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How to Take Losses in Trading | Stop Losses, Risk Management & Trading Psychology — Transcript

by Small Caps Trading Podcast · 4,077 words · 576 segments · language en · Watch on YouTube

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0:00One of the main differences between
0:01traders who last and traders who
0:03disappear is that traders who last are
0:06completely okay with taking small
0:07losses. And I know most people say
0:09they're okay with it. But trust me,
0:11there are levels to this. The traders
0:13who last don't negotiate it. They don't
0:15give it room. They just take the small
0:17loss like paying for a ticket and they
0:19move on. If you can learn to actually
0:21love losses because they protect your
0:24career and put you in a situation where
0:25you could take those A+ trades, then
0:28your results will change permanently.
0:30Most traders feel like they're not
0:31emotionally allowed to be wrong. Your
0:34brain treats a small loss like a
0:36personal failure, so you avoid it and
0:38then you end up taking a huge loss
0:39instead. It's not your fault. It's human
0:42wiring. And the solution is to rewire
0:44your relationship with losses. Make
0:47small losses normal, procedural, and
0:49non-negotiable. Then use stop rules and
0:52sizing rules as the mechanical
0:54enforcement for that. In this video, I'm
0:57going to show you exactly how to do
0:58that. How to become genuinely
1:00mechanically okay with losses so you
1:02take the right loss on time every time,
1:04which keeps you out of major losses and
1:07keeps you in a position to take that A+
1:09trade when it finally comes. This
1:11episode is about neutralizing the
1:13biggest bug in trading because the
1:15market doesn't need to beat you. Your
1:16own wiring will do it for free unless
1:19you understand what is happening and how
1:21to train yourself to change it. Let's
1:23get into it. [music]
1:33Today we're talking about our
1:34relationship with losses and how to
1:37train ourselves to override that human
1:39bug that causes us to cut winners and
1:43double down on losers. One of the most
1:45common things in trading is a
1:47disproportionate relationship between
1:49the size of your losers and the size of
1:51your winners. Even if you do have a good
1:53trading strategy, most traders find
1:55themselves taking outsiz losses
1:58repeatedly that wipe out weeks of gains,
2:00if not more, and make it really hard to
2:03build that consistent performance. And
2:05the thing is that most if not all of
2:07those major losses, when you look back
2:09at them, you know that you did something
2:11wrong. You know, you should have cut
2:13that loser way before it got that big,
2:15but something inside of you stopped you
2:17from doing it. Something inside of you
2:20caused you to wait or add or widen your
2:22stop until you took that outsized loss.
2:25And because it's so common, it's so
2:28human, it's a part of our human wiring,
2:30then people already did the research on
2:32it. There are two things you should
2:34probably know. One of them is called the
2:36prospect theory and the other one is
2:38called the disposition effect. According
2:41to prospect theory, when you're down on
2:43a position, your brain becomes
2:45risk-seeking in order to avoid realizing
2:48the loss. You hold your loser way too
2:51long. You widen your stop because you
2:53don't want to accept the loss. You add
2:55to a loser and you take big risks in
2:58order to just break even. And according
3:00to the disposition effect, you cut your
3:02winners quickly because you want to lock
3:04in that feeling of good, of I made
3:07something, I did something good. and you
3:09hold on to losers way too long for the
3:11same reason in reverse because you don't
3:14want to lock in that feeling of bad of,
3:16oh, I lost or I'm wrong. So, prospect
3:19theory is the wiring and the disposition
3:22effect is the behavior that it creates.
3:24And if you rewire your brain's loss
3:27response, you weaken both of those
3:29things. And if you weaken both of those
3:31wirings, then you can take the right
3:33losses at the right time and never find
3:36yourself with too big of a loser. So,
3:38the problem isn't that you're dumb or
3:39weak or anything like that. The problem
3:41is that you're human, which means that
3:43the fix is a system that makes making
3:45the right choice easier for your brain
3:47to do. Now, what's a good kind of loss
3:49in trading? A good kind of loss in
3:51trading is leaving your position around
3:54the time that your thesis is
3:55invalidated. Today isn't a full
3:58stop-loss placement master class. We're
4:00covering stops at the concept level as
4:02enforcement of the mindset. I'll create
4:04a deeper stop-loss placement video later
4:06on. For today, I'm going to assume that
4:08when you entered a trade, you knew what
4:10you wanted it to do. And at some point,
4:13you knew that it's not doing what you
4:14want it to do and that it's looking very
4:16unlikely that it will do what you want
4:18to do. And that is the moment of the
4:20thesis invalidation. That's the moment
4:22where all of us need to leave our
4:24trades, but most of us don't. Now, going
4:26into trading, you know that your batting
4:28average is going to be much less than
4:30100%. Your job is not to be right all
4:33the time and you know that. Your job is
4:35to protect the positive expectancy of
4:37your trades across hundreds and
4:40thousands of trades. And the way for you
4:42to protect the positive expectancy of
4:44your trades as a whole is to have
4:46reasonable risk for the trades that you
4:48take and then actually respect that risk
4:51when you're wrong. And again, I know
4:53that this sounds obvious, but as obvious
4:55as it sounds, I also know that most
4:58people fail at this. So let's look at
5:00specifically how people fail at this.
5:02The biggest issue is the negotiation
5:05spiral. The negotiation spiral is the
5:08most common path from a normal
5:10manageable loss to a really bad loss.
5:13What normally happens is that the price
5:15does something that puts you slightly
5:17red and starts going towards your thesis
5:19and validation area. And what you should
5:21do in that moment is accept the plan
5:24risk and get ready to stop out if the
5:26thesis and validation happens. But what
5:28happens instead to a lot of us is that
5:30we start to emotionally monitor the P&L.
5:33Ego and pain kicks in. Your brain starts
5:36thinking about all the negative things
5:38that this loss will do. You start
5:40projecting it onto your life, onto your
5:43future, onto your self-worth and
5:45self-image. So, you don't take the loss
5:47where you should. You widen your stop a
5:49little bit. Or maybe you add to your
5:50loser where you should be cutting it.
5:52This is exactly what the prospect theory
5:54behavior tells us that once you're in
5:57the red, you're willing to take larger
5:59risks than you would have before just to
6:01avoid being red. All of a sudden, you're
6:03willing to take a position that was
6:05larger than you planned or a wider stop
6:07than you planned. You delay taking the
6:09loss that you already should have taken.
6:11You start trading off of hope instead
6:14off of what you see in what the market
6:15is telling you is happening right now.
6:17And while sometimes that behavior will
6:19bail you out, it reinforces a bad lesson
6:22because eventually if you keep trading,
6:24you're not going to be bailed out. And
6:25eventually what happens is if you widen
6:27your stop or if you added to the loser
6:30or if you did any of these things that
6:32we tend to do in those situations and
6:34the price continues to go against us at
6:37some point you find your max pain moment
6:40and then you take that major loss and
6:42you're like [ __ ] why couldn't I have
6:45just taken the small loss when it came
6:48why couldn't I have just accepted being
6:50wrong when I was wrong and look I get it
6:53I know exactly how it feels. fails.
6:55Taking a loss sucks. Ending the day red
6:58sucks. In that moment where you look at
7:00the P&L and you feel it in your chest
7:02like you just set yourself back sucks.
7:05And this is where people accidentally
7:07attach trading to their self-worth. They
7:09don't just feel like I lost money. They
7:11feel like I failed. I'm behind. I'm not
7:14good at this. But the truth is that the
7:17manageable loss is the healthy pain.
7:19That's the pain that keeps you in the
7:21game. It's the pain that prevents career
7:23ending loss. It's the pain that makes
7:25sure that when the H rate comes, you'll
7:27be able to take it. Your job isn't to
7:30eliminate that feeling. Your job is to
7:32make the correct response automatic even
7:35while you're feeling that feeling. And
7:37it's a lot easier to separate your life
7:39from your trading results when your
7:41losses are controlled and planned.
7:43Because then a red day is just a
7:45business expense, not a crisis. And the
7:47reason why small losses become big
7:49losses is because we start negotiating
7:53after we're wrong. The negotiation is
7:56the problem. So if negotiation is the
7:58enemy, the solution has to be to remove
8:01negotiation. And one of the cleanest
8:03ways to remove negotiations is to use
8:05automatic stops. That's what I use
8:08nowadays. If you already know where
8:09you're going to be wrong, there's no
8:11reason to wait until you're emotional to
8:13decide. put the stop in immediately and
8:15let the system execute it. Now, I know
8:17that that's a general statement because
8:19maybe you're trading the kind of stuff
8:21the wicks a lot or maybe you're trading
8:23some other kind of strategy that makes
8:24automatic stops less ideal. So, if
8:26automatic stops are not for you, that's
8:28fine. But then you have to be very very
8:30disciplined about your stops when they
8:32do come if you have to take them
8:34manually. And there's also the option to
8:36put in stops for half of your size or
8:38part of your size. That way, at the very
8:41least, you know that part of your size
8:43has been taken off when you seem to be
8:44wrong, and the rest you can use the
8:465-second rule that I'll touch on later
8:48to decide what to do with it. Stops are
8:50not a random number. They're an
8:52invalidation point. They're the moment
8:54where your trade thesis starts having a
8:56negative EV. So the framework for each
8:59trade needs to be that number one, you
9:01have a thesis for the trade, a clear
9:03thesis. And as a derivative of that
9:06thesis, you should have an invalidation
9:08point for that thesis. Like I said
9:10earlier, you know that you're not going
9:12to be right in all of your trades. You
9:14know this. And so every time that you
9:16take a trade, the moment where your
9:19trade is wrong has to be incredibly
9:21clear to you before you take the trade.
9:23And the next step after that is to size
9:26yourself correctly. Because once your
9:28thesis is clear and once your
9:30invalidation point is clear is to size
9:33yourself accordingly so that you're both
9:35making the correct amount of money if
9:37this trade works and so that you don't
9:39find yourself with outsiz losses before
9:42your trade even becomes invalidated. And
9:45then the last piece of this framework is
9:47that when the invalidation happens, and
9:50it will happen to a double-digit
9:52percentage of your trades, you have to
9:54execute the stop-loss without
9:56negotiation. So, super general examples
9:59are if you're following a trend
10:01strategy, well, the first time the trend
10:04creates its first high or low, that's
10:06your sign. Or if you're trading ranges,
10:09then the stop needs to be below the
10:10range. If it's a breakoutbased strategy
10:13and it broke out tested the breakout
10:16level and then didn't respect it, you
10:18got to stop out. Now, your stop has to
10:20make sense with what you're doing. It
10:22needs to make sense with the volatility
10:24of the instrument that you're trading,
10:26with the liquidity of the instrument
10:27that you're trading. Your time horizon
10:30has to match. The time horizon with
10:32which you took the trade has to match
10:34the time horizon with which you take the
10:36stop. And if you want to know if you're
10:37really okay with taking losses, don't
10:39listen to what you say. Look at what
10:41you've done historically while you were
10:43under pressure because behavior doesn't
10:45lie. So, let's go over the most common
10:47behavior that prove that you're not okay
10:49with taking losses. Number one, break
10:52even addiction. If you find yourself
10:54having losers and looking for that break
10:57even exit instead of exiting where the
10:59invalidation point happened, that's a
11:01problem. Number two, stop widening. If
11:04you find that your trade has gone to
11:05where your stop was, but you move your
11:08stop, that's a problem. Time frame
11:10switching. If you went into this trade
11:12thinking it's a day trade and now you're
11:14starting to hold it for a swing trade
11:15because the day trade isn't working or
11:18any other kind of time frame switching,
11:20that's a problem. Averaging up or
11:22averaging down, whether you're long or
11:24short. If the stock moved to your
11:26invalidation area and you're adding,
11:28that's a problem. Oversizing. If you
11:31miscalculated where your invalidation
11:33area is to begin with and now it goes
11:35there and the loss is too big and you
11:37just don't want to book it, that's a
11:38problem. Stop hunt narratives and other
11:41kinds of excuses. If you start to come
11:43up with excuses for why things aren't
11:45working for you and you start with the
11:47tinfoil theories, that's a problem. And
11:51finally, ignoring liquidity risk, news
11:53risk, halt risk, and any other kind of
11:56obvious risk that's staring you in the
11:58face, that's a problem. Now, here's the
12:00good news. You don't fix this by
12:02becoming tougher or anything like that.
12:04You fix this the same way you fix every
12:06human issue with practice, with
12:08repetition. So, let's go over the
12:10rewiring plan, the drills that will help
12:13you rewrite your emotional response to
12:15these situations. Now, if you took an
12:17honest look at yourself when I listed
12:19the common behaviors that prove that you
12:21have an issue with taking losses and you
12:24know that you do have this issue, then
12:26the first drill to rewire your emotional
12:28response is to size down for the next
12:31two weeks and then have extremely
12:34crystal clear definitions of where you
12:36should stop out on every new trade that
12:39you take. And then on trades that do go
12:41to your stopout area, you stop out
12:43immediately without any negotiation,
12:46without any thought whatsoever. And even
12:48though you may absolutely hate the idea
12:50of trading small for 2 weeks, the idea
12:53is that you have to rewire your
12:55emotional response. And the way to do
12:57that is through repetition in real life
13:01situations. And the way to actually make
13:03you follow that plan is to reduce size.
13:06And so, yeah, it's going to suck to
13:08trade small for a little while, but
13:10you're doing it for a very good reason.
13:13You're rebuilding your reflexes, your
13:16emotional response. And so, hopefully,
13:19you trade and you trade and you trade
13:21small. And when you're right, great. And
13:24when you're wrong, you book that loss
13:26immediately in the moment where you know
13:28you should. And you do that over and
13:31over and over until it starts becoming
13:34the new reflex. And you should keep
13:37yourself accountable. Every time that a
13:39stop- up moment happens, you should log
13:42whether you took it immediately when you
13:43should have or not. And even though I
13:45said you should trade small for about 2
13:47weeks, the truth is is that you should
13:49stay small until you have enough proper
13:52stopouts under your belt. Meaning to say
13:55that let's say 10 or 20 situations
13:57happened where you needed to stop out
14:00and you did. And if you stopped out
14:01where you should for 10 times in a row
14:04or whatever, then you can say to
14:05yourself, "Okay, I can increase sizes as
14:08long as I continue the same behavior."
14:10But if you find yourself cheating even
14:11on small size, then honestly, you
14:14haven't earned the right to go back to
14:16your increased size. And another thing
14:18to consider is the 5-second rule. This
14:21is a rule I used a lot while building my
14:24emotional response mechanism to losses.
14:27Nowadays, I don't use manual stops. I
14:29use automatic stops and we will
14:31absolutely get to that in this video.
14:33But back in the day when I used to use
14:35manual stops or when I used to use
14:37automatic stops and then move them a
14:40little bit when they were about to get
14:41hit, then what I would do is once the
14:45trade goes to this invalidation area, I
14:47would give myself 5 seconds to stop out
14:51because the issue is I didn't want to
14:54stop out, right? So, I would put my
14:56finger on the trigger of the stopout and
14:59I would count one, two, up to five. And
15:03if the stock is still trading where it
15:06shouldn't be trading for my thesis, I
15:08force myself to click after 5 seconds.
15:11The next drill to work out is the no
15:13break even challenge. The no break even
15:16challenge is a challenge that you're
15:18going to give yourself where as soon as
15:20something goes to the invalidation area
15:22and your reflex goes to okay, I'll just
15:24hold it till it breaks even. I'll just
15:26add and hope for like a little bounce
15:28and then get out there. You have got to
15:31shut that thought off right away. You
15:34have to immediately tell yourself no.
15:36And I actually don't know how to train
15:39for that, what the drill is. And so I'm
15:41going to leave that one up to you. But
15:43find however you can do it to just every
15:46time that that thought comes up in a
15:48situation where you're supposed to stop
15:49out, you need to sort of laugh at
15:51yourself and be like, "Oh man, no, no,
15:54no, no, no, no. I definitely am doing
15:56the wrong thing if I'm thinking about
15:58waiting for break even once the
16:00invalidation point happened for this
16:02trade." Now, the next drill is super
16:03easy and should become a habit for you.
16:05Every time that you enter a trade,
16:07already put in the stop- loss because
16:09there's a psychological thing that
16:11happens if you put your stop loss
16:13immediately once you put in your trade.
16:15It forces pre-commitment and it removes
16:18that, oh, I'll decide later from your
16:20brain. And the last thing that you
16:22should add to your process is a max
16:24daily loss. There has to be a number
16:27that if you lose that number in a day,
16:30you are done for the day. And that
16:33number needs to be somewhere in the area
16:35of whatever it is that you make on
16:37average in a week or less than a week.
16:40For me, that number tends to be around 3
16:43to 4 days. Whatever I make on average in
16:45about 3 days or so, if I lose that in a
16:48single day, I'm done for the day. No
16:51questions. Personally, I like drills. I
16:53like systems. I like stuff written down.
16:56So, I'd recommend that you write all
16:57these recommendations down, follow them,
17:00and then hold yourself accountable to
17:02whether you followed them or not. If you
17:04can hold yourself accountable, that's
17:05great. If you can get an accountability
17:07partner, that's even better. But you
17:10have to know what you're trying to do.
17:13It has to be clear so that you can see
17:15if you're [ __ ] up here or cheating
17:17there, then you got to try harder. Then
17:19you got to come back and redo this
17:21process until you get it right. because
17:24we're not trying to avoid losses. The
17:26goal is to make losses boring. So things
17:28you can measure in the coming future is
17:31how many times did you widen your stock?
17:33How many times was your average loss
17:35substantially bigger than one R? How
17:37many times did you delay your stop loss
17:39from the moment that it became
17:41necessary? How many times did you wait
17:42until breaking even in order to leave a
17:45trade you know you should have left? And
17:47what's your clean stopout rate? of all
17:49the stopouts that you took, how many of
17:51them were clean, and how many of them
17:54you cheated on as a percentage, more
17:56than 50% clean, less than 50% clean,
18:00your goal is to get to 90% clean
18:02stopouts. And so if you create yourself
18:04this sheet and grade yourself, hold
18:07yourself accountable for all these
18:09metrics and you start with sizing down
18:12so that it should be easy for you to
18:14score high on these metrics. After a
18:17while, the results of this scorecard
18:19will tell you, "Hey, you're ready to
18:21increase size or no, you're not ready
18:23yet. Keep working on it." And
18:25personally, I think that trading size is
18:28a privilege that you earn only once
18:30you've proven to yourself that you can
18:32manage risk properly. And these are the
18:35frameworks for managing risk properly.
18:37Now, I want to touch on social media as
18:39an issue here because on social media,
18:41almost nobody shows losses. And that's
18:44one of the biggest problems in trading
18:46is that everybody shows you what a
18:48winner should looks like, but you rarely
18:50see people show you what a loser should
18:52look like. And you know exactly why that
18:54is. It's because people are being
18:56dishonest to themselves and to you. So,
18:59I want to go back to exactly how I
19:01started this video by telling you that
19:03the difference between the traders who
19:05last and the traders who disappear is
19:08that traders that last take losses like
19:11it's nothing. It's second nature. They
19:14don't get excited about it. They take
19:16it. Hell, they even accept it with love.
19:18I know I do a lot of times. I get
19:20stopped out and I'm like, "Ah, y'all got
19:22me, motherfuckers." And I move on. And
19:25that's the ideal that you should build
19:27in your mind, not the ideal that's sold
19:29on social media. You should start
19:32realizing that a good loss is something
19:35to be proud of. It's something to post
19:37on social media. Look, I cut it right
19:39when I was wrong. That's a great trade.
19:41If you do that, if you fix this area of
19:44your trading, then you will fix the area
19:47that is responsible for most of the
19:50reason why traders fail because they
19:53fail for two reasons. Either never
19:55developing a strategy or never
19:58developing good risk management. The
20:00biggest problem with good risk
20:01management is our emotional wiring. All
20:04right, so let's recap what we talked
20:06about today. The traders who last aren't
20:08the ones that avoid losses. They're the
20:10ones that take small losses immediately
20:12because they're really okay with being
20:14wrong. Your brain is wired to do the
20:16opposite of that. Prospect theory makes
20:18you willing to take big risks when
20:19you're down on your position just so
20:21that you break even. Risks that you
20:23wouldn't be willing to take when you're
20:24actually right on the position. And the
20:26disposition effect makes you cut winners
20:29quickly and hold on to losers for too
20:31long. That wiring creates the
20:33negotiation spiral where a normal loss
20:35turns into a way too big of a loss. The
20:38solution is to rewire your relationship
20:40with losses. Make small losses normal,
20:43procedural, and non-negotiable, and then
20:45enforce that with stop rules and sizing
20:47rules. Whenever you take a trade, define
20:50your thesis. Define your invalidation of
20:52that thesis. Set your size based on the
20:55distance to your stop and execute
20:57without negotiation. If you need help
20:59removing negotiation, use automatic
21:02stops. For the next few weeks, don't
21:04focus on your P&L. Focus on one thing.
21:06Did you take the right loss when you
21:08should have? Now go run the drills.
21:10Small size, clean stopouts, no break
21:14even, and max daily loss. Track your
21:17clean stopout rate, your exit delay, and
21:20whether you widen your stops. When those
21:22metrics improve, your trading improves
21:24because your worst possible outcomes
21:27disappear. And if you want
21:28accountability, we have a Discord room.
21:31Come join people that are going through
21:32the same journey that you are. I'm Mo.
21:35Thanks for watching. and I'll see you in
21:36the next episode.
21:38[music]
21:44>> [music]

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