Tuesday, February 22, 2011

Achieve Balance in Your Trading

Balanced Scale
By Dr. Van K. Tharp International Institute of Trading Mastery


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This certainly would rank as one of my top ten tips to you. I know some of you have read this one before, but it's worth repeating.

We live in a world of polarities: good vs. bad, up vs. down, young vs. old, happy vs. sad. The "win and loss" polarity is just one example of many. In most cases, we tend to judge the polarity in that we prefer one side and dislike the other side. However, one of the secrets to life is to make both sides of the polarity okay. But, what does that mean?

That’s a hard one for most people to understand, but perhaps it will be easier when I explain it in terms of profits and losses. You cannot be a successful trader if you are not willing to have both profits and losses. As the mechanical trader in book 5 of the Peak Performance Course says, "It’s like only wanting to breathe in and not wanting to breathe out." Both are a significant part of the trading process.

Most people don’t understand this concept at all. They want to be right all the time. They want to make money on every trade. Yet that will not happen because losses are a part of the trading process. When you understand the relationship, however, you can come to terms with losses and make them okay.

A natural part of the trading process is to have a point at which you must unload a position or trade at a loss in order to preserve your capital. Those losses will happen to most people about half of the time or more. And you must make them okay or neutral.

If a loss is not okay, you will not take it. When you’re not willing to take a loss, it usually gets a little bigger. When it rains, it pours. As a result, it becomes even harder to take—much more painful. If you didn’t take it the first time, as it becomes bigger you will be even less likely to take it. What’s likely to happen? It probably will become even bigger. The cycle typically continues until the loss becomes so big that you have to take it. This typically occurs when you get a margin call from your broker.

However, investors might never get a margin call if they are not margined. Instead, they tie up valuable capital in a falling investment that might last forever. There are probably millions of investors right now who are hanging on to losing investments, just because they are waiting for it to come back. Consequently, you must make it okay to take losses.

The other half of the equation is also important (and equally puzzling). You can’t put too much importance in gains. People who value profits too highly, tend to take them quickly. Why? Because if they don’t take them, they are afraid they will get away.

An example of this was once pointed out to me through real estate investors. A group of investors got into a real estate deal that started to lose money. Instead of getting out and taking their loss, they elected to stay in and ride it way down. When asked why they didn’t get out of a bad investment, their comment was, "We haven’t gotten our money back yet."

These same investors subsequently got into another real estate deal. It started to become profitable very quickly. In fact, it rose to 100% profit and more. But the investors who were holding onto the bad investment, sold out quickly at a small profit. When they were asked why they sold, the reason was, "We lost money on the other deal, so we wanted to make sure we got our money back on this one."

This concept of balance is very important and it applies to any polarity you can think of—not just profits and losses. It's equally important for traders to find balance in their emotions. If you want to dig into this topic, it's covered thoroughly in my Peak Performance Home Study Course.

About the Author: Trading coach, and author, Dr. Van K. Tharp is widely recognized for his best-selling books and his outstanding Peak Performance Home Study Program, a highly regarded classic that is suitable for all levels of traders and investors.

Click here to learn more about Van Tharp at the International Institute of Trading Mastery.