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Losses: How Do You Handle Them?

John Bogle offers wisdom to those always in search of “complex” solutions:

The Greek philosopher Archilochus tells us, the fox knows many things, but the hedgehog knows one great thing. The fox — artful, sly and astute — represents the financial institution that knows many things about complex markets and sophisticated marketing. The hedgehog — whose sharp spines give it almost impregnable armor when it curls into a ball — is the financial institution that knows only one great thing: long-term investment success is based on simplicity.

Deal with Trading Losses

You are going to have losses when you trade. If you don’t have losses, you are not taking risk. If you don’t risk, you won’t win. Losses aren’t the problem. They are part of the game. It’s how you deal with losses that is crucial. Ignore losses and they will come back to bite you. Trend Followers handle loss by limiting all positions to a set percent of equity. You always know that if your equity is going down due to losses, you decrease trading size (or exit). On the other hand when you are going up, you automatically compound profits and add more. This is the sensible way to trade and not stick your neck out. You can always come back and play the game again tomorrow.

The Impact Of Lifestyle

Maintaining a balanced lifestyle is critical for profitable trading. Some of the best traders are very frugal. They don’t trade in order to live large with the next new sports car, etc. They understand trading is about process. Unlike the majority, they don’t expect the market to do what they want exactly at the time they want it. They don’t make demands on the market to perform at preset times because they know that if you don’t have a passion for the process of successful trading, not the material goal, you wind up losing more. They know that you can’t get more out of a market than is there. If you’re going to be flat because the market is going sideways, there’s nothing to do. So that’s what you do. Nothing. But if you have a lavish lifestyle to support, it may be difficult to do nothing. Lifestyle cannot be your goal. Profits are the goal. If you trade correctly you will make the profits when the targets of opportunity are present. Your lifestyle will unfold as part of that process, but it doesn?t drive the process.

Risk Taking

When most people first start trading they often start small. As they get better at it, they trade more. They might start with one contract and then move to ten contracts. As time progresses, some may reach a certain comfort level and become afraid to take risks beyond that level. The object is to try to keep trading in constant leverage terms. In other words, you trade the same as your equity increases. By using a Trend Following approach to money management, you are never afraid of getting big. You are prepared. You know what you will do in advance as your account grows. This is key to Trend Following money management.

Mechanical Trading Systems

When you take a risk it is useful to have a mechanical trading system for several reasons: You increase your diversification, force discipline, reduce your work load and make your trading life easier through automation. Mechanical trading systems enable you to take a risk without getting personally involved. Although you might not be happy when you are going through a drawdown or taking a loss, at least you’re not agonizing over your trading decisions on a day-to-day basis. It’s the rare individual who can sit in front of a quote screen and make consistently good trading decisions day after day. Other components of your life will always impact your thinking generally and your trading decisions specifically, unless you rely on a mechanical trading system that locks out discretion.

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