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The Difference Between Winning and Losing Traders

Wednesday, August 5, 2009 | Teeka Tiwari

No doubt you know the difference between winning and losing trades -- we've all experienced both and know the pain of the latter altogether too well.

But for all the strategies and opportunities out there designed to make us the profits of our dreams, most times it's not the strategy that fails us but, rather, the trader behind the trade.

Yes, that might just mean you. And today, I'm going to show you how to stop losing money and how to become a winning trader.

Originally, I planned to talk to you about where and how to place buy orders and short-sale orders. But before you even place an order, deciding where to buy or to short is always intertwined with where to place one's stop-loss.

No discussion of position entry would be complete without a thorough explanation of stops. And that got me wondering why so few investors use stop-losses and, if you're guilty of not using stops, I wanted to get this information to you sooner rather than later.

It might just mean the difference between retiring on time with a healthy nest egg or retiring later and still just "scraping by."

Plan to Win, But Prepare to Take Losses

Before we go into the "hows" of buying and selling (be sure to tune in for that next week) we need to examine trader psychology around taking losses.

All professional traders are aware that they must know where they are getting out before they get in. They have to know ahead of time what a wrong trade looks like so they can exit it quickly. This is a rudimentary fundamental that EVERY professional trader knows the answer to.

Can you answer the following questions?

1.) How do you know if you should hang on or cut your losses?

2.) Do you have a rule to tell you when to sell a losing stock?

Don't despair if you cannot answer these questions. All it means is that you need to take some time to figure out some rules for yourself.

Just know though that the answers to these questions are at the bedrock of how to buy and how to short stocks. (I'll have more on this in next week's article.)

However, all the trading rules in the world are meaningless if you don't use them. That's why you and I need to "talk turkey" about what's really going on with you when you refuse to manage your risk in a proactive and professional way.

Many investors refuse to take a loss for generally two reasons:

1. They cannot stomach being wrong.

A trade exited at a loss is a great big unavoidable acknowledgment of one's "wrongness."  For many people, this is just too painful a reality to face. In their minds, the losing trade becomes transformed into an allegory for a perceived failed life or fuel for a persistent, negative mental self-image.

In short, they personalize the loss and experience various degrees of emotional pain. Many traders are so deep in denial that they refuse to acknowledge that their losses are causing them emotional pain. There is no solace that I can offer this type of trader.

This is the type of trader who has to lose it all and then some before he or she wakes up from his or her self-induced fog and begins to change.

2.  They have put on too big a position relative to their overall portfolio value and cannot "afford" take such a large loss.

Of course, there is no such thing as a paper loss. Whether realized or not, your stock is worth what it's quoted and the loss is there whether you choose to pay attention it or not.

Even the 'Big Guys' Crash and Burn

Both of these examples are a form of self-delusion that millions of investors, both large and small, suffer from. Just look at AIG, Merrill Lynch, WAMU, Lehman, etc. ... and you can take comfort in the fact that self-delusion is no respecter of income bracket or social standing.

If this article is making you uncomfortable or bringing up feelings of anger or powerlessness, then that's a good sign. It means you have enough self-awareness to change.

You Can Become a Winning Trader; Here's How

The winning trader uses a very different strategy from the losing trader. The winning trader refocuses the pain from the loss in an impersonal way. They use the loss as a signpost that tells them something is wrong with their approach, NOT that something is wrong with them.

Winning traders explicitly separate who they are from what they do. They inherently know that their trading faults lies in their approach, not in their fundamental makeup as a person.

Any pain they do feel is quickly transmuted into motivation, which they use to fuel their investigations into becoming a better trader.

Contrast this approach with the losing traders who use the pain to emotionally bludgeon themselves. Instead of transmuting the pain into motivation, they take that pain and refocus it into reinforcing their negative self-perception.

Both of these approaches are learned responses and are well inside your control. The opportunity for growth from the pain of losses is the same for both the winning trader and the losing trader. It's what we do with the emotional pain that results from a loss that matters, not the loss itself.

The only meaning the loss has is the meaning we assign to it.

A Real-life Success Story ... My Own

It took the complete annihilation of my wealth in 1998 before I began to grasp this concept. For years, I viewed losses as personal slights against my own self-image.

It hindsight, it all appears so irrational, but that's why they say hindsight is 20/20. My recovery was a slow and painful one, and not without many setbacks. Erasing bad mental habits requires diligence and focus.

At the end of the day, how you process what happens to you will have far more impact upon your wealth-creation efforts than any set of trading rules. You must conquer your own emotional deficiencies first; only then will lasting wealth be truly within your grasp.

I'm not just talking about money. I'm talking about the whole package -- money, self-worth, peace of mind, love and a sense of contribution -- all of which are required to experience that elusive state that we call happiness.

Teeka Tiwari signature
Teeka Tiwari
Chief Investment Officer
ETF Master Trader
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