Survival Before Learning

If you are trading without first assuring your survival, you are just playing a game, a crazy gamble that a drunkard places over the weekend in Las Vegas casino. No real trader who aspires to reach constant profitability will participate in the Market without first assuring their survival.

The above is absolutely essential and goes without saying. It is assumed by default that your risk and money management, as well as psychological well-being, are taken proper care of.

What’s next?

Before anything else, you need the willingness to put in countless hours of work into the Market. Only this will allow you to gain this important subjective feel of the Market as you watch it. The trading ideas will come to you effortlessly and it will only remain for you to execute them. This is how you build your trading system.

Ask yourself: “Why am I not putting enough time into watching the Market? Why am I not willing to take losses, make mistakes and yet continue with my method, learning and improving with each passing day?” Find the answers. Write them in your diary. Propose the solution and implement it.

When you spend enough time on trading and seemingly totally committed to your success in trading, ask yourself this: “Why am I not acting on each and every idea I have? Why am I closing the trades before my targets are reached or my system tells me to close them? What am I afraid of?”

Honestly answering these questions in your daily diary will lead to important improvements to your trading system. Go back to the first step – putting countless hours of work – and repeat the process times and times again, with humble understanding that you will never be good enough to cease improving your method and your execution of it.

Above all else, remember – it is only possible to go through this difficult process when you have absolutely, perfectly ensured your financial and psychological survival! You cannot be worrying about your well-being or losing more than you can afford to lose AND going through the mandatory learning process of taking losses, making mistakes and being clueless.

The best Money Management strategy

If I were to define the most important Money Management rule in one sentence, it would be this:

Make sure you have the money tomorrow to invest with.

It is that simple. Every day, do whatever you should according to your trading strategy (analysis and entry systems), but make sure that no matter what happens today, tomorrow there is money left for new investment opportunities.

I cannot emphasize enough how important this attitude is. Because we are making sure that we have money for investment tomorrow no matter what, we cannot fail. Of course, this simple rule is just the basic foundation for a robust money management strategy, because it implies some important points:

  1. In order to make sure we have the money tomorrow, we have to make sure that our maximum possible risk (and therefore our loss) is limited today.
  2. Because we must have the money tomorrow no matter what, we must also protect against force majeure situations, when all our trade protection can fail (15th of January was such an event, as stop losses were not honored by the market, since it traded thousands of pips away in just one tick). It implies that a complete loss of this trading account should still leave us with enough money to comfortably open a new account the next day and continue trading.

There are many ways how each trader will calculate his risks, position sizes, but in my opinion, if this one simple rule is not honored and he leaves even a distant possibility of losing it all, the money management strategy is not planned properly.

Accepting the Risk, Part 2 – Floating Profit

In the first part we discussed the risk we have on the market – our initial Stop Loss being hit.

I was lucky to have a natural fear of financial loss operating in me on a very deep level from the first days I started trading. Interestingly enough, because I was so cautious with any potential loss, I never let my trades show any substantial gain either. Any time the trade would go my way even slightly I would get nervous and was rarely able to resist taking the profit.

In one of the previous articles I illustrated a very common example, showing how the fear would cause us to look for any signs of the reversal on the market – anything that will allow us to justify taking the profit way before the target.

After we learn that the market will often disagree with our point of view we start accepting that sometimes it goes straight to our Stop Loss. Such situations are inevitable and happen to even the best traders. But what about these situations when everything seems to be going exactly according to our plan?

Managing the floating profit

When the trade is already showing profit many traders automatically identify with that profit subconsciously. They rationalize that the market already showed that they are right and this is their well earned money.

The market can easily reverse against our position, no matter how much profit we have in it.

There are a couple methods we can implement in order to deal with these situations. In this post we covered a couple important steps in order to decrease the risk and reduce the psychological weight of keeping the trades for a longer term:

  1. Enter the trade with a couple positions with the same SL but different targets. I like to set the first target at 3 times the amount of my SL.
  2. When the first target is hit and part of the trade is closed, move SL to breakeven. This will turn the trade into a risk free opportunity to follow the trend (in reality, there is still the risk of losing the floating profit which we can never exclude completely unless we close the trade, but the original risk of losing money is now removed).
  3. From this moment we need to keep reassessing the market and adjusting our SL higher as the market provides an opportunity to do so.

At this point it is extremely important to adapt a different way of thinking about your trade. Instead of looking at the paper profit, look at the amount of money you already accepted and at the value of your current Stop Loss. In other words, the current profit is not whatever is floating, but the amount you already taken plus/minus the amount that will be accepted when Stop Loss hit – not your Take Profit.

Aiming for big targets

When you have the conviction that the market has the potential of giving you 10 times the amount you risked, it is definitely worth it to let the trade go – after we’ve already taken the first profit and made the trade a risk free opportunity by adjusting stop loss to breakeven. Many times the market will not agree with our conviction and stop the trade, but with experience we can hopefully learn to read the market sentiment better and better. When having a longer term perspective (trading Daily and Weekly charts) I found it essential to understand the underlying fundamental reasons why the currency can appreciate or depreciate the way you expect it to.

I like to ask myself this question when I am hesitating whether to let the trade go or close it: “Based on where I can trail the SL in these conditions and where I have my long term target, would I enter the trade right now? Do I still have a good Reward to Risk ratio in this trade?”

In other words, I will first check where I can trail my SL based on the recent price action. After I trailed it, I look at the distance to my target and my SL. Would I place a trade at the current price with such SL and TP? Does it still meet my minimum Reward to Risk ratio criteria?

Let’s take a look at 2 different scenarios:

  1. There was a recent retracement to the trend we are in and we can trail our Stop Loss behind that retracement. After doing so, we have 100 pips distance to our Stop and still 400 pips to our long term target – a respectable 4:1 ratio that makes it worth it to stay with the trade.
  2. The price rushed to our target in an impulsive move, not reaching it by 50 pips. Our floating profit is 500 pips and our SL is set 300 pips lower relative to the current market price. Because the price spiked higher to our target so fast, the market does not show any techincally sound level where we can trail the SL to reduce our risk. If we were to place a trade at this level, we would have been risking 300 pips hoping to gain only 50 – a very bad 1:6 ratio to take. In this case it is a much better decision to close the trade in 500 pips profit, 50 pips before our target, than hoping to catch these final pips and risk giving away 300 pips of our paper money.

Finally, let’s take a look at a recent trade that I’ve been managing over the last 3 weeks. It happens to be a rare example of proper management throughout a couple retracements when I was certainly questioning whether to take the profit or let the trade go. In hindsight, scaling out of the trade in small parts as the market was making new highs, was crucial to lasting throughout the whole move to my original target – it allowed me to secure part of the profit and decrease the psychological burden of supporting the trade.

GN H4 Buy Trade
GBPNZD H4 Buy Trade

Accepting the Risk, Part 1 – Stop Loss

…most traders erroneously assume that because they are engaged in the inherently risky activity of putting on and taking off trades, they are also accepting that risk. I will repeat that this assumption couldn’t be further from the truth.

Accepting the risk means accepting the consequences of your trades without emotional discomfort or fear. This means that you must learn how to think about trading and your relationship with the markets in such a way that the possibility of being wrong, losing, missing out, or leaving money on the table doesn’t cause your mental defense mechanisms to kick in and take you out of the opportunity flow.

— Mark Douglas “Trading in the Zone”

Risk and reward are closely related as we cannot have one without the other. I wrote my opinion many times before that a trade should not be judged as amount of pips or dollars that it makes. It should only be judged as the ratio between what was at risk and what was gained (could have been gained). A trade that made 100 pips but had 1000 pips SL has extremely poor 0.1 RR ratio and it is relatively easy to make such a trade and reach profit with it, just by sheer luck. A trade that made $1000 but had no SL has 0.0 RR since the was no risk limit, and we have to assume that the whole account was put at risk.

In terms of profit it does not matter whether we win 10 trades out of 10 with 0.1 RR or just 1 trade with 1 RR. If we risked $100 in each trade, in the end we’ve made $100 in each case. However, it matters a lot in terms of risk – in the first case we risked 10 times $100 to make $100 in the end, while in the second we risked $100 just once and made the same $100.


 It is interesting that most beginning traders prefer to take a smaller profit, while setting a bigger stop loss (actually, most beginners prefer not to set any stop at all, being sure that the market will go in their direction at least a tiny little bit). I think there is some interesting psychology that we can analyze here.

First of all, there is always a balance on the market. If your trading system uses 1:5 RR and you are able to win consistently more than 80% of your trades, it can still work just fine – especially if that is what your find to be psychologically comfortable. The problem here is actually going with the market flow correctly more than 80% of the time – easier said than done.

On the other hand if you take 3 times the profit compared to your risk you only need to be “right” 1 time out of 3 in order to consistently increase your balance.

Let’s think about it from a different point of view. Imagine that you trade manually and you put 100 pips stop loss trying to make 20 pips. What kind of trading opportunites are you looking for? What is the market setup where you say “The market gives signs that it will go 20 pips in my direction, but it can first retrace 100 pips against me”? Imagine the trade goes against you by 90 pips. What should the market conditions be at that moment that you still keep your trade with confidence – now you want the market to move 110 pips in your direction, having only 10 pips breathing space on the other side.

It really seems to me that trading in this way is a very dangerous psychological trap. It’s like we want our trades to be perfect, we really hate when the market goes against our positions and forces us to take a loss. But we learned that trading without loss protection is a financial suicide, so we calm ourselves by setting a huge stop loss while trying to take a tiny profit – after all, we are protecting our account, right? It really comes down to truly accepting the risk of our trading.

Accepting the risk of losing money

When a trader puts on a trade with a stop loss, he immediately assumes that he is accepting the risk that comes with that trade and that he is in control over his trading. However, we are not benefiting in any way from the risk “acceptance” that comes from the overwhelming fear of losing money.

A trader can put a stop loss, but still hope or even assume that the market will never reach it. He likes to put a bigger SL not because he is ready to take a bigger risk in his trading but because he is afraid to take any loss at all. He hopes that the bigger SL will never be hit. If there is any fear in placing the trade it means that the risk for that trade was never truly accepted.

When seeing your trade being closed in a loss causes you any emotional discomfort it is natural that you will do anything to avoid taking the loss in the first place. The smaller your stop is, the more often it will be hit. It seems that most traders prefer to increase the distance to their stop so that they do not have to experience the emotional pain that comes with losing money as often. Accordingly, bigger stop loss will possibly lead to more emotional pain when it is hit, but there is another element that I find even more important – the pain of being wrong.

Accepting the risk of being wrong

When the trade is stopped out an average trader not only feels the pain of losing money. He also perceives that the market is making him wrong, and for many traders the pain of being wrong is even stronger than that of a financial loss. I would say that even though the pain of losing money can be similar in one big loss or many small losses, the pain of being wrong on any given trade is about the same.

From this perspective we can see that for someone trading without proper mindset (someone experiencing any psychological discomfort at all about his trades) it makes sense to avoid the losses at all costs. He will much rather take $10 profit 10 times in a row, increasing his confidence (and often his ego) and then have 1 loss that takes all $100 away, than experience the pain from losing $10 and being wrong 5 times in a row and then making $100 on the trade that is opened with the market flow. In reality, such trader is very unlikely to last through 5 losses in a row and still continue following his system to get to that 6th trade that makes up for all his losses and more.

The risk of being wrong is rarely acknowledged, which makes it much trickier to work with. Unless a trader specifically studies trading psychology, he is rarely aware that he is actually afraid to take a trade because it might not work out.

How is it possible not to accept the risk?

In other words, how is it possible to participate in an activity (trading) that is risky by its very nature and not to accept the risk? Mark Douglas provides a very good explanation to the underlying psychology in his book:

The typical trader won’t predefine the risk of getting into a trade because he doesn’t believe it’s necessary. The only way he could believe “it isn’t necessary” is if he believes he knows what’s going to happen next. The reason he believes he knows what’s going to happen next is because he won’t get into a trade until he is convinced that he’s right. At the point where he’s convinced the trade will be a winner, it’s no longer necessary to define the risk (because if he’s right, there is no risk). Typical traders go through the exercise of convincing themselves that they’re right before they get into a trade, because the alternative (being wrong) is simply unacceptable.

Such thinking is leading to many problems in our trading. Instead of looking at the market as the source of trading opportunities he can act on, the trader thinks of it as the enemy he needs to fight. He is trying to learn everything he can about the market so that he can build such a trading system that will not lose any trades. The only way such trader can be psychologically comfortable with his trading is if he can win all his trades, since any single loss causes a lot of psychological pain that makes him start questioning his trading system.

You can imagine how difficult and frustrating such trading will be.

On the other hand, it is simply a matter of adjusting one’s beliefs and expectations about the market in order to solve this problem once and for all. A good trader does not simply say that it is possible to lose money on the market, he expects to lose money on any single trade he makes. He never knows what trades are going to be winners and which ones will pay the market for the opportunity to trade. A good trader sees such loses as the cost of doing business, similar to a restaurant owner who has to buy food before he can serve it to his customers for profit.