How to Psychologically Deal with BIG Losses
So if you’re reading this, maybe you suffered a big loss, or maybe you suffered a big loss in the past, or maybe you never suffered a loss at all. But the reality is that if you’re trading, a big loss, one that you didn’t expect, is bound to happen.
The worst part isn’t the loss. That’s bad enough. The worst part is what it does to your psychology.
Maybe you’re doing great, your positions are going with you, life is good. And then BAM! You hit something unexpected. Maybe a winner turned into a loser. Maybe there was a big gap move against you. Suddenly, you’re dealing with a BIG loss.
Your ego is hurt, you’re doubting yourself, you feel blind-sighted. You want to do something right now. Or maybe you need to wait. It’s so hard to tell. Oh no, the stock is still moving! What do you do!!!
A lot of psychology of trading experts will likely tell you to calm down, breathe deeply, center yourself, don’t try and use your fear to guide you. Try to think rationally during this time.
I agree with all of that for the most part. However, I generally take a different approach:
HOW DID YOU GET HERE IN THE FIRST PLACE!!!
A BIG loss is relative. It is relative to your account size. It is relative to the rent you pay, or your monthly salary. It is relative to the time it took to save for your trading account to go live. It’s relative to so many things. But whatever it is relative to, it is BIG.
If it is BIG such that it affects you emotionally, then why are you trading that amount of money? Well, the usual answer is that you set aside that much money to trade. But are you willing to lose ALL your money? Is it even possible to lose ALL your money? Certainly not! The probability is so small! Everything needs to go against you a lot.
If you flip a coin 1,000 times and there are 15 heads in a row, would you be surprised? The probability is small but not zero. So why act so surprised?
I personally noticed that when I had a loss, I always subconsciously seemed to compare it to my rent. I’m a psychiatrist so I make plenty of money to be able to trade. I set aside the money specifically to trade with it. I could lose all of it and be perfectly fine. I shouldn’t really feel any “pain” per se when I see a loss. Yet when the amount I’m losing starts to hit the amount of rent I pay, my body begins to tense. I begin to re-think my positions, I begin to doubt myself.
But the opposite is true as well. When I trade an amount that is only 5% of the amount of rent I pay, I don’t think much of it. It’s basically “throw away” money for me. A long shot I don’t mind taking. And I might make 10 of those types of trades without a second thought. When I win, I don’t win that much but it’s a nice bump to my ego. And when I lose, I don’t lose much. That’s all fine and well, but at the end of the day, I don’t really go anywhere.
A BIG loss is a very psychological concept. What is “big” to you isn’t necessarily “big” to me. Although we feel a lot of pain with a BIG loss, we feel really happy with a BIG win. Those are nice to have…
The pain we feel when we have a BIG loss changes the way we see the world.
We go from a clear, rational state, to a fearful, emotional
state.
We can be subject to 3 types of responses:
Overtrading
Trying to revenge trade back the money we lost so that we can feel whole again
Paralysis
Not knowing what to do, and essentially doing nothing
Giving up
A lot of people lose so BIG that they give up. They’re forced to
So what are you supposed to do with a BIG loss?
Well, I ask again – How did you get here?
A BIG loss on a single position is not supposed to wipe you out. If you’re trading just one stock and that stock goes against you in an unpredictable way, you’re hosed. You’ll want a portfolio of stocks, 8-12, to properly diversify your opportunities. Are you properly diversified? Or did you YOLO everything on TSLA or Bitcoin?
And no, buying 10 tech stocks does not make you diversified. It needs to be in multiple industries.
And no, trading S&P 500 or other index funds doesn’t make you diversified. You’re essentially trading the market, subject to a single black swan event that can cause the markets to go against you in a big way.
So what is a BIG unjustified risk?
All your positions in a single sector/industry/or a handful of positions that are highly correlated to each other
Not having a stop loss, or an options position to limit the loss
These are the things that wipe you out and take you out of the game, making it impossible to learn more. There’s no way to psychologically recover from that because your account is wiped. Psychology is irrelevant.
If this describes you, you need a better process. You need to understand the nature of volatility and how to build a portfolio of stocks so that the risk is significantly reduced. This means any individual position won’t wipe you out. It’ll still hurt, but it won’t wipe you out. Check out the Introduction to Professional Level Trading (IPLT) by ITPM for more information on this topic.
But let’s say you do this.
Let’s say you have a well-balanced portfolio such that a BIG loss for a single position is no more than 10% of your entire portfolio (10 positions for 10% per position).
It still hurts but it’s not as bad. And yes, you can be unlucky and have 3 out of 10 positions go against you, but you’re telling me that 3 out of 10 positions went to 100% loss making a 30% loss with your portfolio. If that’s the case – HOW DID YOU GET IN THIS POSITION?
Assuming that your process is good, and you’re just running into bad luck then let me share a set of tools to keep your head in the game and winning back consistently.
Step 1: Understand what losses mean to you on a personal level
I said above that my losses were compared to rent. I grew up in challenging circumstances and I couldn’t wait to move out of the home I grew up in. Having enough money for rent was one of the first things I needed to calculate to be self-sufficient and free. I calculated that number a lot in my life. I always felt secure when the number was small and anxious when the number was high. It is, after all, the price of a roof over my head.
Trading to me represents my freedom. But it’s more than just “I have more money, then I’m free” logic. It has more to do with “Everyone is trying to make money off of me. From my employer to the government to my retirement accounts to finance fees, and even Ticket Master.” I don’t want to work hard, grow old, and see my retirement cut in half because some finance jerks took too much risk and tanked the economy. I want to be free from that fiasco.
When I trade, I trade to become financially free by becoming highly financially sophisticated. So sophisticated that my personal accounts perform like hedge funds.
On the flip side, if I fail, I’m trapped. I’m no longer free. And I begin to think about how I felt trapped at home when I needed to make enough for rent to become free.
Thus, when I see a loss, my mind subconsciously connects it to rent. And when I see a loss that is close to my rent, my emotional brain starts to take over.
Step 2: Structure a way to view your losses that negates the personal meaning to you
This part is personal to you and can be a little challenging. However, I recommend trying to be as creative as possible.
Since I learned viewing dollar amounts allowed my brain to connect losses to rent, I started viewing my portfolio in terms of percentages. I would still have the dollar amounts listed, but I would create a new column on Excel that had the percentage changes and percentage relative to my portfolio in bold and highlighted.
My eyes would naturally draw to those numbers, and it ended up being a much more rational way to view my account. On top of this, it would allow me to scale my strategies up as the strategies work the same at a $100,000 and $1,000,000 level since my decisions are all based on percentages.
Resulting/Outcome bias is a bias where you judge the decision you made based on the result rather than the quality of the decision given the information you had at the time of the decision.
There’s also Hindsight bias where you think you “should have known” things in hindsight. There are probably a billion biases going on, but let’s just stick with these.
This can be VERY dangerous for traders trying to learn how to trade better. Just because you made money in a trade doesn’t mean you made the right call. And just because you lost money on a trade doesn’t mean you made the wrong call. So how do you avoid these biases?
When you lose money on a trade, you must ask yourself, “What COULD I have done differently AT THE TIME OF THE DECISION to avoid the big loss?” If it is nothing, then you didn’t necessarily do anything wrong. But if you could have looked up something, if you could have changed your position slightly to reduce the risk but maintain the same upside reward, these are things you can do next time. This is what it means to grow.
Step 4: Create Rules and Structures to prevent a future loss
Once you’ve learned the core reason why you had the big loss in your book, you need to build structures to ensure it doesn’t happen again.
If the big loss is because you had 40% of your money in Tech and all of tech decided to go against you, your lesson will likely have to be not having more than 10% exposure in one sector or industry. You might also want to do some correlation analysis to see how much of your portfolio is correlated to each other. (Something you learn in ITPM’s Professional Trading Masterclass (PTM)).
This is a personal step that you need to take for yourself. It’s hard to give you general rules or guidelines on how to do it. Rather, I’d like to share an example of how to go through these 4 steps.
Example
When I first started trading, I purchased growth stocks from time to time because I believed they would continue growing. That’s what growth stocks do! I had stock options in them that would continue past earnings. Prior to the earnings, the stock was up quite a bit, and I was fairly happy. But a few days before earnings, there was some volatility, the stock would go down prior to earnings. I wouldn’t think much since my “unrealized profit” number was still high.
Once earnings released, some of those growth stocks continued to grow, yet some of those growth stocks declined. And when growth stocks stop growing, they TANK LIKE A ROCK.
When that happened, I got upset, angry, disappointed. I lost the entire positions because when they went down, they went down A LOT. Since I was using options, some of them went to 0 for a 100% loss (keep in mind, I had a diversified portfolio, so no one position would be more than 5%-10% of my account. It still hurt though, but not catastrophic.)
I experienced this from time to time. I won some trades with growth stocks and lost in other trades. But the big losses hit me the most on an emotional and personal level. These were 100% losses with my options trades, down from positive unrealized profits prior to the earnings. For shame!
I thought to myself, “What can I do before the earnings report for growth stocks to prevent large drops?”
I realized that I could do a lot of things to reduce risk.
💡 I could do research right before earnings to see if there was anything I missed.
💡 I could reduce my position prior to the earnings – This reduces my risk but also reduces my possible gain
💡 I could sell a deep in the money call option to collect the credit in case the stock goes against me at earnings
💡 I could purchase a short-dated put option prior to the earnings 2 standard deviations out of the money.
There were a lot of things I could do. So I decided to start doing something if it felt right.
So then it came. I was long a growth stock and earnings were coming up. The growth story was beautiful and made a lot of sense. It was practically a straight line from the bottom left of the chart to the top right of the chart. I was up about 50% on the position prior to earnings. I knew that if the stock is going to go ex-growth or if there is a threat of its growth, it would come out during earnings.
Now, here I am, and I got burned by BIG losses in the past. I knew that there was a risk that the stock goes ex-growth and it could happen here. I hope it doesn’t but it “could” happen. Out of the 4 choices above, I review the stock again (1) and I decide to go for (4).
I decided to purchase a small Put position out of the money that was 2 standard deviations away. So these are the outcomes:
👉 If earnings were expected, the stock would go flat and I’d sell the put position for minimal loss as it seems volatility would deflate.
👉 If the stock goes up, my put position would go to 0, but my long position would continue its trajectory.
👉 If the stock tanks to the strike of the put position, I would reduce my loss significantly and close out of my position, maybe even make a profit.
👉 If the stock tanks less than the strike of the put position, it means the trend had not yet broken and I may want to consider adding more to my position with the profit from the put position.
I liked all of these scenarios. So what happened?
Earnings came out and growth was poor. Booooooo!!!!
Could I have predicted it? Possibly.
But instead of losing 100% of my money like before, I just lost 20%, a non-catastrophic loss.
The stock had broken its trend and I got out, able to fight another day. Since I had a well balanced portfolio, the down move in the market was broad based shorts in other stocks made money, balancing out the 20% loss.
I’m not saying that I was correct to make this move just because I didn’t lose money. I’m showing you the process of how I analyzed my previous big loss to prevent the same big loss in the future. Look at the lesson that was learned.
In the past
- Bought a growth stock. It goes ex-growth during earnings. I lose 100%
- When the growth stock continues to grow, I continue making money
Now with the adjustment
- Bought a growth stock. It goes ex-growth, I lose 20%
- When the growth stock goes flat, I’d probably just make 30%
- When the growth stock goes up more, I continue making money
It’s hard to get specific numbers only because it’s hard to tell what “could have been”. But if you can compare the “past” version of my big losses of 100% with my adjustment I made, I’d say that was a significant lesson to learn.
Keep in mind – Some people might do things differently. Some people might want to take the big 100% loss knowing that their other wins are 200% or 300%. My method might not be optimal for everyone, but it was one I created by analyzing my decision making at the point of the decision, not based on the result.
Big Takeaway
Dealing with BIG losses can be challenging. Your first step is to ensure that your process is solid. Please check out ITPM’s IPLT course or PTM course for more information on how to have a rock-solid process.
Once you have a solid process, these BIG losses aren’t catastrophic so you can still trade another day. In this setting, you need to understand what losses mean to you, decouple that, and then learn from your mistakes.
Once you’ve learned the lesson, you need to build personal rules and guidelines to prevent your inherent weaknesses with trading. These rules are personal to you and if you have enough of them, you’ll become a consistently profitable trader.
Your trading psychology might be the deciding factor for your next BIG win or your next BIG loss.
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