choice. Then there are those who exercise discipline and embrace their losses, as learning from them as experience is the best teacher. "What went wrong? How can I improve? Did I size correctly?" These are the questions that help traders stick around for the long term.

Of those questions, the one on sizing is particularly important: It's the one area that can permanently ruin traders. Too large a position -- and it only takes one play -- can be a recipe for disaster. These folks not only lose their capital, but they are so far gone emotionally that their behavior becomes forever changed. Never again will we see the gunslinger firing from the Wild West. We're more likely to find a cautious creature who may only put some money down on a very conservative play.

So keep your trades in control, use a disciplined method of risk management -- for me it's 2% to 3% of capital on a trade -- and allow yourself to withstand tough outcomes. Surely as the day is long, you will have them.

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