“No bastard ever won a war by dying for his country. He won it by making the other poor dumb bastard die for his country.” -George S. Patton
Did you hear about that new medical invention that can now bring the dead back to life?! No? Oh, that’s because it doesn’t exist. Just like there is no way to bring the money we lost in a trade back into the account. Pardon the morbid start to this commentary but it is meant to shock us into paying attention to a very important point:
Small losses are better than large losses.
Again, small losses are better than large losses. Get it? Seriously, repeat this over in your head ten times and then keep reading. I’ll wait. In the war that is trading we are going to take losses. Period, end of story. It is a simple fact. What we can control is how big of a loss we choose to take. And believe me, a small loss is the best option. There are several reasons for this.
First, mathematically it is very easy to make back a two point loss as opposed to a ten point loss. One good trade erases the damage done by a paper cut. However, several days of good trading are needed to overcome the hemorrhaging that is a large loss. Again, the math is easy. If a trade hits us for -1 we only need +1 to get back to even. If we allow a trade to get to -10 then we need trades of +2 and +1 and +3 and +2 and +1 and +1 just to get back to even. Making up a small loss is mathematically much easier.
Second, large losses are psychologically devastating. A big loss totally crushes confidence and creates a sense of absolute shock. A large loss can physically hurt (thus the term puking up a trade). This is a brutal feeling and often takes days to overcome. A small loss is like a mosquito bite, annoying and non-fatal. A large loss is like getting bit by a shark; irreparable damage and a crippling fear of ever going back in the water.
Third, a large loss is a sign of a much greater problem; total loss of trading control. We, and we alone, can control how big a loss becomes. Seriously, cut the loss when it is small, laugh it off as an annoyance, and move on. But let that loss spiral out of control; now a discipline problem has arisen. And most traders, when faced with this type of loss will double down and take on even more risk to “get it all back.” Well, if the loss was small, getting it back would be easy with one disciplined trade. With a large loss, an absolutely ridiculous out of control trade must be taken to gain it all back. And that is a recipe for disaster.
We can’t get the money we lose back from the dead. But we can choose how many “soldiers” we lose on any given trade. Lose a few, and your army is still in fantastic shape. Lose an entire division and the war could easily be over.