10 min read

How to stick to a daily loss limit

This problem comes up a lot with day traders:

  • They know they should have a daily loss limit.
  • They set a reasonable daily loss limit in their heads.
  • ....but they keep breaking it, over and over.

The standard advice out there tends to be some version of this:

"Just stop breaking the rule."

"Just be disciplined, dummy."

There is a degree of truth in those responses, but they're far from complete and ultimately not very helpful.

Breaking certain rules - especially around "bigger" losses - can get into some of the deeper psychological issues a trader may have.

If you want to resolve these more complex problems, it's important to dig into why they're so powerful.

For example, let's say you're a day trader who takes 10-20 trades per day.

  • Losing one trade might equate to $50. Not the end of the world, and it can quickly be replaced by another trade - potentially a much bigger winner.
  • "Losing the day", on the other hand, is more painful because you cannot quickly replace the bad feeling of loss with a winner.

Let's go deeper with this character.

Let's say you're just not successful. You could be an overall losing trader, you could be breakeven, you could even have made a little bit of money - but your results are nowhere near what you thought you'd have.

On top of that personal frustration, you feel pressure from your family and friends. They might even be nice about it, but they range from disapproval to disappointment - maybe even anger and resentment.

You carry that around with you all day, even if you're not always aware of it. So, what happens in the trading session?

  • Losing a few small trades? That's recoverable, quickly.
  • "Losing the day"? Suddenly you seem to be confirming all that negative stuff about yourself. It might be all in your head, but it's incredibly powerful.

So what can you do about it?

  1. Replace $ profit/loss with # of trades.
  2. Set a daily loss limit that's not going to stress you out.
  3. Set a daily loss limit that's not going to kill your week.
  4. Automate it (more on this in a bit).
  5. Journal.
  6. Be transparent and ask for help when you need it.

Step #1: Replace $ p/l with # of trades.

Losses, in general, are painful.

Financial losses, specifically, are extra painful.

...and pain is one of the major factors behind irrational decision-making.

Therefore, the quickest way to remove some of the extra pain-based irrationality from trading losses is to make them feel....not financial. Or at least, less financial.

It's a pretty simple shift to make - you've just got to change the focus from dollars to wins/losses.

I do this whenever I'm on a bad streak and feel like I'm out of sync with the market. It usually shows up as a losing week, multiple losing days in a row, and a general sense that I'm the sucker getting trapped more often than not.

Here's how I hit reset:

--> Stage 0: Take a few days off of trading. No study, no thinking about it, just take a break and focus elsewhere.

-->  Stage 1: Back at the screen, I get 3 trades. I know the day will end as:

  • 3W, 0L
  • 2W, 1L
  • 1W, 2L
  • 0W, 3L

There's no uncertainty, and I know that even an 0-3 session will result in a small loss that I can handle.

--> Stage 2: When I'm ready to move on, I'll upgrade from 3 trades to 3 losses (think of it like 3 strikes). At worst, I'll end up 0-3 and quit. At best, I'll have a huge green day with a bunch of wins and up to 3 losses.

--> Stage 3, I'll carefully come back to a dollar based loss limit and trade within in. Carefully.

(I say "stage" instead of "day" because personally I usually need to spend a few days in each stage before moving on comfortably. If you've been through the confidence shaking/rebuilding process, you'll eventually be able to feel yourself "ready" to move on.)

Step #2: Figure out your painful number.

I'm borrowing this idea from a consultant I know.

After years of testing his pricing, building many different products and offers, and generally selling his services, he's come to a very simple price for his phone consulting: $750.

When I asked him why he doesn't charge more, he shrugged and said, "Meh, that's my minimum happiness number. I know I could probably squeeze more out from whoever, but $750 is a number I know I can trade my time for and not feel bitter or ripped off."

I think there's something to that. That number may change over time, but there's probably a number that'll make the day feel decently good.

On the flip side, I think that concept applies to our losses, too.

If you walk away at the end of the day down $50, you're probably not pulling your hair out, questioning life choices, etc, right?

What about $500? $5,000? $50,000? $500,000?

That number totally depends on you, your account size, and your personal pain threshold. But, that means you should have a think about your number - it's something personal, not a number someone can assign to you.

Since going through this type of exercise, I've found several levels that stick out to me.

The first one that starts to shift my mood is losing $400. For whatever reason, I hit that number and I can feel myself start to shift into negative mode. The more I push past it, the more irrational trading will creep into my session.

If I look at my losing days, this lines up with my results - I've got a double bell curve in terms of losses. One clump is sub-$400, then there's another clump at $1,000.

Takeaway: This isn't scientific, but think about what numbers trigger changes in your behavior. There's probably a number that'll start to upset you - note it down.

Step #3: Relate your DLL to your winning days.

Many traders think of a DLL as a mega-emergency-disaster-catastrophe-brake.

Like, "I couldn't possibly bear to lose $10,000 in a day. It'd be a disaster. So, therefore, my daily loss limit will be $9,999.99."

Here's a suggestion - don't make it the maximum possibly loss you can take before the account is destroyed.

Instead, think about your DLL as a more gentle guide. Assume you will regularly have losing days.

What is the loss quantity you can handle and still end with a positive week/month?

The way to do this is relate it to your winning days, not just your account size.

This will depend on your stats and your preferences, but the basic idea is:

"If I lose today, can I make this up in a day or two?"

For example, I've become increasingly conservative with my DLL.

I want to lose no more than half of the quantity of an average winning day.

For example, let's say an average winning day for you is $1,000.

If you set your DLL to -$500, you can string together two losing days in a row and still make up for them relatively easily.

I know another trader who does the opposite - he sets his loss limit at 2X his average winning day.

So in his case, if your average winning day is $1,000, he'd set a DLL of $2,000.

The idea is roughly the same - it limits your losses to something you can reasonably make up for with your winning days.

On a related note, I believe I remember Lance Beggs talking about aiming for a ratio of 70/90/100 - in other words, he's aiming to win 70% of his trading days, 90% of his weeks, and 100% of his months.

That's a very strong set of numbers, but think about what that means for his losing days vs winning days. Assuming he hits his targets, 30% of his trading sessions are losers....and yet 90% of his weeks are positive.

Most day traders I know don't know their stats on a session-by-session basis. They know their trade-by-trade stats, but not their overall daily and weekly numbers.

That's interesting because they're mostly all really good about sticking to individual trade stops. But many are terrible at respecting a "daily" stop loss.  

By zooming out and thinking about each day as just one of many, many trading sessions, you remove some of the pressure to profit at all costs that day.

Speaking of Beggs, he pointed me to a great little blog called The Forex Bird. It was written by a Greek trader from 2008-2012 and it's great for many reasons - but most importantly, the author keeps coming back to this performance summary chart:

From Forexbird.blogspot.com

Ironically, I think swing traders need to focus on their trade-by-trade stats, like expectancy. Each trade carries a ton of weight.

Day traders, on the other hand, need to be much more focused on their day-to-day and week-to-week stats. Each trade is still important to be very careful about, but you cannot get sucked into focusing on winning every battle (each trading session) over winning the war (the wider collection of sessions).

Takeaway: Figure out a DLL that relates to your average winning day. Make it easy to make up for a loss.

Takeaway 2: Zoom out and track your weekly performance like Forexbird did. This should take some of the pressure off your individual sessions!

Step #4: Automate your DLL.

I just mentioned an interesting paradox:

Most traders have a good grip on using automated stops (and targets). They've got a hard -X ticks stop and +Y target, and roughly know what sort of R:R they're aiming for.

But, all that planning disappears on a day to day basis.

Well, guess what?

That's why/how day traders blow up accounts.

It's almost never about one bad trade. But one bad trade can turn into a slippery slope of many small bad trades that ends up in a terrible session - the kind that'll wipe away days or weeks of gains (or more).

The thing about slippery slopes is that they're....slippery. :)

For traders - especially day traders - one of those slopes is trading on tilt.

Here's what I mean by that:

Step #5: Journal your losing days.

I can't stress this enough - I've done it, I know many traders who do it, and I'm guessing you've probably done this, too....

....you journal your wins and you skip your losing days.

I might be stating the obvious, but one reason I think people struggle with repetitive bad behavior is that they avoid confronting it.

I get it, it's painful. It's tough to look back at a series of bad decisions - especially if you've got people asking about your results or you're on Twitter where people post ridiculous numbers that'll just make you feel bad.

This is where self-coaching is essential. You've got to understand how to get yourself back to the study session and focused on practical improvements, not all the external emotional crap.

One way to do this is to create a couple of personalities.

Bear with me.

There's "Trader You", the person who sits down to trade every day. Let's call this character "Travis the Trader".

Today, let's say "Travis" blew past a $1,000 DLL and lost $10,000, which is a big chunk of the trading account.

After the session, you've got two more personalities you can/should choose to use.

One is the positive voice that's there to tell you that everything is going to be OK. Various people call this the nurturer, the parent, or the friend.

The third character is the coach. The voice that's there to pick apart your actions and come up with practical actions.

I'll write more about how these voices interact when you're developing properly and learning from your mistakes in a future article.

For now, though, the basic idea is that after a massive loss, a straight up coach probably isn't going to help. You're already beating yourself up, so what's the point of picking apart things even more?

Instead, you need to create a little bit of space to recover from the shock of a really bad session.

I recommend taking the rest of the day off to do active things, like take an extra long hike with your dog. Spend time with your family. Go for a drink with your friends.

The next day, you can come back to the table ready for the "coach" voice. It'll still be painful, but spend a session not trading - just reviewing your actions.

I've found these sessions valuable because they remove the majority of the pain, allow me to really figure out where, when, and why it went wrong.

Most importantly, I've found that these sessions also result in:

  • The realization that the "disaster" really isn't as bad as it seems.
  • The realization that the "disaster" really came down to one or two specific things.

This takes the huge, painful ordeal and turns it from a vague chaotic monster and makes it smaller, more specific, and fixable.

If you force yourself into a journaling session when you're in mid-freakout, it's not going to be very productive.

But if you give yourself a bit of space and use the inner characters....it'll all work out a lot more easily and effectively.

Takeaway: Don't skip your journal after you break a DLL. If it's really bad, take an extra day to get yourself "right" for a productive study session.

Step #5: Be transparent and ask for help.

Let me be really clear about this - I think sticking to a daily loss limit is a key component of trading success.

It's also a very important safety valve.

If you don't develop the right habits around losses, it's a slippery slope towards gambling and wildly irrational behavior.

Believe me, I'm speaking from experience - if you get stuck repeating this sort of thing, it can be a lonely place. Trading books won't really help, you probably will be scared to hire a coach, and the standard advice ("just stop doing it") doesn't help in the least.

If you:

  • Consistently let one day ruin your week or even your month, seek help.
  • Consistently feel the effects of a losing session for the rest of the day, seek help.
  • Consistently find yourself waking up at night thinking about this, seek help.
  • Consistently find yourself afraid to start a trading session because you're worried about blowing up, seek help.

If you're not already doing so, here are a few suggestions I've used in the past that have helped:

  • Find an accountability buddy who you can check in with once a week or send a message at the end of the trading day. You can usually find someone on a forum or inside a chatroom - but take the relationship private and set clear check in times with clear DLLs.
  • Consider including your spouse in the process. Explain that you'd like to "report" once a week. The right person will feel included and probably support you better than you treat yourself. A close friend could work too.
  • I've yet to try it, but I'm considering therapy these days. When I look at my most successful friends (traders and entrepreneurs), the overwhelming majority of them use therapists.
  • Surround yourself with a few real traders. As much as I like Twitter and I lurk in a few forums....it's not the same as actually having 2-3 trader friends who you can call up and go for a beer or a hike with.

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