You Might be Using a Stop Loss, But Are You Using a “Loss Stop”?
The first step to fixing a problem is admitting you have one. Chances are if you have spent any amount of time conditioning yourself as a trader, you have run across the age old saying “Don’t throw good money after bad!”. But do you really understand the meaning? Better yet, do you practice and apply this simple wisdom in your trading plan?
The idea is simple, if you lose a trade you should accept the loss, journal your emotions and experiences then MOVE ON without carrying an avenging attitude into the next trade setup!
The problem is, it becomes hard to separate yourself emotionally from a losing trade in the heat of the moment and you keep trading until you cook yourself inside a boiling pot. Let me explain.
I often use the boiling pot example with my mentorship students. If you place a live rat inside a boiling pot of water, it will jump out quickly and run franticly as far away as possible. However, if you put a rat inside a pot of warm water and start slowly turning up the heat, the rat will get used to this gradual increase and stick around until the very last moment. You could clearly see demise that was coming for the rat, however – Do you have a way of measuring the water temperature in your pot? Do you have a cue to get out when it starts getting hot quickly?
Meet the loss stop, a different approach to money management than the more common and talked about stop loss method.
A loss stop is your thermometer, and automates the task of removing yourself from the market when your psychology begins to shift and you begin stringing together consecutive losses. It is time to find out your individual loss stop number and how to apply this method:
- Analyze your trading journal and identify when your psychology begins to shift for the worse, is it after one losing trade in one period, two, three, etc? (Daily for scalp trading and weekly for swing traders)
- You know your peril, now STOP trading when you have reached your maximum consecutive trade loss.
- Leave your trading cave and go do something completely different to mentally and emotionally unwind and recharge.
- Start trading fresh the following session!
- Repeat this process and see the difference it can make to your trading profitability!
The loss stop prevents you from taking trades which are damaging to your account. Avenging your losses puts you at a significant psychological disadvantage and can very quickly blow your trading account up. Successful traders are aware that knowing when to stay out of the market is actually more important than knowing when to enter a trade.
The loss stop is not the one thing that will make you a star trader, but when built into a solid money management strategy and implemented through a development system, you will be on your way to profitability. It has worked for me, and many of the students I have mentored over the years.
When the temperature begins to increase beyond your comfort level will you get out of the proverbial trading pot or let your account get cooked?
In order for a loss stop to be effective, it is very important to keep a detailed trading journal to keep track of your psychological progress. Identify your mood, your concerns, attitude, desires and aspirations before placing every trade and the patterns that emerge will help you jump start your progress. Using a journal means you don’t have to know what you’re doing wrong at first, it will make itself apparent.
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