Have you ever heard the saying, “a penny saved is a penny earned”?
In case you haven’t, it refers to the idea that money saved is more valuable than money spent right away. The proverb was originally crafted based on the idea that saving money is a good thing.
And who can argue with that, right?
But the benefits of this idea extend beyond a savings account at your local bank. In fact, most life lessons can be applied directly to trading in some way, shape or form. And make no mistake about it, there is much to be gained by applying this concept of saving money to the way you manage your Forex trading account.
Those who have followed me for any length of time know that I’m a huge advocate of the “less is more” approach to trading. In other words, the less you trade, the more money you will ultimately make, assuming you have a profitable strategy, of course.
But this idea of a penny saved is a penny earned, or perhaps in our case, a pip saved is a pip earned, is a bit different. While it still revolves around a minimalist approach to trading, it tackles the subject from a less obvious angle – it highlights the value of not losing.
It’s okay if that doesn’t make perfect sense at the moment, because it will by the time you finish reading this article.
An Unconventional ApproachIf the statement above regarding the value of not losing sounds odd or even unconventional, I suppose it’s because it is. As human beings we have a tendency to view things in a manner that would ultimately benefit us.
For example, if I asked you why you got involved with Forex trading in the first place, chances are you would say to make money or even to become wealthy. Granted, I believe that trading for the sole purpose of making money is a misdirected approach, but that’s another topic entirely.
Chances are, you wouldn’t answer that question with, I began trading Forex to not lose money. Or, I began trading Forex to not be poor.
See the difference? One set of answers tackles the question from an offensive point of view while the others take a more defensive stance.
Both of the latter responses probably sound a tad ridiculous. Funny thing is, they are (in my opinion) more appropriate responses than saying you want to make tons of money and become wealthy.
Don’t get me wrong, it’s okay to want wealth. If that’s your driving force, go for it. But if that’s your sole purpose and focus every time you sit down in front of your trading platform, you are destined to fail.
The reason is simple. When you think about putting on a trade, your mind naturally begins to focus on how much money that position will add to your account. It’s human nature to want to focus on the reward rather than the risk.
But as natural as it may be, it’s an entirely misdirected approach.
If you want to last in this business, your first thought should be how much of a dent that position could put in your trading account. In other words, how much you could lose if the market turns against you.
Not only will a defensive mindset help keep you out of trouble, it will ultimately help you grow your trading account. This is because, as I’m about to show you, taking excessive trading losses is more destructive than most realize. Or rather, most traders fail to realize the extent of the destruction until it’s too late.
The Numbers Don't LieThe best way to illustrate the adverse affects of excessive losses is to, well, illustrate it. The chart below shows the percentage of gains needed to offset trading losses, where the green line represents gains and the red line represents losses.
As you can see from the chart above, if you were to lose 50% of your account, it would take a 100% gain to make back that loss. That’s a pretty tall order to ask of any Forex trader.
And if you were to lose 80% of your trading account, it would take a massive 400% gain to get back to breakeven.
What’s more, if you truly intend to recover those losses and effectively move forward, it must be done in a safe and strategic manner. Simply throwing money at the market in hopes of making it all back will only serve to dig a deeper hole. Anyone who has tried knows that to be true.
So there you have it, the numbers don’t lie. Taking excessive losses is extremely damaging to your trading account. It’s why I practice and preach a “less is more” approach to trading. It’s also why I believe that having no position is having a position.
But don’t take it from me, just ask Bill Lipschutz, who said the following…
If most traders would learn how to sit on their hands 50% of the time, they would make a lot more money.
What he’s referring to there is the power of doing nothing. As surprising as it may seem, your priority as a trader should not be to make money. Your top priority should be to protect your capital, making money comes second.
The Less Visual SideWithout question, the figures provided above paint a bleak picture when it comes to taking unnecessary losses. There is no better way to explain the effects of consistently losing money in the Forex market than with cold, hard numbers.
However, the real tragedy, if you will, of losing money on a consistent basis is the emotional damage it does. Taking unnecessary losses can wreak havoc on your emotional stability, which in turn greatly reduces any confidence you may have had in your abilities as a trader.
If you have traded for any length of time, you know that having a strong mental game is a key element if you intend to find success. You can have the best, most advantageous trading strategy in the world, but if your mental game is broken, you don’t stand a fighting chance.
This brings us to a universal truth – the best way to protect your mental health as a trader is to avoid taking unnecessary losses.
You’re probably thinking that the statement above is obvious and therefore of little help. But don’t be too quick to brush it off. This is one of those obvious, yet seldom followed truths in the world of trading. And those who fully embrace it are at least starting to find success, mark my words.
All that aside, avoiding unnecessary losses is easier said than done. But the good news is that there are a few simple things you can do to help cut down on losses and thus, build your trading account in a manageable and sustainable way.
A Few Simple IdeasNow that you know how damaging taking losses can be in the Forex market, you are probably asking…
Okay, but how do I avoid such losses?
Before I get into a few simple ideas you can implement to help minimize the damage from unnecessary trading losses, let me be very clear in saying that losses are a necessary part of trading. You can’t trade a financial market without taking losses along the way.
However, these losses should not be viewed as a bad things. Instead, see them as a learning experience rather than a black mark on your abilities as a Forex trader. In time, you will begin to see them as business expenses that are a necessary part of the profession you chose.
With that out of the way, there are a few simple ways to cut down on the losses you take.
Here are a few of my favorite…
Trade from the daily time frameIf you’re serious about trading price action, the daily time frame needs to become your secret weapon. Although the time frame in and of itself isn’t so secret, the advantage it brings to the table is hugely overlooked.
Why is that, you ask?
In my opinion it’s because most Forex traders believe that the lower time frames provide more setups and therefore offers a way to make more money faster.
This couldn’t be further from the truth. After all, there is a reason why most of the big names in the business, from Bill Lipschutz to Bruce Kovner to George Soros, all focus most of their attention on the higher time frames.
Not only will the daily chart provide clearer trade ideas, it will help you to become more selective about where to allocate capital, thus allowing you to trade less frequently and ultimately make more money.
Give yourself a limitMany Forex traders want to believe that they can earn 10 pips each and every day. The idea is that it allows you to compound your gains quickly in order to “fast track” your way to wealth.
Although it sounds great on paper, it doesn’t quite work that way for reasons I have previously mentioned.
I say, do the opposite. Instead of setting a goal of how many pips you want to make each day, give yourself a limit of how many trades you can take each month. To be clear, this is a limit rather than a goal.
For example, if you are trading from the higher time frames and being selective about the setups you pursue, you really shouldn’t be taking more than 10 trades each month, 15 at the most.
By setting a limit for yourself of 10 trades each month, it will force you to be more selective about the setups you take, which will in turn help you grow your account that much faster.
And if you really want to challenge yourself, set your limit at 5 trades per month. Just know that once those trades are exhausted, you can’t trade until the next month.
Know when to walk awayThis is perhaps the most important of the three. Truth is, most “excessive” losses don’t transpire over the course or days, weeks or months. Instead, they manifest themselves over a much shorter period of time, typically just 24 hours.
How do I know this?
Simple, I had to start somewhere too. I know all too well the temptation of revenge trading – the type of trading where, instead of reducing position size after a loss, you increase it in an attempt to win back the money you just lost.
I don’t have to tell you how destructive this kind of behavior can be. Chances are, if you’ve traded for any length of time you’ve already suffered through a similar situation.
Luckily, the solution is as simple as it gets. All you have to do is learn to walk away. It won’t be easy, but walking away from your trading desk when things aren’t going your way is absolutely essential if you intend to survive in the Forex market.
And if you implemented a trading limit as specified above, know that every single “revenge trade” you take counts against your limit. This alone will help deter you from taking additional trades immediately following a loss.
