Ever had a big loss you wish you’d managed better? Be honest, we all have. When trading the financial markets discipline is paramount. Ask any successful trader and they’ll concur. A dollop of luck is important, but sticking to key rules is essential.

Without discipline one’s trading lifetime can easily be cut short prematurely. Closing losing positions early, before they get out of hand, can help keep your capital intact for far longer, giving you the opportunity to keep trading and recoup those inevitable losses. Either by trading the same instrument again or trying a different one.

If a position goes against you, close it and move on. Holding on to it in the hope that it comes back (it might do, but it might not) is a classic mistake, refusing to take a loss. It’s often the reason for a short-term trade becoming a long-term trade, one that becomes a millstone round your neck. Lots of decent profits versus a few small losses make a much more happy and profitable trader.

As Victor Sperandeo wrote in Chapter 3 of his must-read “Trader Vic – Methods of a Wall Street Master”, the three things to focus on are capital preservation, consistent profitability and pursuit of superior returns.

Most traders lose money by risking too much on each trade, over optimistic about how successful they will be. Instead of focusing on a few big winners, he suggests, 1) protecting your capital, 2) working towards consistent decent returns and, 3) using only part of your profits to increase future risk. Trading is a long game. Big wins will come, but what does it matter if you’re not in a position to capitalise?

Protect your capital

When looking at a potential trade the first question is, quite naturally, “what profit can I make?”. However we also need to ask “what loss am I prepared to take?”. Most overlook the latter. A risk vs reward ratio of 1:3 or better is good. Calling every trade correctly is unlikely. When a trade comes good, the bigger reward should go some way to helping make up for the inevitable few losses incurred previously. The trade should also be allowed to run as far as possible, using trailing stops to lock in gains along the way and close out with a profit when the price eventually turns against you.

Profitability. Consistently

To grow your capital you need to be consistently profitable. To be consistently profitable requires you to preserve gains and minimise losses. Putting at risk the full value of your account on your first trade would be extreme. All your eggs in one basket is gambling. The aim is to find trading opportunities and ride the momentum. If a loss is taken, it should small, leaving maximum capital for future trading.

Capital allocation

One way to protect your capital, and prolong your trading lifetime, is to limit any particular trade exposure – say 20% of your pot. Stops losses can then be used to limit individual trade risk – say 5% of the trade. This equates to risking just 1% of your pot on each trade.  If the trade goes against you, and your stop loss triggered, then a whole 99% of your account remains available to trade. Each time a profit is made, half of it can be used to increase the risk on the next position.

Summary

Discipline is easier said than done. It requires being honest with yourself, admitting a decision was wrong, putting one’s pride aside. Nipping a bad trade in the bud can make all the difference between being able to continue trading and not being able to do anything about it.

Be honest. Be consistent. Run profits not losses. If you’re disciplined, your capital should be able to take you a long way.

Happy Holidays and enjoy the break!

Mike van Dulken, Head of Research, 22 Dec 2017