“I’m always thinking about losing money as opposed to making money. Don’t focus on making money, focus on protecting what you have” Paul Tudor Jones
Marcel Link first came across the phrase “Preserve Precious Capital” when he was starting out as a trader.
While initially trying to multiply his profits rapidly, a more experienced trader suggested that Marcel concentrates on preserving his capital. Many of the worlds’ best traders will tell you the same thing. When you start out trading your priority is to keep your trading account intact and focus on minimising the downside.
Many of the world's best traders will tell you the same thing. When you start out trading your priority is to keep your trading account intact and focus on minimising the downside.
When you start out trading, your priority is to keep your account intact and focus on reducing the downside.
There is a very famous saying among traders which says
“Focus on protecting the downside and the
upside will take care of itself.”
This article will highlight 9 critical areas that will enable you to do exactly that; protect the downside and minimise the damage you might inflict on your account in those early days. Experienced traders are not immune from this either; the difference being is that their focus on protecting the downside is now subconscious and in their blood.
Experienced traders are not immune from this either. The difference is their focus on protecting the downside is now subconscious and in their veins.
“Rule number one of investing is never lose money. Rule number two is never forget rule number 1,” Warren Buffet
76% in 8 days!
Excitement and Greed are both very common emotions when taking that first handful of trades.
Most new traders are motivated from hearing stories of incredible trading success like how a good mate at work made 76% in 8 days buying some speculative stock.
With visions of turning his $10,000 into a small fortune, the new trader hits the markets with no fear, only to find that turning $10,000 into $8,000 is much easier than doubling his account.
Initially, your priority is to take very small trades where risk is minuscule compared to your overall account. By risking 1% or less of your overall trading capital, it will ensure you can learn the lessons of trading and keep you account intact at the same time.
By risking 1% or less of your overall trading capital in any one trade, it will ensure you can learn the lessons of trading and keep you account intact.
Winning and losing is usually closely correlated to your confidence as a trader.
Suffer a large number of losses or take one big loss and confidence sinks, rendering you hopeless at taking the next trade.
On the other side of the coin, those experiencing a large run of wins find no difficulty in taking the next trade as their confidence is soaring to all-time highs.
Failure to make the next trade due to lack of confidence means your system is useless.
No matter how brilliant your edge is, if you don’t take the next trade, then no profit will result. It’s as simple as that.
What are the time and financial cost of graduating with a degree in economics?
You’ll find it’s around three years full time and kiss goodbye a good portion of $50,000. That’s your tuition fees. Trading shouldn’t be any different.
The major advantage of learning the skill of trading is that your earning potential is unlimited, whereas even the economist has limitations on what they can earn.
Establish your ‘learning capital’ of around $2,000 in your first year (cheap compared to a university degree) and commit to learning the essential elements required to become a profitable trader.
Your mindset will be rock solid when you realise that you are just paying your tuition fee. Whereas most new traders get bitterly disappointed when they haven’t tripled their trading account in the first three months.
Leading on from the above example of setting your ‘learning capital’, it is vital to set some clear goals with your trading.
Initially, your goal is NOT to burn through your ‘learning capital’ of $2,000. Instead, you want to experience as much of the market as possible while minimising losses and maximising gains.
The golden rule of stock market success is to let your profits run and to cut your losses off short.
In other words, make sure your wins are on average bigger than your losses.
So in your first year, establish a goal of completing 30-50 trades with an average win at least two times the size of your average loss. Also, another goal is to ensure your trading account is at break even or better by year’s end.
Having watched hundreds of trading accounts over the years and witnessed a good portion of those wipe themselves out, it is plainly obvious that over-leveraging your trading account is the quickest way to the poor house.
Leverage is incredible when the stock markets are moving in your favour but devastating when they are moving against you.
We have seen one trader go from $100,000 to over $3million and back down to $50,000 in the space of 8 months.
Leverage is a double-edged sword that you must control. Until you have a well-defined trading plan, don’t trade at more than three times your capital base.
Traders and investors should be aware that their account balance, as it reads on their daily statement, is not how much money they have.
A trader’s actual net position is what we describe as ‘at stop loss valuation'.
This means your correct account balance has taken into consideration all your current positions with regards to your stop losses.
If the market turned against you and all your stops got hit, then that is a closer representation of your current account. Keep in mind; stock markets can gap, so it’s hard to determine this figure correctly.
Understanding your real current account balance helps you determine the next point.
What would happen if your positions turned against you and hit your stop loss? How much would you stand to lose as a percentage of your overall account?
Trading safely is about minimising worst-case scenarios. So you must have safeguards in place to ensure maximum risk in any one month is kept to a minimum.
Remember, recovering from losses is much harder than banking small wins. Set a maximum loss in any one month, a point where you stop trading.
For example, when trading stocks with no leverage, you may decide to stop trading when your monthly loss as a percentage of your overall capital reaches 6-10%.
When trading stocks with leverage, you may choose to halt the haemorrhaging when your monthly loss reaches 15-25% of your trading capital.
Losing 10, 15 or 25% of your capital is never nice, but a good trader can recover from that.
The problem starts when losses exceed 30%+ and traders typically resort to gambling to recover.
Hopefully, the term backtesting is not foreign to you. You want to backtest to determine your worst drawdown.
By finding out your worst drawdown, you can then plan your money management to ensure your maximum loss at any one time does not exceed say 25% of your total capital.
For example, if your backtesting showed total consecutive losses of 20 in a row then you can adjust your position sizing accordingly. You will want to ensure that 20 consecutive losses do not erode more than 25% of your trading capital.
Are you the type of person that when you are on a winning streak, keeping records is a breeze? But after a string of losses the record keeping gets too hard?
If so then you are not alone!
Nobody likes to record and analyse the losing trades. But if you are to preserve your capital and win in the long run, then you and record keeping are going to have to become best friends.
Having an up-to-date record of all your trades will allow you to plot an equity curve and monitor your drawdowns visually.
This is a powerful tool and will serve as a constant reminder to reduce position size when you are on a losing streak, thus preserving your capital for that purple patch.
Excel is a powerful tool that will allow you to keep great records and you most probably already have it. Microsoft's Office or Google's Sheets are two of the most common Excel programs.
If running professional portfolio management software is your thing then check out Stator-afm with their free 30-day trial.
A useful trick which you might find handy involves a little bit of computing or utilising the services of portfolio management software like stator AFM.
The idea here is to plot your equity curve and then plot a 20 day moving average of your equity curve.
The goal is to stop trading when your equity curve moves below your 20 period moving average of your equity curve (i.e., you are in drawdown).
Once you stop trading, you continue to monitor each trade of your system and resume trading once your paper profits get your equity curve out of drawdown.
While this is a little complicated, it is nowhere near as complicated as having to explain to your significant other the reasons the family can’t afford to go on that seven day Pacific Ocean Cruise!
Hopefully, these 9 rules of Investing money to make money will help you achieve your financial goals.