Attachment to Results Part Two—holding or adding to a loser
For the most part, almost all losses can be traced back to the same root problem. By losses, I am not referring to the usual and reasonable winners-versus-losers results successful traders have; I don’t mean “a particular loosing trade”. In this case I mean a consistent and net loosing result that occurs over time. The inability to cut losses is the symptom; the actual problem is a variation of the same theme basically all the time. Most significant or consistent losses are a result of some form of attachment to results on behalf of the trader. Not placing initial stop-loss orders, holding losing trades past a reasonable time, overtrading, etc. are all symptoms of an emotional attachment of some sort. In those cases, the trader simply cannot “let go” and exit the market. Nothing says that you have this problem louder than holding or adding to a loser.
In the case where a trader feels compelled to add to a losing position, the problem is actually a more severe manifestation of attachment. In the case of a loss getting larger than originally intended or several small losses all adding up to a large cash debit; the problem is a lack of discipline or a denial of the actual net order-flow. In the case of adding to a loosing trade the attachment is now a more internal conflict inside the trader and shows a dramatic form of inflexibility.
In this case, a trader is unwilling to see objectively and the cash loss is ignored while at the same time risk exposure is willingly increased. All other common sense concerns that at any other time a trader would agree were in the best interest of his account are completely discarded. The trader is actively participating in his own demise. Somewhere inside the trader there is a conflict and that conflict has nothing to do with market price action or the net order-flow. It has to do with the trader’s own unwillingness to protect the account, his “need” to be right, his hope that “the market will come back” or any other justification process that particular trader has to hold a losing trade in the first place. But instead of holding a loser past a certain point, in this case the trader actively increases his risk.
If we stop and use a clear head when we trade, what benefit do we receive by willingly increasing our risk and our cash loss? There is no benefit whatsoever as far as our long-term trading success is concerned. Why then do some traders add to losing positions?
The psychology behind “Never add to a loser” is very simple: Don’t throw good money after bad. The only way you or any trader could be in the position of holding or adding to a losing position is if there was a failure to define the risk before the trade was done in the first place. Rather than accept a reasonable loss and learn the lesson that loss has to teach you the trader, the trader now makes a conscious and deliberate act based not on the fact of the net order-flow but on the trader’s own emotional need for something. That need may be to get back a loss, a need to fight with the market, a need for the market to pay a profit, a need to make a car payment or any number of little ways of saying the same thing. In the case of adding to a loser the trader is complicating the process of cutting a loss by making his situation more difficult and this act is based on something the market doesn’t have any knowledge of to begin with: The trader’s own emotional need.
Remember, the market only moves because of the net order-flow imbalance. Once you have executed and are now in a position, you are no longer in control of the net result to your equity. If you are not on the correct side of the net order-flow as far as your chosen position is concerned, your account will accrue a cash debit until you liquidate; or the net order-flow turns in your favor. If the net order-flow never turns in your favor it is possible you could run out of margin funds before the price action stabilizes. By doing anything other than liquidating you are increasing the risk that you will suffer ruin. Adding to a losing position is actually pyramiding your loss! As an intelligent individual, how ridiculous does this sound to you? What trader would willingly put himself in the poorhouse at a geometrically faster rate?
As a serious trader looking to master your game you cannot afford to allow emotional or perceived psychological needs to influence your willingness to protect yourself. The reason you must never add to a loser (under any circumstances) is because the probability of being on the correct side of the order flow has already become evident due to the open-trade loss you already are holding. You are on the loosing side to begin with, you haven’t seen it right and that FACT alone, in and of itself says “liquidate”—nothing else. Failure to liquidate means a bigger loss. Adding to the loser means an even bigger loss. How is that in your best interest? Ask yourself exactly what is the reason you feel the desire to add to an existing loss. If you take a step back and think it through, the reason will most likely be some form of emotional attachment to the trade results and some form of unwillingness to do the right thing. Adding to a loser is a symptom of a bigger problem the trader has; no real control over his feelings or emotions. A trader in that position is an accident waiting to happen.
Some traders make the mistake of defining a “loosing trade” as a factor of cash debit. By that I mean, an entry execution followed by a liquidation execution and the two prices marked into the trading account is a net minus dollar amount. I think it is far more beneficial for you to re-define your concept of a loss to include more focus on the issue of personal discipline.
If you find yourself executing into a market for some reason and on further evaluation of your actions you come to the conclusion that you are doing the wrong thing for you personally; you need to liquidate to exit the market immediately. If you have broken a trading rule, if you have done a trade because of something you normally wouldn’t trust as an indicator, if you have emotionally wanted a profit, etc. you are most likely taking more risk than you otherwise would have. Ruthlessly liquidating to protect yourself is your best option; even if the trade had an open trade profit at that point. A “loosing trade” is any trade done for any reason if your personal discipline has been broken to make that trade.
Once you re-define a loosing trade from the point of view of your personal discipline and not a change in your cash balance you now are in a position to learn what you need to learn from your first loss—how to effectively participate on the right side. The issue of adding to a loser is never in question because you aren’t trading from a financial focus to begin with. You are trading from the focus of discipline to do the proper thing all the time. You will not be tempted to add to your loser because you will have cut the loss by liquidating. You can always get back in so there is no need to hold something that isn’t working and certainly no need to make matters worse by adding to something that isn’t working.
At the basic core level, making this rule work is admitting to yourself you need something to control your emotional bias as it creates your urge to action. You need to confront the possibility that you personally have a “something” somewhere in your thinking and that particular little something has nothing to do with successful trading. When that particular little something shows up for trading today, you have already decided that you are not going to break your discipline today. The urge to add to a loser is a signal to liquidate because something is not right with me today. If something is not right with you the trader that has nothing to do with market structure or where the net order-flow is. If you aren’t seeing it correctly today that is clearly shown by an open trade loss to begin with. At that point you liquidate. Adding to or holding a loser demonstrates that you are not in the right frame of mind to profit today. The only difference between the two types of execution is the trader’s depth of attachment to the trade.
This article is an excerpt from the new book by Mr. Jankovsky titled “Trading Rules that Work: 28 Essential Lessons Every Trader Must Master” published by John Wiley and Sons Publishing for release in October 2006; direct link to pre-order at:
Full description of content will be available at that site shortly.