Reasons and lessons behind blowing up trading accounts

Mentoring

“Blowing up” means we took the account down to basically zero, where we couldn’t place a trade any longer, or something similarly distressing.

As many of you know already, I have blown up a couple accounts in my days. None for many years thankfully, but it has happened. I view it as part of the learning experience, and naturally in hindsight it would be very easy to see why I blew up, and that I deserved it.

We can’t expect to make poor trades and be consistently profitable. Blowing up an account (no matter how large or small) isn’t necessary to become successful, but it has a tendency to smack us on the head with reality. It also seems to separate the pretenders from the contenders.

If we are willing to evaluate the damages after blowing up, then regroup and come back to attack with the new knowledge gained, we’re on our way. There’s no guarantee of success, but we’re a step closer than we were before. Like the old proverb says – “A man who wishes to travel a 100 miles should consider himself halfway at 90 miles.

Let us stick to the point here for a moment. There are numerous reasons for blowing up an account and I would like to highlight a few here.

Reasons for blowing up an account

1. Trading without stoploss

I can still clearly recall several times in my trading career where I thought I had solved the puzzle, and literally unlocked the mystic gateway (holy grail) to making money in trading. During those times, I would repetitively see the price hitting my SL and atleast come back to original entry point(or move into profits). This created a new connection in my brain and the next time the trade goes near the stoploss, I would gladly remove(or move the SL away from the entry further) the SL as market has a tendency to come back to breakeven point. Boy, I was so wrong. This can be brutal to the trading account.

2. Focusing on potential gains and not potential losses – ignoring risk

When we do focus on potential gains and not on potential losses, we tend to trade bigger (by usually using more leverage and not necessarily more capital) or risk more to get those desired returns.

Those who focus on making as much money as possible while ignoring risk will invariably lose the majority of their accounts. No matter how talented we are, we will face ruin, just as Jesse Livermore did and Victor Niederhoffer did on several occasions. Even the best traders like Alexander Elder and Nicolas Darvas blew up accounts when they first got started. Why? We simply can’t out trade the risk of ruin. If we risk a consistent 10% of our initial starting capital per trade we are done after just 10 losses. Everyone who has traded for any length of time has had ten losses in a row. If we risk 1% of our total starting capital per trade, 10 losses in a row will only bring us down 10%.

3. Not tracking the trades

A trader executes a strategy (usually not well-tested) and accumulates losses due to standard drawdown. But, without a trading journal, it is almost impossible to know where we are or are going, if we have no record of where we have been. I strongly believe one of the best things a trader can do is start keeping a journal.

Unfortunately, this does not seem to be the case for most of the traders. In the process of selecting candidates for mentoring, I had talked to at-least 60 people and the common theme among these budding traders is that they never maintain a history of their trades.

Lessons learned from blowing up an account

1. Taking responsibility for our actions

What I learned during these painful events was that I was wrong. I took responsibility. That is the first step.

Taking responsibility is the key. Accepting that we (temporarily) failed, and that we don’t know everything. From there, we can start building a solid foundation. We should be asking questions like what happened and why. This isn’t so much about investigating specific trades, but instead analyzing our overall behavior.

For example, did we bring a new methodology from forums/twitter without fully testing it? This is a difficult lesson to learn, particularly because most people simply don’t know how to properly test. So then, we would have to acknowledge we didn’t test properly (if at all), and go about learning how to do that.

2. Maintaining proper risk management

Another very difficult lesson was that we can be right about a trade, but still lose money. The market can remain irrational longer than we can remain solvent. This lesson involves learning about risk and proper money management, so that when we are in a bad trade it doesn’t do crushing damage to our account.

A key lesson is that we must live to fight another day. The single most important factor in trading is survival. The longer our survive, the more experience we gain, and eventually given enough time that experience will become valuable by providing we an edge over all of those with less of it.

3. Recording the trades – Trading Journal

The lesson we learn from the journal is not about recording our trades and screenshots, it is about learning our behavior. We must routinely go back and analyze what we have written, identify mistakes and patterns. Learning about our strengths and weaknesses in an objective way is crucial, so that we can then further develop in those areas. It is critical to be honest in our journal. It is important to talk about why we made a trade or decision, not just list the entry and exit price. It will also be helpful if we record our emotions during entry, while in the trade and during exit. This would clearly demarcate our emotions during those times and would reflect back on which feelings are overwhelming us and when.

4. Get out of simulated(paper) trading

Many aspiring traders sit on simulated environment (paper trading) for a long time – sometime months and even years together. I always advocate that paper trading is virtually worthless as a learning tool (unless it is done to understand about the trading software nitty-gritties) and when I unequivocally put that point across, people can’t reconcile that thought easily as it directly undermine their dream of becoming a successful trader one day.

The fact is, the majority of people are not good traders and are not cut out to make it in this business. It is a very harsh reality, but there is no denying it. Unfortunately, everyone thinks they are the exception to the rule.

If we want to be the exception to the rule, then we have to be put ourselves in a competitive position. That means being sufficiently capitalized, and having sufficient real trading experience (again, paper trading does not count).

You don’t have to take my word for it. Everyone that goes from paper trading to cash loses money, no matter how much of a rock star they were on paper trading. It’s my belief that the longer we are on simulated environment, the worse we condition our mind for bad behavior and thus the more likely we are to fail as a real trader. Again, you don’t have to take my word for it, it has been proven countless times before.

The entire point I am making — paper trading is not trading education. The real education is obtained once we start trading cash. We do not need to risk our monthly salary. Just start by risking a small amount and get off that orgasm-inducing paper trading.

Final thoughts

When we blow up an account, it is time to ask tough questions to ourselves – are we willing to commit the time (and money) that this profession takes to succeed? Look at it like any other profession. We need years of dedication and experience to become successful and even then, it still doesn’t happen for everyone.

When we have a stake in the game, it is completely unlikely what it seems to be when we are just watching it. We will find that trading is mostly about the acceptance and management of risk, and the management of our own reactions when we have money on the line, and are either making it or losing it. Both success and failure have their own psychological/emotional pressures, both can garble our judgment, and learning to handle the issues that both give is probably more than 90 percent of what real trading is about. The things that we are able to learn by studying the market are about 10 percent of the puzzle, if that. Really.

Happy trading all !!

Trading Q&A – Discipline

Mentoring

Someone asked me a question on ‘how to be disciplined all the time?’ and there was no easy answer. He was disciplined in following his plan most of the times but could not do it 100%. Tried my best to address this typical mindset.

Here is the question (quoting it) and the complete reply-

Question:

“Is/was breaking system/method rules a problem for anyone here? How did you/do you plan to overcome it? It is a problem I struggle with often, I have many days when I dont break rules and suddenly, the gambler in me, the tuktuk in me all get out on a single day and try to destroy my profits. It is not a continuous thing, I do follow rules most days, the gambler and tuktuk guy remain suppressed until one day they rear their ugly heads. Would be great to get some help in overcoming this failure in part, almost feels like a character flaw”

Answer:

We all go through this from time to time. If a trader is disciplined 90 pct of the time and if occasionally there is a lack in trading discipline, the reasons could be multifold —

Probable causes of the problem:

1. Lack of fit between the trader and the trading system

Discipline problems are not due to trading woes. Usually, there is an underlying problem. Just as a problem maintaining the “discipline” of monogamy in a marriage is frequently the result of underlying relationship difficulties, failing to be faithful to one’s trading plans is often a sign of conflict between the trader and those trading plans.

When traders who are normally disciplined find themselves breaking their trading rules, the momentary lack of discipline are a symptom of a lack of fit between who the traders are and what their rules demand. A fine system on paper is unprofitable if it cannot be followed by a trader. A trading method not only needs to be good; it needs to be good for the trader. A trader and a trading system should be like lock and key – it should be a perfect match !!

2. Trader trying to fulfill his short term needs

Sometimes, the lack of discipline involve failing to take trades that are indicated. Other times, the problem is one of overtrading – taking trades that lie outside of one’s rules. If we think of momentary lack of discipline in other areas–cheating on a diet, for example, or procrastinating on work that needs to be completed–we can see that, many times, we act against our longer-term self-interest by becoming caught up in shorter-term needs. If, for example, we cannot tolerate boredom, we might eat to fill the void and break our diet.

Solutions

Problem # 1

Keep a journal and truly investigate each of your small trading discipline slips. Then view those slips as information, not as problems. What do they say about you? Which rules do you find yourself breaking, and what is actually conflicting with those rules?

Now look at your trading successes. What came naturally to you? What rules and plans can be derived from those winning trades? Don’t force yourself into a pre-made set of trading plans (usually derived from somebody else’s plan) but rather, identify what you do when you win and see how you can make *that* into your system. This is one of the primary reasons why ‘copying’ someone’s system never work in the long run.

Problem # 2

When discipline works, it’s often because people have found constructive ways to meet those short-term needs. The smoker who craves a cigarette may chew gum as a substitute oral activity.

The key to sustaining discipline is to identify the specific short-term needs that are occasionally overshadowing trading rules. Once you’ve made that identification, it is easier to then brainstorm constructive ways of addressing those needs. Traders who overtrade, for example, often have problems during quiet market times. Their needs are for stimulation. By creating stimulating activities during the trading day that don’t take them away from their screens, they can avoid using unwanted market activity as their stimulation.

Other times, traders fail to follow their rules because they don’t truly have confidence in their ideas. They front-run their own signals out of anxiety and wait for perfection in setups before they act. Their short-term needs often are for safety and security – they need to believe in what they’re doing. Very often this problem occurs when traders have short-circuited their learning curves. They are putting meaningful capital at risk before they’ve done small real-time trading that is needed to build a successful track record. You believe in your system when you see, in your own experience, that it works over time, across market conditions.

So, keep working on your problems and am sure you will better off gradually!!

Good luck and hope it helps