“Where you want to be is always in control, never wishing, always trading, and always, first and foremost protecting your butt.” -Paul Tudor Jones

This week was a lesson in how well traders managed risk, and how fast they could cut losses when they were wrong. If you made money this week, BRAVO! However, the majority of traders likely lost money in the Bernanke Put trade. Most call option buyers were losers this week, and most put sellers were crushed. This was a week that traders learned if they were managing risk effectively and  would suffer single digit losses, or if they caution to the wind and would blow-up in leveraged positions.Buy the dip traders lost money for the first time in a long time.

This market has been a difficult environment both emotionally and financially, with many head fakes and reversals, followed by the plunge. Luckily, the market forces traders to take two days off each week. It is time to reflect on our trades and see what we can do to get better. For most traders, there was little they could do about this week. It was volatility and choppiness  that caused many systems to lose this week. This is the kind of week that separates the traders who manage risk, from the traders who do not.

Many will be surprised that great  traders are not born that way; most blow-up there first accounts. For example, Alexander Elder, Dan Zanger had to start all over again after going to near zero the first time out of the gate. Nicolas Darvas also had a huge drawdown of over 50% before making his $2 million. While the 1% risk rule can change a blow up into a drawdown,  mental errors are what cause traders to risk too big, and do so at the wrong times. Account blow-ups usually stem from psychological limitations, and not bad math.

Account blow-ups are usually due to not implementing proper risk management, but psychological  mistakes are WHY traders stop managing risk.

  1. Trading too big to get back to even.
  2. Going ‘all in’ on one trade that they believe they just can’t lose.
  3. Being on the wrong side of an asymmetric trade.  Being short options for possible small gains if right, but big losses if wrong.  Eventually, this will blow up.
  4. Fighting a trend over and over again. A trend that a trader or investor can not see the danger because shorts look better the higher a stock goes, and longs look like they are getting a bargain as the stock sinks.
  5. In a losing trade, the trader starts thinking “add more to a losing position” instead of “I need to cut my loss short”.
  6. The trader believes they are right and the market is wrong.
  7. Traders are trading markets they do not fully understand. Traders must fully understand the risk and leverage involved  in currencies, futures, options, and commodities.

“The elements of good trading are: 1, cutting losses. 2, cutting losses. And 3, cutting losses. If you can follow these three rules, you may have a chance.” -Ed Seykota