I have worked with thousands of traders and having watched our students trading in real-time in our Trading Simulator, I’ve discovered the most common cause of failure revenge trading and poor risk management. By understanding the intricacies of these struggles, new traders can learn how to overcome the most common hurdle.
Poor Risk Management & Revenge Trading
Traders with poor risk management will take 10 trades, and may suffer from poor accuracy by being red on more than 1/2 of their trades. But what’s worse is that one or two of their losers will be huge. When students start our Trading Courses we put them on a 3 month trading plan that beings with $50 of risk per trade. When a student in our class takes a $500 loss in the simulator, it means they had a blow up, taking a loss that is 10x greater than it should have been. There are a few different scenarios that lead to these losses.
The first path to a big loss is when students overextend themselves on the big moving stock of the day. As momentum traders we are always looking for that stock that has the potential to move 50-100% or more (see $TROV chart). Unfortunately new students often mismanage risk on these trades by taking too much size, or by chasing the momentum without understanding the proper stop. The solution to this bad habit is to use smaller size on stocks trading in a large range and to always understand your max loss and stop loss price.
The second path to a big loss is revenge trading. There is nothing worse than a revenge trader! I know this because I’ve been there myself. A revenge trader will double down, triple down, average down, and dig themselves deeper and deeper into a position. The end result is that they either get lucky and the stock bounces up and they get out breakeven or for a small profit, or they are unlucky and they experience a massive loss. As professional traders know, we can’t allow our careers to ride on luck. We must fall back on skill. This means we need to do everything possible to avoid finding ourselves in the position of revenge trading.
Revenge trading can be triggered by experiencing an unexpected loss or going from big green on the day to big red. Revenge trading is always an emotional response. Keep in mind that human emotions rarely serve to improve our trading. Successful traders learn to separate emotions of fear and greed from their trading strategies. We make our strategies mechanical, consistent, and emotionless. We become trading machines! Rogue traders acting from an emotional place will leverage their entire accounts to try to recoup losses or avoid experiencing a loss. Fear, anger, and frustration are driving these traders.
How do we help revenge traders? We must rehabilitate them!
First things first, revenge traders need to go into Trader Rehab. Students in trader rehab are forced to use discipline. They trade in our Simulator and are restricted by 200 share max size and have to use 20 cent hard stops as soon as the enter a trade. This means the worst case loss is 20 cents x 200 shares = $40. In addition to rules on position size and max loss, students have punishments for breaking rules.
The last time I was in Trader Rehab the punishment was running 5 miles for each time I broke rules. On one day I had to run 10 miles, and I never made that mistake again. That was my the last day I broke a rule in rehab. I found out I don’t like running! I don’t like running so much when I’d think about revenge trading I’d realize it wasn’t worth the punishment. That’s what gave me the idea to apply this rule to our students. Our students will either be horrible gambles in the best physical shape of their lives, or they’ll be disciplined traders.
Trading with small size is often a big step back for revenge traders who have been using 10-15k shares, but the purpose is to help them break their bad habit. After 30 days of rehab if students have been able to avoid revenge trading AND maintain accuracy that allows profitable trading, we increase their share size to 400 shares. During the 3rd month we increase share size to 800 max shares. Trading with 800 share positions is more than enough size to make a living as a trader.
We teach students to trade Gap and Go, Momentum, and Reversal Strategies and not take more than 10 trades/day. The key to success is to maintain discipline and never allow emotions to overtake you. Revenge trading is driven by fear, often a fear of loss. This means during your 3 months of rehab you become comfortable with experiencing loss. We condition you to experience so many small losses you stop caring about them. After all, getting stopped out with 200 shares at 20 cents is really no big deal. It’s not a big enough loss to trigger an emotional response.
Eventually every former revenge trader will experience the temptation to fall back into old habits! It’s happened to me where I suddenly lose $500-1k and I think the fastest way to make my money back is to take 10k shares and get a quick winner. As soon as I recognize that thought process triggering, I shut down my computer and walk away. Once you can do that, you have been rehabilitated!! As a former revenge trader, I assure you recovery is possible!