Investing and trading is as serious a profession as running a business. Just like any other business a lot of planning goes into investing and trading. There are goals, aim, structures, targets, budget allocation and monitoring which are applicable to trading and investing as much as they are in running a business.
However, there is one aspect of trading and investing that is least understood and that is losses.
In the business of investing and trading, there are two main inputs – knowledge and capital. Knowledge can be borrowed or can be one’s own. By borrowed knowledge we mean relying on someone’s recommendation or listening to media or simply a friendly ‘tip’ to buy the stock. Capital is the money that is allotted for the business of trading and investing.
Among the two inputs, knowledge, especially that possessed by the trader or investor is akin to the assets of a business, using which the company derives its revenue. Money on the other hand is like consumables or raw materials which are used up to add value and in turn generate more money.
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While running manufacturing units there are some materials that will either go waste or the output will not be as per the quality norms. Initially, during the trail process the losses would be more but as production is stabalised, losses decrease and are finally negligible as compared to the overall scheme of things. Similarly, in trading and investing the losses are the expenses that one needs to take in order to learn.
The entire game is thus of reducing your losses and letting your profits run.
Here are 10 ways that can help you reduce your losses.
- Know what you want: The first thing for an individual is to know if he is a trader or an investor. Even in trading he will have to know what kind of trading he would like to undertake. Would he like to be a scalper, an intra-day trader, a swing trader or a positional and trend follower? Similarly in investing the individual needs to question if he is a value investor or would like to invest in growth stocks or turnaround stories. Knowing exactly what you want and what you are looking for is half the battle won. This way one would not run to try the next brilliant idea in town and add on to their losses without knowing what hit them.
- Have a plan:After it is decided by the individual that he wants to be a trader or an investor, the next move is to have a business plan in place. The plan not only includes the strategy which will be in play but also the entire process of how much time will be allotted for research, money allocation, broker selection, hardware and software requirements and the works. But central to the business plan is the strategy that the trader or investor will use. The strategy has to be studied to the minutest detail before putting it to test. Entry and exit levels, stop losses and re-entries in the trade should all be worked out. The idea behind having a plan in place is not to react to market development but to be proactively ready for any contingencies.
- Test the plan: Before starting to trade or invest with real money it is important to test the strategy. Back-testing the strategy gives an idea of how the strategy has worked over time. Knowing how long were period of losses gives an idea that such series of losses may occur in future. Thus the trader does not get disturbed and losses faith in his strategy and sticks to itirrespective of the spate of losses. Most losses in the market are taken by traders trying many systems and jump from one system to the other after taking a few losses. Hold on to a strategy that has been tested, but in case of losses one can cut down their position so that the losses are limited.
- Trust yourself and your strategy: The most important trait of a successful trader or an investor is that they trust no one else but themselves and their strategy. They take their losses in their stride because they know that it is part of the strategy that they have been following for years. Beyond the losses are strings of profits. If there was nothing wrong in the process of execution in the trade then the losses will be taken care of by the profits. Not trusting your strategy is like a businessman not trusting his own product. Is it possible for the businessman to succeed if he is selling a product that he cannot trust?
- Have enough capital to start: Before starting trading or investing, even on a part-time basis it is important to have enough capital. This is not only important to pay for the losses that will happen in the due course but also because chances are there that there would be more than one position open in the market and the trader might have unequal sized open trades. If the trade with a higher capital allocation is a losing one, the trader would lose confidence on his system just because of one trade. Trading and investing works on the law of large numbers. The law states that no single trade defines the trader or the strategy.
Data has to be collected over a series of trades and then evaluated. A trader should have enough capital in order to last so that he can collect enough data from the series of trades. Taking small losses is important as it will keep emotions out of play. A trader in his initial days would not have enough capital and a big loss can break him.
- Money management: If there is one thing that will define if a trader is going succeed or not, irrespective of his strategy then it is his money management skill. A bad money management will over time result in losses even if the trader has developed the best strategy. Similarly a good money management system will help the trader to sustain over a longer period of time even if he is trading a bad strategy. The idea is to have the best of both worlds. Capital has to be divided in such a way that you are not risking more than 1 percent of your capital on a single trade. This will allow you to collect larger data point before increasing your bet size or allocating more capital.
- Remove the noise: A key factor in trading and investing is not to be carried away by noise in media and what other traders or investor are thinking about. It is normal to get swayed by ‘experts’ in media saying where the stock or market is headed, especially in the formative days. A small test of what these experts have said in the past and how the recommendation has worked out will be enough for the trader to keep away from them. Social media posts on these experts also bring out the experience of others who followed the experts. If you need to be successful you have to be your own man. You need to take responsibility of the losses and profits and not blame others for their recommendation. This can happen only when you stop listening to other and have your own style. Own up to your mistakes, even in small things like the internet has stopped working, because you should ideally have had a standby arrangement. Only then will profits start pouring in.
- Measure your performance:You are your best coach and the best book that you will ever read as a trader is your own trading logs. Learn from them and make it a point not to repeat them. It is important as a trader to keep a track of the number of winning trades, losing trades and the average size of a loss and average size of a win. A trader in order to succeed needs to keep average size of loss and number of losses as small as possible. There is no point in keeping only number of losses small but taking big losses by stretching the stop loss point.
- Learn from your mistakes: It is important that you make all the mistakes that one can make when you are in the learning phase, because if you learn from it you will not repeat it. And if you have struck out all mistakes that can be made in trading, very few will be left to be made. It is very important to keep a track of your trades and read it regularly, lest you forget the mistakes you have made earlier. Reducing losses can be possible by not repeating your mistakes. Forgetting a loss and not learning from it is a bigger loss.
- Learn to forgive and forget: Every trade is a new trade. Previous trade which has resulted in either a win or a loss is history. Learn to forgive yourself if the previous trade was a loss one and forget a win trade, because the next one can knock you off. Like cricket where the batsman cannot be overconfident even if he has knocked the previous five balls out of the boundary, the sixth one can send him packing. It is important to maintain discipline and not go overboard in a winning streak as well as not to get depressed with a series of losses and stop trading. Trading has a lot to do with cricket, you need to stand at the wicket, score from as many balls, though many may result in singles and few may not result in any, but the key is to stand there for the loose ball which has to be swung hard and one that you need not waste. The rule of 80-20 is applicable to trading as it is to many other fields. 80 percent of the profits will come from 20 percent of trades, but one will have to be there to take all the trades.
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A trader should not psychologically tie himself to losses, he should not take it personally, which is why it is important to trade small while you are learning the ropes.