Have you ever placed a trade without a stop, only to see the market go against your position ?
And let me tell you, it didn’t end well.
The issue of holding on to losing trade’s stems from a problem traders face called ‘the need to be right’
The need to be right has been the downfall of many traders. Whether you’re an institutional trader in a bank or a retail trader trading from home, when traders get caught in the trap of needing to be right it can cause unprecedented financial damage.
My objective with today’s article is to give you some background as to where the problem of needing to be right comes from and what you can do to overcome it. Whilst this wont be easy, it is possible to reduce its effects to a point where it will no longer be an issue for you. Besides this I’ll also show you a real life example of just how severe an issue the need to be right can become when it affects traders in an institutional environment.
The Downfall Of Barings Bank
I think the best way to start this article is by giving you an example of how the need to be right not only affects retail traders, but professional traders in charge of millions of dollars.
Barings bank was one of the oldest banks in the world until a trader by the name of Nick Leeson caused the whole bank to collapse after suffering huge losses from unauthorized trades he was making.
Leeson was head derivatives trader in the Singapore branch of Barings bank, in 1992 he began using one of the banks error accounts to hide the losses he was incurring on the bank.
The massive losses he was taking were not noticed by the London branch of Barings. This was due to him not only holding the position of head trader, but also head of settlement operations. Being the head of settlement operations meant he was responsible for reporting any losses made by the traders in his department back to the London branch of Barings.
With no one to report to Leeson was able trade unsupervised, he exploited this role by reporting his trading activity back to the London branch of Barings as begin profitable when really he had made significant losses. By the end of 1994 his losses had cost Barings almost 200 million ! Not only was this bad he told the London branch he had made them 102 million in profits !
As head derivatives trader Leeson’s trading strategy was supposed to be arbitraging the price differential between the prices of the Nikkei index found on the Osaka securities exchange in Japan and the prices of the Nikkei index found on the Singapore international exchange. However, instead of buying on one market and then selling on another like he was supposed to, he instead brought on one market then failed to sell on the other.
By the time the Kobe earthquake struck in the beginning of 1995, Leeson had already taken huge losses on his trades, the earthquake only ampifed these losses. As the markets fell, Leeson continued to bet on a recovery occurring to no avail. In early 1995 Leeson sent a confession note to the chairman of Barings apologizing for the losses he had inflicted on the bank, this was all in vain however because at this point the losses made by Leeson had ballooned to 850 million ! Which was essentially all the capital the bank held. Not long after Leeson sent the confession note to the chairman of Barings, the bank went into administration, eventually being brought up by ING a bank based in the Netherlands for the measly sum of £1. The various different branches were sold off, with only the asset management division being absorbed by ING itself.
Although this is a rather extreme example (I doubt any of our trading is going to bring down an entire bank) the fundamental problem nick faced was the same as what many traders face themselves, the need to be right or rather, avoiding being wrong. Not only did nick want to avoid being wrong when placing trades he also didn’t want to face up to telling people about his losses. It was only when knew things were too far gone that he decided to inform the chairman of baring of his activity, ( though it should be mentioned Nick did try to flee Singapore, so technically he still couldn’t admit to his losses ) Had nick admitted to the 200 million in losses he had made back in 1994 there’s a high probability Barings bank may still have been around today as the bank still had around 300-400 million capital left in its accounts.
One of the biggest issues traders encounter is holding on to losing trades. You may have found yourself in this situation before ?
After placing a trade without a stop the market begins to go against your position and instead of closing it like you know you should, you hold on it with the hope the market will eventually return to your entry point. You rationalize your decision by saying things like “It’s got to turn around at some point” or “The markets can’t go down forever ! ”
Eventually the loss on the trade becomes so big that you have no choice but to admit that you were wrong and close the trade, losing alot of money in the process.
We all want to be right on the trades we take. When you place a trade you want the market to move in the direction you’ve placed your trade because you want to make money ! The reality is alot of times the market won’t go in the direction you want, and when it doesn’t you have to be quick in letting go and accepting you loss. If you don’t, its possible you could do end up causing yourself alot of unnecessary financial damage.
Losers Average Losers
If you search around online you’ll find a famous picture of Paul Tudor Jones sat at his trading desk with a poster in the background which reads “losers average losers”.
Averaging is a method traders who suffer from the need to be right will use when the market has moved significantly against their position. Rather than closing the trade at a loss, these traders will start placing more trades in the same direction as the trade their losing on.
This is a situation where accounts are likely to be margin called.
To go from losing a large amount of money on one trade to then multiply it by placing more trades in the same direction is a recipe for major disaster.
At any point the trader could have hedged his losing trade by placing a trade in the opposite direction, however the thought of doing this never enters his mind because his ego is so concerned with not being proven wrong on the losing trade, he would rather lose money than accept he was wrong.
When starting out trading forex you may have spent some time demo trading, you may have found when demo trading that you were able to make consistent profits, maybe this wasn’t the case when you were a complete beginner and had no actual knowledge of how to trade as during this time costly mistakes are easily made, but when demo trading with a proper trading strategy you plan to use when live trading what you’ll tend to find is your able to make consistent profits.
This is proof the most important component to successful trading is having the right mindset ! If people can make money demo trading using the same strategy they would use when live trading, it means the mindset traders have when demo trading is the one they need to be replicating when live trading, traders don’t care whether their right or wrong when demo trading because nothing personal to them is at risk, the money’s fake, it doesn’t matter if you win or lose.
Compare that with live trading when every profit or loss causes the trader to suffer incredible emotions then its clear to see the money at risk is the main issue.
The concept of being right or wrong is linked to the pain traders feel when losing money. If you were trading with an unlimited amount of money you would find that you wouldn’t care about the outcome of any individual trade, meaning your ego is not involved in decision-making process. What difference does it make if you win-lose when there’s an unlimited amount of money available ?
How To Remove The Need To Be Right
The only way to eliminate the need to be right is to lower the amount of money risked on each trade to an amount that your comfortable with losing. Theoretically, if the maximum you could lose on any one trade was £1.00 would you care about being right or wrong ? Do you think you would cling on to losing trades ?
If you trade with money you can’t afford to lose then lowering the risk to a point your comfortable with is impossible, as every loss you make is magnified by knowing your unable to put any more money into your trading account.
The best way to remove the need to be right is to always be making money.
I know this may sound stupid to some people, I mean, the whole point of this article is to give people methods to remove the need to be right in order for them to make money, for me to tell you the best way of removing the need to be right is by always making money is a bit of a contradiction.
But think about this for a moment ?
If you were in a trade right now which was in profit to the tune of £1000 do you think if you placed another trade you would care about potentially being wrong and losing £10.00 ?
I’m guessing you probably wouldn’t ? Why ?
Because you’ve already made £1000 !
What difference does it make losing £10 when you’ll still have another £990 left ?
The question you have to ask yourself now is” How do I put myself in a situation where I’m always making money” ?
Well the only way I think its possible to do this is by holding on to the trades you place for longer amount of time. Trading setups on the daily chart whilst simultaneously trading the 1 hour chart will allow you to not care so much about the outcome of your trades. The trades you take on the daily chart, whilst being less frequent, have a higher chance of working out and making you money than the trades you take on the 1 hour chart.
The majority of traders do not trade like this because their too focused on the outcome of their current trade.
Let me ask you something. When you place a trade, do you sit in front of the screen and watch the market to see where its going ?
I bet 90% of traders who read this do.
If you have trades placed on higher time frames which are making you money what purpose would it serve to sit in front of the screen and watch the market to see how your current trades are going to play out ?
There’s no need ! Your making money !
What I suggest you do is only take trades off the daily chart until you get into a profitable position. When the trade is in a little bit of profit don’t close it, instead, leave it open and begin taking setups off the 1 hour chart or whatever time-frame you usually trade on. With the daily trade open and making money, your mindset trading the 1 hour chart will be different, because you know any losses from trades taken on the 1 hour chart will be covered by the trade you have open on the daily chart.
This will ease the problem of “needing to be right” as well as other trading psychology issues like not taking trades which meet the criteria of your trading plan, this is down to the fact that your less scared about the outcome of any individual trade you place.
If you take a loss on a trade its effect on your psychology is neutralized because the loss is covered by the gains your making on other trades.
Below I’ve listed some strategies and articles available on this site which you should read to learn how to trade in a way where your always making money.
The only way for you to reach your full trading potential, is if you remove the need to be right. This will be an ongoing process, its impossible for you to just suddenly get up tomorrow and think “I’m not gonna care about being right or wrong anymore” and actually believe it, because as soon as you lose money on
If you cannot trade two times frames at once then the only other way for you to remove the need to be right is by risking less money on each trade. This can be achieved by becoming better at getting tighter entries into the trades your placing. The better the entry, the smaller the distance of your stop-loss from the entry price.
Whilst risking less money on your trades is simple enough, getting tighter trade entries is a little more difficult. The only way you can do this is by increasing your understanding of the market and the trading strategy you use to trade it.
The more proficient you become in understanding the market, the easier it will be for you to predict when things are going to happen. This means your entries and exits will be more accurate allowing you to get into trades with a smaller stop-loss.