Avoid account blowout

Posted on by Henrik

Key Rules and Strategies:

  1. Stop Losses are Non-Negotiable: Every trade must have a predetermined stop-loss order to limit potential losses. The text stresses the importance of setting this limit before entering the trade, using the example of buying a stock at $100 and setting a stop-loss at $95 to cap the loss at $5 per share.
  2. “Setting a stop loss is not just a recommendation, it’s an absolute necessity.”
  3. Honoring Stop Losses is Crucial: The text strongly cautions against the temptation to cancel or modify stop-loss orders when a trade moves unfavorably. Emotional decision-making in such situations often leads to greater losses. The 2008 financial crisis serves as a stark example where those who adhered to stop-loss strategies mitigated damage.
  4. “The point of the stop loss is to prevent your emotions from taking over.”
  5. Maximum Dollar Risk Limits: Traders should collaborate with their brokers to establish daily or per-trade risk limits. This prevents overtrading and impulsive decisions, especially after a series of losses. The example provided suggests risking no more than 1% of a $50,000 account per trade, limiting the potential loss to $500.
  6. “This is a great way to prevent emotional decision-making after a string of losses, protecting your account from further damage.”
  7. Disciplined Trading Practices: The text condemns overtrading, driven by the urge to quickly recover losses. It advocates for quality over quantity in trades. The dot-com bubble serves as a cautionary tale where excessive trading, often fueled by leverage, led to catastrophic losses for many day traders.
  8. “Overtrading is a common mistake that leads to account blowouts.”
  9. Accepting Losses and Moving On: Stubbornness and clinging to losing trades out of pride or denial will exacerbate losses. Recognizing mistakes and adapting is crucial for capital preservation. The text cites the 2000 dot-com crash where investors who refused to cut their losses on plummeting tech stocks faced devastating consequences.
  10. “If the market tells you that you are wrong, don’t fight it.”
  11. The 3-Loss Rule: A practical guideline that mandates stopping trading for the day after three consecutive losses. This forces traders to step back, reassess, and avoid emotionally driven decisions.
  12. “This rule is designed to prevent emotional decision-making and impulsive trades after a series of losses.”