It's All in Your Head Part 2: The Fear of Loss

A couple of weeks ago I wrote an article called "It's All In Your Head". I would like to thank everyone for their feedback on that particular article, as it seemed to hit home with quite a few of you out there and I enjoyed writing it very much. The last thing I was planning on doing, however, was writing a follow-up, yet much like trading for a living, unexpected events occur and you have to learn to evolve, so here I am revisiting this subject once more. As a writer and instructor for Online Trading Academy, I am used to getting a lot of emails, some from my classroom graduates, some from my ongoing XLT Futures and Forex students and others who are new to Online Trading Academy. After the aforementioned article was published, I received an email which stood out from the rest, in direct response to the article itself. This email caused mixed feelings for me and after some time, I decided to respond. This article is that response and my aim is not to offend the sender of that email but instead, help this person. I will not name this person, as you will probably know it's you, but I hope that I can shed some light on a common mistake which the vast majority of novice traders make and help to cure it. See the email below, in which all names have been removed for the sake of privacy:

As we can see, the sender has concerns that if a trader uses a stop loss order to minimize risk, they may be taken out of a trade for a loss, which then means that if price reverses again, they would then have sacrificed potential profits. This is a common theme or should I say fear among new traders and one which can kill off any potential trading career very quickly. Once again, I believe that by addressing this person's concern, I may be able to point them in the right direction, as well as anyone else out there who shares the sender's concerns.

Any consistent trader in the world today fully understands the importance of using stop loss orders. If we don't control loss, we have absolutely no chance of ever making trading work, as we simply can't get it right every time. A stop order is your best friend in the market...in fact it's your only friend, as trading itself is simply a transfer of money from one person's account to another's. The losers consistently pay the winners and if you don't protect your capital, then you need to understand that when you lose money trading, someone else out there is probably eating a better meal than you that day, driving a nicer car, living in a better home and making the most of your money by spending it on the things which they enjoy. Sounds harsh doesn't it? Sorry, but that's the reality of the market and the sooner we can grasp this concept, the better. Yet many individuals, who are well aware of this ongoing transfer, still choose to trade without stops and protection! The reason for this, like most things in trading, is not too complicated...they suffer from the Fear of Loss.

As human beings, we were never designed to trade. It's not a natural process for us, as emotions like greed and fear often lead to costly mistakes and big losses. Most are drawn to trading because they want to make quick, easy cash and lots of it! This greed or desire to be a winner is the main reason why novice traders don't use stops. If their stop loss gets triggered and they are taken out of a trade, they feel like a failure. If they make money, they feel like a success. The twisted part of this mindset is that it leads the novice to be fearful when they are making money and greedy when they are losing. They tend not to use a stop loss or put one in, then move it as it's about to get hit, because they so desperately want to make money...the thinking is that if they don't close the trade for a small loss, they may end up being right! Sometimes this works, and they end up taking a $1000 of heat before the market turns and they close the trade out for a $200 win. After this event the common thought is, "See I knew I was right," and they have just embedded the worst trading habit of all, because one day it won't come back. This is not a sustainable risk to reward parameter and things will not last long. Think about the thought process going on here: The novice is prepared to endure huge losses because they need to be right...the fear of losing money and the desperation to make money invites them to take greater losses! Typically, these traders also don't know how to take a winner either and often end up with the frustrating scenario of closing out a $150 winner, just before the market shoots off again in their direction, meaning they probably could have made two or three times as much. "I'll get it next time," they tell themselves, only to continue being fearful of losing for weeks to come as the big losses mount up and the small winners fade to nothingness. It's a vicious cycle of events and if you are stuck in this rut, then really, you need to do something about this now. What do these events look like day to day on a chart? Let's take a look:

This is a screenshot of a 30 min chart of EURUSD leading up to and after the events of the most recent FOMC Statement, an economic event which usually moves the market at quite a pace. After trading around the price of 1.4770, the currency pair jumped with force to put in a new high of 1.4843. Anticipating a breakout for higher prices the novice trader buys, right into an area where Supply is greater than Demand. This is where the seasoned trader would be looking to go short. A few hours later EURUSD found support around 1.4690. Imagine if you had been that buyer and had not used a stop loss? That's one huge draw down on the account. Now imagine you are hoping that the market pulls back to retest the highs, trying desperately to get back to breakeven...let's hope you have a big enough account to take the heat. Not a pleasant place to be, while all the time knowing that you have paid somebody else with your money and misery. In the meantime, the pro trader had exited the short where the novice went long and is now riding profits back to the upside from buying in an area of Demand, while the novice is still trying to break even. It gets worse. Some traders out there would have tried to reverse their original failing long and sold short at the pivot lows, enduring even more pain. Is this a situation one would really choose to be in? I hope not, but without a sound trading plan, the right education and strong risk management skills, this is the road many traders walk each and every day, until they run out of money to pay somebody else with. I have a saying when I teach: "I don't have to be a $1000 down to know I'm wrong when just a $100 would have told me the same thing." At the time of writing this article, EURUSD was back at the lows. Let's hope those against using stops knew when to call it a day...

On a brighter note, let me show you another email I received on the very same day, this time from one of my seasoned XLT - Forex Trading students. It reads:

I can stated in his email that he has learned to execute his plan without thought about the profit and loss, ignoring his emotions and getting on with the job at hand. Yes, it has taken time but through good education and discipline, he is now seeing that things "rapidly got better." This is how it can be, only if we follow the rules and ignore our emotions. If you don't know what the rules are then simply learn them from someone who does and apply them. It's as simple as that.

It has not been my intention to offend the anonymous sender of the email regarding the use of stops. I felt that it is something we all have had to go through on the journey to consistent trading, myself included, hence its inclusion in this newsletter. I hope that this exploration of fear has been or proves to be helpful to Mr. X, or any other trader out there in the same predicament. If you need help, then seek it. To keep doing the same thing over and over again expecting a different outcome is not the answer. That's just insane. I hope this helped. In the meantime, I promise that "It's All in Your Head" will not become a Trilogy. But then again, never say never...