We previously talked about the importance of risk management when it comes to trading. Tim Grittani reiterates the message by sharing some of his most harrowing experiences.
Tim Grittani is a consistently profitable short seller. In the past, however, he has made some devastating mistakes. His biggest loss to date was a whopping $290,000. On top of that, he endured even more 6-figure losses throughout his day trading career. All these mistakes had one culprit: a lack of proper risk management.
Pretty early into his trading journey, Tim discovered what seemed to be a smart way to avoid losses on trades that were going against him. Whenever a stock did the opposite of what he believed was supposed to happen, he would add to his position in order to adjust the average entry price, hence changing the course of the trade whenever his guess proved right. And this strategy worked for a while, allowing him to achieve a small loss or even a small gain instead of incurring the expense of cutting his losses in the first place.
The problem is, that strategy works only about 90% of the time. The remaining 10% of the time, it led to huge losses that were wiping out entire weeks of hard work. Any Black Swan event had the potential to destroy his trading account. That statement isn’t an exaggeration since many previously successful short sellers had to end their day trading careers by getting caught up in a mess just like that.
For Tim, the same cycle was repeating itself for months. It got incredibly frustrating because he felt like he was undisciplined and out of control. And worst of all, he couldn’t figure out how he had become that kind of trader.
In search of a solution, he went back to the basics. These adjustments he made seem simple, but it took Tim months of hard work in order to change poor trading habits and develop new, healthier ones.
First of all, he reduced his position size. That allowed him to manage his losses, even though his gains became smaller as a result. He considered it a loss that was necessary to regain discipline and unlearn his bad habits.
After that, he took a look at the lack of his risk management process. To fix that, he started planning ahead for a clear point where he’d be giving up on a trade and embraced cutting his losses. Him being a short seller, it was typically a high of the day mark.
Tim calls it a golden rule of a short seller: if a stock surpasses his stop-out point, he can’t add any more shares no matter what.
The change didn’t happen overnight. He still occasionally allowed himself to be stubborn and held the stock for longer if he truly believed that he was right about the market. However, the old scenario where he’d be carelessly adding shares was broken. He still incurred losses, but they were somewhat limited by the smaller number of shares involved overall, thanks to both a smaller position and the no-adding rule.
And as it turns out, once he prohibited himself from “fixing the trade”, the thrill of staying in was gone. In turn, cutting losses became that much easier. When you limit yourself in the actions you can take in a losing situation, it incentivizes you to move on from a trade gone bad faster.
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