You’ve undoubtedly heard the phrase, “He who fights and runs away, lives to fight another day.” But what about trading? Does he who trades and runs away, live to trade another day? While running away from a fight can be seen as an act of cowardice, if you are up against an unbeatable opponent, running away just may save your life. The same thing goes for trading. Running away from a losing trade can literally save you. I’ve seen traders ruin their accounts, their marriages, or even their lives due to massive losses in the stock market. It’s not a pleasant subject to talk about but it’s an important one. Take a look at the following charts.
SHOP, SQ, TDOC, NFLX, ZM, and UPST were at one point in the recent past the darlings of wall street. But where are they now? Even the mighty Amazon has fallen onto hard times. In crypto, Luna has collapsed to unimaginable lows.
At some point, I owned all of these. I’m actually planning on having some of these charts blown up to huge poster size to hang in my trading room. They will be an ever-present reminder of what happens to those who disregard risk management. Take a look at those charts again. Let their images be burned upon your mind, so that they will never be forgotten. The next time euphoria hits and stocks start to go parabolic, they’ll be a good reminder of what can happen when the market turns and of the inherent dangers that are forever present to a trader.
Looking at these charts, I can’t help but to imagine what I would be feeling if I still owned them. I can’t think of a time where I have been more grateful for stop losses. Sure, during bull markets I look foolish to be stopped out only to see a stock turn around and rally without me. But that’s not the point of stop losses. We use them not to be perfect but to manage our risk and to protect ourselves in the times when things go terribly wrong. Remember, there are no good stocks unless they go up. No matter how much I love a stock or believe in its’ technology, I’ve learned the hard way that the market is always right. While it’s not exciting or macho to be a weak hand, weak hands are rich hands now and forever. There is and always will be massive risks in the market and those who don’t respect risk eventually pay an extremely heavy price.
The markets can be a very cunning and shrewd master. After many months of a bull market, it’s so easy to be conditioned to buy the dip. After all, it’s a strategy that works over and over again for years with massive success. The market begins to bread complacency amongst traders and a complacent market is a dangerous market. But here’s the deal though: it's the one time when buying the dip doesn’t work that can ultimately be the end of you. Writing about this phenomenon, Jesse Livermore once remarked, “This semisucker is the type that thinks he has cut his wisdom teeth because he loves to buy on declines. He waits for them. He measures his bargains by the number of points it has sold off from the top. In big bull markets the plain unadulterated sucker, utterly ignorant of rules and precedents, buys blindly because he hopes blindly. He makes most of the money until one of the healthy reactions takes it away from him at one fell swoop.”
While it can be painful to the account and the ego to take a small loss, it’s the only way to prevent a big loss. Although it’s nice to be optimistic, wishful thinking and seeing the world through rose colored glasses can be very dangerous to a trader.
When thinking about the past, it becomes evident that human nature and the laws of speculation never change. But the lessons must be learned over and over again by each new generation of traders as the memories of the past fade away as the next generation of traders begin to take over. Manage your risk and never get complacent. While it can be frustrating to take small losses, it is the only strategy I can think of that will allow you to “live to fight another day.”
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