From YourSITE.com
Pitfalls That Lead to Catastrophic Loss
By Jared Putnam
Dec 10, 2007 - 7:31:36 PM
“It feels impossible to be in this position, after so much effort and so many good choices how could this have happened?” continually echoes within what is a now seriously deflated notion of trading acumen and success after a catastrophic loss. Yes, losing 25% or more of one’s account value is a tough challenge to overcome. While losses of such magnitude occur in an array of markets and circumstances, these stem from relatively few root pitfalls. To add what may be much needed stability and the pluses it fosters to our trading, let’s look closely at two common pitfalls: 1) failure to expand our skill and 2) size we are not in a position to handle. Rather than racing for the exits cursing the markets as a brutal, luck-laden enticement in which losses are only for the “little guy”, perhaps by knowing these precursors to catastrophic loss, the foundation upon which we seek to grow can be made sure.
Aptly, it’s been said that closing a profitable trade is the ‘hardest way to make an easy dollar’. Hence, to accomplish this daily requires specialized knowledge of a variety of aspects to trading. We can ask ourselves, how skilled am I in the areas of intra-day market structure, trade context, the correct use of Fibonacci ratios and any chosen indicators, pattern recognition, and price-action analysis? If these areas enable or complement our trade strategy, are we as informed as possible? If not, perhaps we did not know the pertinence of each of the aforementioned specialties. Or, has a desire for profiting from our “comfort zone” clouded the reality that consistent profitability, or the lack thereof, is a mirror reflection of no one else’s but our own level of expertise? By honing our skill level in every area that impacts our particular strategy, we can minimize the risk of catastrophic loss.
Little facilitates this type of loss as readily as the size with which we choose to trade. To maintain the overall balance needed to trade profitably, we must trade in size best suited to us at the present time. Therefore, when in the beginning phase of our use of a trade strategy it is wise to channel our enthusiasm into one single contract. Only when we accumulate sound trades and the profits that eventually follow should we increase our quantities, expanding our total risk per trade to no more than five-percent of our account value. While this approach seems to keep so-called “real money” from entering our account, it is exactly the opposite! Every trader’s skill is born in time, and then rewarded in size.
We must be mindful that the adage, “there are old traders and there are bold traders, but no old bold traders” is 100% true. Therefore, may we avoid the pitfalls that lead to catastrophic loss by resisting the tendency to want more than we have earned by refusing to increase our skill level, trading with size disproportionate to our skill level, or both. Doing so may be just what prevents us from having to ask: “How could this have happened?”
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