Revisiting some of the costly mistakes we made as novice traders can prove to be a cathartic and healthy exercise. Particularly if the mistakes taught us valuable lessons and helped nudge us in a better direction, causing us to eventually find a better place in relation to our trading. Blowing up an account, or losing so much of your account’s worth that you receive a margin call from your broker, has to register as a low point in any trader’s fledgling career. But from that low point we should take solace that this is as low as it gets and if we pay the harsh lesson the right amount of respect, then it’ll never happen again.
However, despite it being a simple part of our ‘tough love’ education that we can easily avoid, it’s always shocking to read on trading blogs or forums of new traders losing significant amounts of their capital in their accounts. Or wiping their accounts out completely after receiving margin calls, which could all be easily avoided by applying the simplest of rules to prevent possible ruination.
Before we discuss what we learn from blowing up an account, or receiving a margin call, we should first address how even blowing up an account to a disaster level shouldn’t be the nightmare scenario we dread, if we’ve kept the initial account funding to a sensible starter level.
It’s important that when we fund our first account we only fund it with cash that we can afford to lose. Now that’s a horrible concept to accept; that we’re placing money into a trading account that we may never see again, let alone witness it grow. But the reality is, for the vast majority of traders, their first funded account won’t grow, either instantly or by stealth, that quickly. So how much we place into our first funded account is a very important step and concentrating on this aspect of money management will be one of the first critical success factors for our future prosperity.
Let’s surmise that we have €20K savings, savings built up by you (and perhaps your partner) over a period of years and together you’ve decided to try FX trading as an additional method of wealth building for your savings. You wouldn’t risk all those savings on your first attempt, you’d sensibly discuss what proportion of your savings you’ll commit to your first account. This commitment should only occur once you believe you’ve developed a robust trading method and overall strategy, through the effective use of demo accounts.
What would represent a reasonable amount to risk on this first venture into trading differs on personal circumstances and our tolerance to risk. But let’s suggest, as an example, that we’d risk 10%, a total of €2K of our savings to our new trading venture. Then we decide that each trade we take we’ll only risk 1% of the original trading account. Therefore we’ll be risking only 0.1% of our savings on each of our first trades, €20 on each trade. Moreover, having developed the skill of using trailing stops (during our demo period) we’ve controlled our actual empirical loss down to 0.75% per trade. Our actual loss per trade is averaging out at €15. Now we commit all this incredibly simple to follow detail into our trading plan. Do readers see what we’ve done there? In the space of a couple of paragraphs we’ve outlined how we never have to experience an account wipe-out or margin call, ever.
In fact we’ve now turned our original concept and title on its head as even if we only experience a 50:50 win rate (losers versus winners) but let our winners run, up to perhaps 1:2 R:R per winner and close our losers early, at an average of 0.75% account loss, then in theory and hopefully in practice, we’ll enjoy a healthy return on our risk. In a few short paragraphs we’ve proved that by controlling our risk from; savings, to account size, to risk per trade, we’ve outlined a method (if embedded into our trading plan) that would make it virtually impossible to blow up our account. Especially as we’ve put in our own ‘circuit breakers’ in the form of drawdown levels in our trading plan, levels that we won’t move past before re-evaluating our complete trading strategy.
However, moving our bullet proof blueprint to one side is there a way we can recover from a severe drawdown, wipe out, or margin call, if we have ignored all the advice we’ve offered up and if so how?
The short answer is yes, of course we can recover. The long answer is that it’ll take time and the impatience that led us to come close to losing it all has to be addressed before we step back into the arena.
Let’s pluck an arbitrary loss figure of 50% account loss. We didn’t risk ten percent of the original savings on €20K, we risked it all by placing it into our trading account. And we’ve lost fifty percent, €10K. How long could it take us to recover our loss without resorting to excessive risk depends on many factors, but let’s make an attempt at some reasonable targets.
We decide that we’ll trade with a €10K account and stick to our risk of 1%. We’ll be risking €100 per trade. We’ll be day trading, a single currency pair such as EUR/USD and be looking to take two trades a day, but only if our high probability set up occurs, if not we exercise patience and wait for the next set up.
If we take ten trades per week, and our win loss ratio is 60:40 and our losers see us lose on average €75 per trade (due to our effective use of trailing stops) and our winners reward us on an average 1:2 risk v reward – €200, then we can make a significant improvement on our losses within a month. Four losses at a cost of €400, six winners at a gain of €1200 will equal an €800 profit per week. $3,200 in our first month. A considerable recovery on the overall €10K loss we recklessly allowed to happen.
But now we can clearly see light at the end of the tunnel, two more months and we’ll be close to recovering what was a disastrous initial loss after the market served us up one of the most humbling experiences it can. And we can be sure in ourselves that, having begun to recover our losses, we’ll never revisit the ill-disciplined trading methods that caused us to be in this situation in the first instance. Can’t we…?
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