Step 1: Feel it All
There’s a ton of emotions that result from a blown account or significant financial loss. Allow yourself to feel them…all of them. This step is more important than you may think and it’s not easy to do, especially when your limbic system (the brain region responsible for most of our emotional responses) is fighting to assert dominance over your cerebral cortex (the region responsible for logical/rational thinking). If you don’t let your brain engrain the pain from loss, you’re more likely to follow the same thought-processes that got you in this mess in the first place. Minimizing pain or hurt through logic-driven thinking is an incredibly useful evolutionary skill for survival…not so much for finance. You’re not lost in the wilderness after a grizzly bear attack in desperate need for quick decision-making to find a way to safety before another attack…you’re staring at your account with no money in it likely because of a series of poor decisions.
Everyone says to “keep emotions out of trading” and for the most part I’d agree with that, but not in this situation. You need to FEEL the pain, shame, disappointment, embarrassment, etc.…whatever it takes for your brain to remember this feeling in order to learn from it. See, teaching and learning are not the same thing. Training and learning are not the same thing. Experience and learning are not the same thing. Learning is a conscious choice for adults; we have to decide new raw sensory data is important enough for us to store it as a memory. There’s one exception to this—It’s called Emotional Learning.
Do you remember your first kiss? Your first broken bone? Your first rollercoaster? For most of us those experiences happened a long time ago but yet we often remember them “like it was yesterday.” Why is that? Our brains are hardwired to create memories around highly emotional events for its own protection. Without this evolutionary ability our species likely wouldn’t have survived. Sticking your hand in a fire or on a hot stove triggers an immediate and strong emotional reaction as child, usually involving tears, crying, and mild hyperventilation. While you’re freaking out, some part of your unconscious brain is saying “Well we’re definitely not doing that again, that hurt.” These experiences are emotional learning moments that shape our future reactions to similar situations.
You need that right now. You might not know it yet, but you do.
I’m not suggesting that you wallow to the point of depression, there’s no need to push things to the extreme here for this to be a powerful emotional learning event. I’m simply suggesting you allow yourself to truly feel all of the emotions you’re feeling in this moment before proceeding to Step 2.
If your reaction to blowing up an account is “Well that sucks, but I won’t let it stop me” then you’re asking to be in this same situation again in the future. That’s a fantastic reaction to not getting a job you wanted or losing a game of sportsball, but it’s a terrible reaction for traders.
Why? Because it’s possible that blowing up an account SHOULD stop you (more on that later).
If your dominant thought is “I can make it back” then unfortunately you haven’t properly completed Step 1 yet. You have some more emotional reflection to do because that’s the wrong way of thinking about this. You can’t “make it back,” it’s gone forever. It’s possible you’ll earn different money in the future, but you’re not going to make this loss back. It’s gone.
The purpose of Step 1 is to spend time digesting the emotions associated with a blown account in order to make your brain more risk-adverse in the future. Thinking “I can make it back” is the opposite of risk-aversion, it’s indicative of neuropathways too focused on reward and not focused enough on loss. Once you’ve processed these big (but important) emotions, it’s time for Step 2.
STEP 2: The Investigation
Before you even think about putting another dime at risk in the markets, I’ve got a job for you to do. While it’s important to really feel the emotions from Step 1, you can’t stay in that mode forever or it’ll be detrimental for your mental and physical health so to give your brain a break from processing emotions I’ve got a gig for you should you chose to accept it:
You’re going to be a detective. You’re tasked with solving a problem. Your job is to study the trading history of a specific account in order to piece together everything that went wrong.
The account in question? Yours.
Whether or not you ever trade again, in order for a blown account to turn into a learning experience, you need to spend time analyzing all the things that went wrong. In order for this exercise to work, you should try to approach it from an outsider's perspective. Try to pretend the account you just blew up belonged to someone else…if you had to give them feedback, what would you say?
Here's some questions to consider during your objective analysis:
What were the primary failure modes?
What was the strategy for the account? Did they stick to it? Did the strategy have any backtesting associated with it?
How were the trades expressed? Stock, options, futures, etc.? Did they use the appropriate trading vehicle for the strategy?
Was it poor entries? Poor exits? Poor stoploss locations? Were stops used at all?
Inappropriate sizing?
Taking profit too early? Too late?
Was the trader spread too thin, trading too many markets?
Did they have any business trading those markets? What was their perceived “edge” for trading those markets?
Remember earlier when I mentioned it’s possible that a blown account might mean you should be done trading? This exercise will help you determine if that’s true or not for you. If you can’t find anything wrong with your trading that lead to the blown account, then I’d argue trading may not be for you. The reasoning for that is objectivity. Traders need to be able to see the market AND their own performance without a bias. Clearly something went wrong for you to lose all of your money, and if you’re not able to objectively list those things then your brain may not be wired for trading.
This is a hard thing to confront for most people and it brings me no pleasure to say it, but it’s a reality we all have to face at some point. There are numerous ways to make money or supplement your income, the purpose of Step 2 is to figure out if trading is really the right fit for you. It’s fairly well established that the vast majority (some studies say +90%) of retail traders lose money in the markets; logically, before putting any more money in the markets you need to figure out what (if anything) will put you in the 10% that are successful.
To do so, you not only need to take the time to understand what went wrong, but pinpoint what went well. What were your strengths as a trader? Was there a specific type of trade/setup/timeframe that produced better results? It’s possible you did have a legit edge in the markets but absolutely butchered the execution and/or risk management. If that’s the case, you obviously don’t want to do that again so you need to make an objective list of all your strengths and weaknesses before moving to Step 3. By the end of this phase you should be able to give a short presentation on your investigation, clearly stating all of the positives and negatives that lead to this moment (you’re not really going to give a presentation, but you should know the facts of the investigation inside and out).
Step 3: Take a Break
It doesn’t matter if your investigation found some troublesome aspects of your trading that you’re determined to correct, you need to take some time away before trading again. It’s very possible your investigation brought back some big emotions. You may be thinking “I can’t believe I did that” or “Wow I should have just done ___ and I would have done way better.”
Sometimes Step 2 can make us eager to get back in the action and start trading again…that would be a mistake because we’ve still got a couple very important steps ahead of us so take a break from trading and only move to Step 4 once you no longer have any strong emotions connected to the blow up.
Time is an important factor in this process. We may be feeling anxious to start trading again now that we’ve taken a critical look at our mistakes, but taking some time away from trading after a blow up is crucial because it puts distance between our emotions and the event. Remember the old saying “Absence makes the heart grow fonder?” Taking some time off is a means to test the validity of that saying: If after some time away you still have a burning passion for trading then maybe another attempt is worth it. In some cases after taking time off traders may have a change of heart and decide trading isn’t really for them or maybe there’s better uses for their expendable cash at this point in time (expendable is a key word, we should never trade with money we truly need to survive).
Once you’ve had some time away to focus on other things, if you’ve determined you’d like to try trading again it’s time for Step 4. It should be emphasized that it’s absolutely okay to decide not to trade anymore. According to the statistics, that’s probably a very wise decision simply because of how difficult it is to outperform the market year after year for most traders. There’s no shame in packing it in or simply shifting your focus to passive investing. In my experience working with retail traders, it’s common to wrestle with pride and ego after taking a beating from the market. Those are normal feelings; however, those feelings should NOT be the reason we put more money at risk in the markets without a solid plan.
If you insist on continuing, it’s time for the hard work…it’s time to make that plan.
Step 4: The Business Plan
I want you to take a moment to envision the following hypothetical scenario:
Your best friend recently started a business. They were extremely excited and passionate about their new business venture, but they suddenly went bankrupt and lost the entire business. Your friend calls you on the phone and at some point during the conversation they ask you for money to help them start another business. How would you react in this scenario?
Most rational humans would probably feel bad for their friend’s loss while simultaneously thinking "There’s no way in hell I’m giving them money after they ran their business into the ground.”
Continuing with this analogy, what would it actually take for you to give money to your friend after they blew up their business?
For me, I’d have to see a rock-solid business plan with a detailed strategy, defined risk, backup plans, repayment plans, etc.
Reality Check:
YOU ARE THE FRIEND. YOU BETTER HAVE A DAMN GOOD BUSINESS PLAN BEFORE GIVING YOURSELF ANOTHER DIME.
It’s very common to hear experienced traders say “Treat trading like a business” and while I agree with that, it’s a vague statement and in need of some clarification in my opinion. Most of the retail traders I’ve worked with thought they were treating trading like a business: “But Horse I reviewed all of my trades and took it very seriously.”
That’s cool, but that’s not a business plan, that’s a journal. I do the same thing with my sports betting on PGA Tour events…but that’s not a business, that’s a hobby involving gambling.
If you’re going to take a risk and invest money in yourself again after losing it all, you need a business plan that someone would want to invest in. Some key elements to consider include:
What is your edge in the market?
What are the trades you will actively look for and limit yourself by only taking those trades?
What data is there to prove your strategy has an edge and beats the market?
How will you quantify when your edge is gone or has materially changed?
Be specific: What timeframes will you be trading? Why?
What are your goals? Are you looking for supplemental income or to become the next Paul Tudor Jones? Why?
What products will you be trading? Why those?
What info do you have that gives you a leg-up vs your competition?
What trading conditions will you NOT be trading in?
Who will hold you accountable?
What Key Performance Indicators (KPIs) or metrics will you use to determine success? How often will they be reviewed?
How will you know when you’re wrong? What is your risk management strategy for each position?
How will you know when your strategy no longer works and what will you do? Will you trade the account down to zero equity again or do you have a means to recognize when the strategy is toast before losing everything?
How do you plan to address all of the areas of weakness you uncovered from the investigation in Step 2?
If your new strategy does happen to work, how will you pay yourself?
Obviously I could go on forever with the list above, but I hope these questions can serve as a starting point to creating a robust business plan for yourself before you place another trade. It may crush your ego but it would be a great idea to share this plan with someone else you trust and respect. To me, this is part of really treating trading like a business. Public companies generally update their shareholders quarterly; ideally, you’ll want to find someone in your life you can update as well. What’s working? What’s not working? How are you performing? How are you feeling mentally & physically?
Successful businesses rarely operate in the dark. Considering you’ve got at least one blow up under your belt, it would be a good idea to find a mentor or an accountability partner if you’re going to continue trading.
The reason for this is incredibly important: You need a control mechanism in place to ensure your trading doesn’t regress into a gambling addiction. Nobody likes to talk about this subject, but it’s a VERY real risk that needs to be taken seriously.
If you’re attempting to trade in a vacuum apart from everyone else in your life, it’s possible you don’t have good accountability in place to keep your spending in check. I’ve unfortunately witnessed more instances of day traders turned gambling addicts than I care to admit—it can happen to anyone. The neurological processes utilized in trading are powerful risk/reward mechanisms that can be detrimental if not kept in check. I’ve seen many traders treat the markets like a casino and none of those stories ended well. While I do believe trading and gambling have a lot in common, I don’t think that justifies a true gambling addiction that could ruin your life or the lives of your family members. A solid, articulate, thoughtful business plan WITH accountability is a great control mechanism to keep you from spiraling into addiction.
Step 5: Start Slow
If you’ve done the work to create a sound plan for your new trading business, pitched it to others, and feel ready to continue trading then I suggest you start very slowly. Trade smaller size than your business plan outlined and take as few trades as possible. There’s no rush in trading; even if we miss a great setup there will always be another one. Far too many people treat trading like a “Get Rich Quick Scheme” rather than an actual business that should grow slowly but sustainably over time.
This should go without saying, but part of starting slow is sticking to your plan! We’re all guilty of veering from plans at some point in our lives, but when deploying a new (or improved) trading strategy this can be detrimental. Give it a chance to work, a chance to form new neuropathways of risk/reward in your brain. Celebrate sticking to your plan instead of overly celebrating wins.
The goal now is steady growth.
It's critical to rewire your brain after your previous blow up to focus heavily on NOT losing money, rather than making money. Your brain will naturally gravitate towards the excitement associated with “winning,” but with time and practice you can teach your brain to be equally excited about expertly managing risk and adhering to your written plan. Bending or breaking rules to improve performance is a key part of trading, but not at this juncture…you need consistency which will help improve your confidence and manage your emotions in order to avoid future large losses.
While I’m no Paul Tudor Jones and I’m always trying to improve my own trading, there’s one thought that changed my trading forever after my first large loss. My mentor at the time said “Put all of your focus on not losing and you’ll eventually start winning.” It sounds so stupid, but it had a profound impact on how I was approaching the market and helped me rebuild my account after making some stupid trading decisions. For me, heeding this advice meant stopping myself out of a lot of trades that barely went against my entry and getting back in at the same level I initially liked when price returned. Granted, I missed some trades but changing my mindset to be hyper-focused on not giving a dime to the market dramatically helped me grow as a trader and avoid blow ups.
We’re all wired different, but I’d rather miss an opportunity than blow up an account…there’s always another trading opportunity, but there may not always be another trading account.
Cheers,
Horse