Rule # 3 on being a profitable trader: Take Small Losses.
This is the corollary of Rule # 2, which is to: Avoid Big Losses.
While you should be mindful in your trading of taking losses that are too big, at the very same time, you need to be completely comfortable with taking small losses.
If you are like most traders, while you are seeking to maximize your average losing trade, and minimize your average winning trade, you are still only entering into profitable trades 50 – 60 percent of the time. This why expected value is so essential to your trading.
You have got to get comfortable with being wrong!
Good-grief. If you are going to be a trader, you are going to be wrong – and be in a losing trade about 40 – 50 percent of the time.
I mean, how many other careers are like that? Imagine in whatever other jobs you have done in the past going into work and making a decision. You decide to pursue – or not pursue some project, and in doing so, you make a decision that looses your company money 50 – 60 percent of the time.
Trading, venture capital, and film production are some of the only roles that come close to this.
But here it is. And it is simple. The key to being comfortable with losses in trading is this: Use stops in your trading – and only risk what you are comfortable losing.
A good rule to start is to limit your loss on a trade to 1% of your equity.
Have a $50,000 equity roll starting out?
Only be willing to lose $500 on a given trade.
That way, the coin of the trade can come up tails 10 times in a row – and you would only be down 10%.
This is mostly psychological. Most people care more about avoiding losses than finding gains (loss aversion), and large infrequent losses are easier to take than smaller frequent ones.
But – if you are going to be a trader, losses are something you are going to have to mentally overcome.
Take small ones – and never, ever, let one loss take you down.
There is always another trade.