Let’s face it. Nothing feels worse than taking a huge financial hit.
The fact is, the stock market is a risky game and sometimes things go wrong. Every expert trader has been there at some point or another.
However, what really separates the pros from the rookies is how they handle the loss. Pros know that bad things happen, and when they do, they take the time to manage their emotions. This is what allows the experts to properly learn from their mistakes to better manage risk in the future.
On the other end of the spectrum, inexperienced traders are prone losing confidence and spiraling into a series of increasingly bad decisions following a loss. That said, the question becomes how to prevent this from happening.
The following is a guide for getting back on track like a pro after taking a hit.
Why Does it Hurt So Bad?
Losses are difficult to stomach for more reasons than one. Firstly, there are the real world financial implications. Anybody who loses a significant sum of money is going to have to learn to function on a tighter budget until that money is recovered, which can be a tough pill to swallow.
But what about the emotional toll? When new traders take a loss, they often underestimate the emotional baggage that comes with it. When confidence dives, it is surprisingly easy to fall into a cycle of bad decision-making that leads to even more hits. This makes a bad situation even worse.
So, why do rookie traders so often fall victim to this vicious cycle? In short: emotions. Inexperienced traders commonly underestimate the psychological impact of a large financial loss. They let emotions get the best of them and become desperate, therefore falling victim to risky trades.
Let’s face it. A loss is a loss. What matters most in these unpleasant situations is how it is dealt with. The following method will help inexperienced traders learn how to get back up and wipe that dirt off the shoulder after taking a hit.
#1. Acknowledge Emotions
This point is absolutely key when it comes to regaining confidence. After taking a hit, it is easy to underestimate the emotional toll and become obsessively focused on the bottom line. The result? Risky trades that lead to more financial hits and a rapidly deflating confidence.
After a loss, any mix of confusion, anger, resentment, fear, and doubt are normal things to feel. The problem is that all of these strong emotions cloud ability to make good decisions. And after a loss, good decisions and a smart, safe strategy is exactly what is needed to gradually recover.
After suffering a hit, close the laptop. Take a day off, maybe a couple. The key here is to resist succumbing to the temptation to try to immediately bounce back with a knee-jerk reaction. This is a trap. Rather, take a break. Do whatever is needed to dispel that negative energy so that the big picture comes back into perspective.
Physical activity like sports or yoga are great ways to relieve stress, as are self-care strategies like massage or meditation. This could also be a great time to schedule a counseling session. There is no particular way to release emotional energy, so just do what works.
#2. Own The Loss
Yes, circumstances played a role. Certain things happened that couldn’t have been prevented. However, another crucial step to recovery is learning to own up to mistakes. This means fully taking responsibility for what went wrong.
Once a trader owns their mistakes, they effectively deal with denial. Denial is psychological defense mechanism that, just like strong emotions, clouds judgment. It prevents people from seeing things as they really are. In order to not repeat the same mistake in the future it is imperative to acknowledge the very basic fact that it was indeed a mistake. Now it becomes possible to learn from the experience.
#3. Revise and Plan
Effective risk management is the trick to preventing future loss. This means setting both high and low limits on every investment before going in. Once money is already on the table, it is easy to become caught up in a negative emotional cycle.
Remember that it can be just as hard to take money off the table when it is rolling in as when it is rolling out. Setting safe limits is an objective way to ensure that loss is always mitigated and nothing gets out of control.
So, what if a trade is obviously doing well? In these situations it is okay to adjust the limits. If money is already coming in at a safe and steady pace, move the low limit to a point above the original investment price to ensure a gain on the original investment no matter what. If the original limit was set within a range of 15%, stick to that range. The stock will automatically sell while things are still good so that the investment becomes a foolproof win.
The key here is moderation. These strategies will not only minimize risk, but prevent the temptation to hastily make back all the loss all at once. Like it or not, when it comes to recovering from a loss, the process needs to be a gradual one.
#4. Get Back on the Horse
The first thing to do is regain confidence by making some safe bets. Start with small investments that will definitely pay off.
The wise investment is one where the price is obviously lower than the actual value. That said, always apply the risk management strategy outlined above and stick to it. Don’t invest too much at the start. The important thing is to establish that things are going in a positive direction.
Remember: Attitude is Everything
The bottom is line is that when the pros take a hit, they know how to use it as a learning opportunity. In the heat of the moment, looking at the situation as an opportunity to improve on what went wrong might seem absurd. But this is exactly the attitude that anybody, rookies and pros alike, need to adopt when stuck between a rock and a hard place.
When a trader takes the time to acknowledge and manage their emotions when the going gets tough, they give themselves the capability to objectively assess their mistakes. This type of knowledge really is power. Now it becomes easier to successfully manage risk in the future so the same mistake is never repeated again.
Remember, every trader takes losses. However, when it comes to recovery, the pros know that attitude is what matters.