In our last lesson we looked at what one can reasonably expect to earn from their trading over the long term, and how one can avoid the common misconceptions of most traders which ultimately cause them to fail. In today’s lesson we are going to look at the next step in developing successful money management strategies which is how to manage your losses.

One of the main key’s to successful trading is the preservation of capital. Beyond the obvious point here that if you loose your trading capital then you will be out of the game, is the fact that it takes much more to come back from a loss than it does to take the loss you are trying to come back from.

As an example here lets say you start with $10,000 and loose $5000 from a string of bad trades. That $5000 loss represents a 50% loss on your account which now has $5000 left in it. Now ask yourself this question. What percentage gain will you need to make on the $5000 left in your account in order just to be back to break even (the $10,000 level) on your account? If you have done the math correctly you will see that in order to make back the 50% loss you took on your account you will need to make a 100% return or basically be twice as successful in your comeback as you were unsuccessful in your draw down.

It is this concept that is one of the most important to understand in trading, as it underscores the importance of protecting one’s trading capital, as it shows the difficulty of coming back from a loss in relation to the ease of taking a loss. It is also most traders lack of understanding of this concept that causes them to take risks which are way to large and is a major contributor to the high failure rate among traders.

That’s our lesson for today, in tomorrow’s lesson we are going to talk about how to design a plan before entering a trade or managing the position in case it starts to move against you so we hope to see you in that lesson.

As always if you have any questions or comments please feel free to leave them in the comments section below so we can all learn to trade together, and good luck with your trading!

I have another question too. What about cost opportunity along with spread cost and trade losses? Is this too much pressure on the profit goal and trader?
Also, taxes; did I miss the lesson on that?

...and TX for the EliteTrader.com suggestion. You get quite a few opinions over there!

Hey Ivan,

Good to hear from you.

I am not sure what you mean by cost opportunity but if you would not mind expanding on that a bit I will do my best to answer your question.

As for taxes I have not done a series of lessons on this yet however we do have a thread with some free third party resources where you can learn more on taxes until we get a course together here. You can find a link to that thread below:

Tax Resources for Traders - Forex, Futures, Stocks

Glad you liked the Elitetrader reviews I agree they are quite helpful.

Best Regards,
Dave

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Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.

Yes OK, cost opportunity is the loss I have accrued because I have money in a trading account and not earning interest in some interest baring instrument (no risk); in affect losing yield each day I’m not in a positive trade situation. Is this a component of a traders target yield calculation (i.e. I’d like to get 25 pips but I need 26 to cover cost opportunity) or is it considered just a cost of business (assuming we’re running this as a business).
I realize that this sounds a bit sticky but considering your assertion that a very large number of trades fail one could run a full month or more with negative net yield that would be compounded by trade spread costs and whatever in taxes ( I’ll review the lessons on that) plus cost opportunity.
TX

Its a good point that when you lose money trading you are not just losing the money in your trading account but also the opportunity to make a risk free return in another instrument.

This is why I think it is important for new traders to start small and only grow larger after they have proven their strategy can outperform what they would get investing in what are considered risk free assets or a diversified portfolio of instruments designed to track the overall return of the market.

Best Regards,
Dave

__________________
Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.