June 23, 2017 at 10:35 am #24340
The title of this piece is an anonymous ancient proverb, often wrongly attributed to the ancient Greek playwright, Euripides, who lived from 480BC to 406BC.
The quote was used in a book that I recently read, and the context had nothing to do with trading but I couldn’t help make a very obvious connection and chuckle to myself:
The Revenge Trade.
Above: Euripides looking on disappointingly at your latest revenge trade.
The Revenge Trade is an ugly beast. Usually, the unprepared trader takes an unexpected loss, gets mad at the market, and quickly puts on another trade (usually risking more) aimed at quickly winning it all back.
Most of the time, the Revenge Trade goes south too, now leaving our trading in an even bigger hole and into a massive downward spiral. I have seen traders completely drop their system at this point and simply take positions in the market, determined to win it all back. Five or six trades later and they’ve wiped out 20-30% of their accounts.
This bahaviour is unchecked anger, and it will destroy your trading account.
The simple solution is to just get some perspective and stop trading like an amateur. Let’s unpack the problem first, and then we’ll loop back and make some solid steps to ensure that the revenge trade is a thing of the past.
A losing trade is a problem…
…but if you are not mentally prepared for it!
Where does the losing trade lead, if not managed properly? Only one place: The Revenge Trade. You take a loss and you are consumed with anger directed towards the market (as if it could care). You don’t even wait for the next setup; you see price moving in a particular direction and you jump on, with twice the risk of your first loser. You’ll recover the losses and put yourself in profit. You’ll show the market who’s boss.
When this new trade loses as it invariably does, you’re now 3x down what you were. And you’re starting to feel a little desperate.
Sound familiar? Alright, maybe you don’t go “full revenge mode”. Instead, you take a loss but you can’t stop focussing on your PnL statement. It makes you feel sick to your stomach looking at how much you lost.
You are not alone. Every trader has been here. What separates the successful from those who give up is what they do next.
Lean into what you are feeling. (You are not a robot.)
Let’s examine what you are feeling a bit more closely. We all know that emotions play a huge part in trading.
Are the best traders like robots – emotionless? Are they unaffected by wins and losses? Do they have so much experience that they feel nothing anymore?
No! The best traders both feel and acknowledge their emotions. You cannot file them away and pretend they don’t exist because subconsciously you will still act on them.
Instead, lean into what you are feeling. Acknowledge the pain.
So how do we deal with our losing trade? I acknowledge to myself that it sucks, and I am upset. That’s my first step. Then I split the loser into two categories:
Did I make a mistake?
Did I do everything right and the trade was still a loser?
This is an important distinction.
If I made a mistake like an incorrect stop-loss, or perhaps I clicked into a trade I didn’t want to, or I placed an order before I should have (all these things can and do happen) I say to myself “one mistake is OK”.
I am not joking – I stop and say this to myself “one mistake is OK”. This statement allows me to acknowledge that I made a mistake (I am taking responsibility), it allows me to forgive myself (because mistakes do happen and I need a clear mind to trade) and it allows me to move on, following the rules of my system. The revenge trade has been defeated.
If I didn’t make a mistake, and the trade was just a loser, I remind myself of whatever the win-rate is for the particular system I am trading. This is perspective.
When you win a trade, do you review your win rate? Most traders pat themselves on the back and consider themselves top traders after a winner. How arrogant. When they lose, they complain about the system, the markets, the brokers etc., How silly. Let your win-rate be a function of your system, and let the system do the work – don’t internalise it.
What about a series of losses?
What about when you’re in a drawdown – you’ve taken three or four or five or ten losers in a row (or more, depending on your system)?
Has the market changed? Is your strategy doomed?
Here is Market Wizard Ed Seykota’s take “The markets are the same now as they were 5 or 10 years ago, because they keep changing – just like they did then”
I suggest a simple 3-step process:
Step 1: Get away from the charts
Take some time away from the market. How long is up to you.
Bring up your long-term equity curve. If you’re trading a system with a positive expectancy, and you’re in a drawdown, your recent trades might look like this:
You just can’t seem to break out of the cycle of losing. A winner followed by three losers! Will it end?
Then back that chart up for some perspective:
Not so bad any more right?
Here is what happens if you just plod on with the same old system:
Step 2: Back-test
Confidence in your system is key and a drawdown makes you question whether your system is as good as you thought it was.
So back-test it again!
I like to use great software like ForexTester to help with my back-testing. I’ll test multiple pairs over years and years – it sounds like a lot of work, but it is invaluable.
Once I’m done, I come out knowing and having confidence in:
My expected win-rate
My expected winner size
And most importantly, what my losses are going to look like and what my expected drawdown is going to be
Re-armed with confidence in my system, I move over to Step 3.
Step 3: Review my rules
Each system has a very specific set of rules.
Have I been following them in my live trading?
Are there some that I have almost forgotten because they haven’t been relevant?
Am I cheating by making allowances or exceptions in my rules that are costing me?
Knowing and sticking to a very precise trading plan is the only way to trade for consistent profits.
Don’t take trades that end up as losers, only to look over the setup and kick yourself when you realise you didn’t follow the rules. Let losers be losers just because they are!
Be picky with the trades you take.
Print out your trading plan as a checklist and have it next to you when you’re about to pull the trigger.
Make sure every requirement is ticked before you trade. Don’t make silly exceptions out of greed because you don’t want to miss out…
And don’t change your system based on “the last trade”. We have a terrible bias towards letting what ‘just happened’ change the way we approach the markets, forgetting that our rules are based on the best results of hundreds, or even thousands of trades.
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