Be a better trader. Part 3. Avoid big risks

This is the continuation of the series “How to be a better trader?”. Click here to start from Part 1

There are no points for valor in trading. Taking stupidly big bets is not courage. There is no glory in losing money.

In the last post, we looked at the right attitude towards money. In this post, we discuss one of the biggest mistakes people make with the wrong attitude towards money

Overbetting.- taking huge, irrational risks and making losses they cannot handle. We will see why it happens, how people end up doing it, and how to stop it.

Why do we overbet?

1. We need money for something

This is the classic recipe for disaster. The wrongest reason to trade is to make money to fulfill some need. Chances are we will lose money.

This happens because we need that money. We are emotionally attached to that need. When emotions are involved, We know what happens in trading.

Never trade with a target number. At every point, just take the trade, do the right thing, hope for nothing. Do what you have to do, and do the right thing with the trade. As Lord Krishna said, “Do the Karma, never wish for the results”

Or as a fabled trader who is often referred to in this series says: “Putting this money number goal [of making an X amount] is not a very smart way of trading in the market. I let that go a long time back. When you put a number, you tend to compromise on your trades.”

2. We have had a big draw down/ loss, and we are trying desperately to recover it.

What is wrong with that?

But before that let me ask a question:

Why would this desperation happen in the first place if we were betting with money we do not care about?

The problem with trying to recover a loss is that

1. it indicates desperation, which creates emotions and irrational decisions
2. It brings in a sense of urgency. Stock markets are a patience game. If you try to do anything quickly, chances are that you will go broke

3. We have a trade, it has gone against us, and now we think it is a great level to double down or average.

The trouble here is:

1. If the trade has gone against us, there is something wrong with the logic in entering the trade in the first place. Why are we doubling down on a wrong logic?
2. Markets are often trended. When big moves happen they tend to continue in the same direction
3. If at stock has fallen, it does not mean that it is at an attractive price. Ask the people who bought PNB when it fell from 160 to 140. (The stock is under 100 as I am writing this)

How do people overbet?

1. Buy options — The worst trading idea of all times. Not only are you trying to bet in the (probably) wrong direction, now you are trying to time the trade before expiry. Plus vega loss, theta bleed. You get the drift
2. Double down on a trade type which has lower margin requirement — Like convert your overnight position to intra-day, cover order, or a bracket order. The problem is simple — It is very difficult to mentally handle the losses (and profits) which come on thrice your normal bet size. And if you are not right by the end of the day, you do not the margin have to maintain the trade overnight.

How do you prevent overbetting?

1. Do not buy options, especially OTM to make money quickly. NEVER.
2. Always have constant risk limits. Something like not more than x futures or options at a time. Have these written down. Increase them rarely — Once in a quarter or something.
3. Stick to this number, no matter what. Get a trade buddy. Ask his help to keep you disciplined.
4. Remember, there is always a next trade. Markets will be always there. You want to get wealthy eventually. Not go broke tomorrow.
5. When you hit a loss, instead of trying to recover immediately, take a break. Cool off your emotions. Tell yourself that you will eventually recover it. After your break, come back and start trading normally. Trade as per your plan as if the loss never happened. Your plan should revolve around what the market is offering now. Not around how to recover the lost money from the past. If you keep trading well, you will eventually recover that money and make much more.

Do you end up overbetting? What do you do to prevent that? Let us know in the comments! Have a great weekend!

Continue to Part 4…