Why traders get knocked out

Many traders are nervous to step into the markets because they fear losing money.

It’s a healthy, sensible fear – no one wants to lose money. And certainly no one wants to get wiped out.

And yet, again and again we hear stories of people losing their entire trading funds.

It’s estimated that over 90 per cent of forex traders lose money and end up quitting (although, I have to say that I’m sceptical of how these figures are arrived at.)

But there’s no doubt that many, many people do lose money – and some will wipe out their entire trading funds.

If we understand what goes wrong for these unfortunate traders – we can ensure that we don’t suffer the same fate.

Your trading fund

The common wisdom is that you should only trade with money that you can afford to lose. Of course, this is true. But the concept of having “money you can afford to lose” is one that’s going to get you into trouble.

If you treat your trading fund as “money you can afford to lose” – chances are, you’ll lose it.

Your trading fund may be “spare cash”, but it’s also your ticket to financial freedom. You need to guard this money ferociously.

Another question with trading funds is how much should be in them?

Too little, and you won’t be able to trade with a sensible risk profile (see more on risk below). Too much, and you could be risking more money than you’re comfortable with.

I recently read advice from a trader that you should “filter” money into your trading account. Start off small, and gradually add funds.

While there is some wisdom in this, it can also be a sure-fire way to lose a lot of money via a slow, gradual trickle – I’ve lost that £200 … so I’ll add another £200 …

What you need is a master plan.

If you’re going to add to your trading fund – that should be part of your plan too (not done ad hoc, because you’ve had a losing run and need a top up, or because you’ve had a winning run and are feeling a bit flush that week.)

Your risk profile

The number one rule here is to always trade with a stop loss. That way you’ll always know what your maximum potential loss on a trade could be.

And that potential loss should be restricted to a maximum of 3% of your trading fund (1% or 2% would be even better).

You can improve your risk profile further by moving up stop levels when you’ve hit your first profit targets (you can find out more about this technique HERE).

So, let’s say that you’re trading with a fund of £2000, and are risking 2% per trade. That means that your maximum risk per trade is £40. Therefore, if your stop is 20 points away from your entry price, you should be trading with a stake of £2 – that way, if your stop is hit, you should lose no more than £40 (your stake * distance to your stop).

Preserving your trading fund should be your priority. Every time you lose money, you’re making your job of increasing your wealth significantly more difficult. For example, if you have a big drawdown, losing 50% of your trading fund – you’ve now got to double your money just to get back to your starting point.

If preserving that money means sometimes sitting out of the market until you’re really confident of your trade set-up – then so be it. Don’t trade in a rush – be patient and be persistent.

Your mental attitude

When we look at the markets, it’s easy to see pound signs flashing before our eyes, and to imagine that we can hit it big, with huge winnings, and have a work-free life of luxury ahead of us.

The truth is that big winners are only for traders with big trading funds.

If your means are modest, and you’re trading with a sensible risk profile, you should be looking for modest winnings. And you should be very happy if your trading fund has grown by a few percentage points by the end of the year.

Realistic expectations are essential to trading success and keeping on the straight and narrow.

If you expect too much, you’re likely to start using stakes that are too high and taking unnecessary risks with your money.

Also, if you expect too much, you’re likely to become disillusioned with trading pretty fast!

Which brings me neatly to the two other essentials you need in your mental armoury: discipline and consistency.

As I discussed in my post last week, successful trading requires: simple plans and clear rules that you can follow to the letter. And that’s why a trading strategy – whether it’s one you’ve developed yourself or have bought in – is so important.

And keeping that trading strategy up an running means keeping track of your results, so you can measure just how effective it is, and assess where it requires adjustment. If you aren’t keeping records of your results, then I recommend you download the Trader’s Bulletin journal which will get you started on the right foot. (CLICK HERE to download).

Your trading knowledge

It may surprise you that knowledge of the markets comes so low down on my list.

The truth is that all traders will experience rough patches – whether they are novices or pros. What separates the successful trader from the ones who get wiped out is how they deal with those rough patches – in terms of mental attitude, tracking results, and risk management.

As a much smarter man than me put it: “The only true wisdom is knowing you know nothing.” And I think that really gets to the heart of how traders should approach the markets. The more we think we “know” about how the market will behave – the more danger we’re in of making stupid mistakes.

The best we can hope for in the markets is to recognise behaviour patterns, and gain a statistical edge by using those patterns.

And that’s where clear rules will again help to keep us in line – and on a profitable tack.

Related posts:

This quick checklist separates winners from losers How to identify turning points