Lose or die

In the movie Moonstruck, the late great Olympia Dukakis wonders out loud, 'Why do men cheat?' She concludes that it's because all men are afraid to die. She then turns to her cheating husband and says, 'Cosmo, I just want you to know that you are going to die.'

It's a great comic scene that could easily be repurposed to our world of trading, with Ms. Dukakis wryly staring at a group of traders and asking, 'Why do all you schmucks go on tilt? Because you are afraid to lose. And I just want you to know that you will all lose.'

Trading, of course, is the business of losing. Yes, yes, I know that we are all taught that it's the art of winning, that trading is the one place where you can take a dollar and turn it into a million. But the truth is that winning is often accidental, while losing is always a matter of choice. If you don’t understand that from the start, you will more likely turn a million into a dollar.

As Nassim Taleb often says, the single greatest predictor of a hedge fund blow up is a high Sharpe ratio. So if someone shows you a perfect 45-degree sloping equity curve, you can be 100% certain that they will lose all their money.

To even begin to make money in trading, you need to make peace with losing. This is admittedly very hard to do, and it has taken me years to always trade with a stop. Yet even that will not be enough to save you from tilting if you continue to force trades against a market that is all too happy to take all your money.

Monroe Trout, one of the best Market Wizards ever, had a great formula for how to trade. If he lost 1%, he stopped for the day. If he lost 5%, he stopped for the week. If he lost 10%, he stopped for the month. Think about how much money could have been saved if we all followed those simple rules.

Every single strategy you use will lose and will lose mercilessly. If you don't understand exactly how that can happen, you will always be shocked and dismayed when the system fails and conclude that nothing works.  That's not true, of course. Your strategy may work very well... under a certain market regime. But as I often say, there is no strategy that you've created that I cannot destroy in five minutes flat with a proper shift in market regime. That's because all strategies fall into two broad categories: continuation and mean reversion, and each is successful or not only to the degree that it fits the price action going forward. So, change the price action and your results will change drastically.

That's why the single most useful data you can have from your backtest is all the periods of loss. Stop looking at the winner and start studying the loser. Once you know EXACTLY how your system loses, not once, not twice, but perhaps as many as ten times in a row, you can begin to imagine such possibilities and prepare yourself psychologically, technically, and financially.

In trading, it's always the 'Why is the market doing this to me?' question that spells the inevitable doom for your account. The market will always do it; it is your job  to step the f- back when it does.