By Rob Colville on September 20, 2014 in
How would you like to hear a good horror story? Now as it happens, this one’s not about zombies, or vampires, or Jack the Ripper, but about a losing trade that you’re likely to find just as scary. I just heard it for myself the other night, and at times, I could barely believe my own ears!
You see, while sharing a good scotch with a friend and colleague, we talked about “hard knocks,” or the ups and downs we traders encounter on the path to continued knowledge and profitability. And while a losing trade (or several) is just part of the game, some do teach us more than others.
This is one of those trades, and my friend, Nick, in telling me this story, helped remind me that one losing trade can change everything. It can alter the path of your entire career, and even worse, your entire financial future, and that’s why we have procedures in place to guard against that.
This is the story of one devastating losing trade, what caused it, how it could’ve been prevented all along, and what ultimately happened afterwards to help the trader go on to a very illustrious career that continues to this very day in spite of it.
With the market near a key resistance level, a short option trade was selected and a very large position was taken. The trade quickly moved in the desired direction, and in just minutes, the position was up over $8,000. All good so far, right?
Well, the market then spiked higher, and those options, which were originally worth $8, were now priced at $7.50. That seemed like a “great price” at the time, so he added to the losing position and bought 100 more, intensifying what was already a huge bet.
See related: Trading Rules No Disciplined Trader Will Break
When the market gapped open 150 points higher the next morning, the position was effectively blown out of the water, and for the days that followed, the market ran further and further away. When the smoke cleared, those $8 options were worth just 70 cents, and a healthy, six-figure trading account had practically been wiped out.
This is not one of those times when you can just blame the market for going against you, nor is it really a cautionary tale about the dangers of option trading. Unlimited losses can happen in any market,afterall, so this is really about the series of critical errors that combined to produce this disastrous losing trade:
Trading with Money in Mind – What you really need to know about this losing trade is that it was taken with a set dollar amount in mind: $30,000. That was how much the trader hoped to take out of his account in just one week’s time in order to use it as a down payment on a new house. That ultimately formed the basis for all faulty decision making, and was why the trader—who knows better than that—chose to ignore acceptable risk and trade management procedures.
See also: How Traders Can Stop Self-Sabotage
Too Much/Unlimited Risk – There should be no circumstance where you risk more than 1% of your account for a given trade, and so there’s definitely no excuse for risking up to half of it at one time. He never would’ve done that had he been trading according to plan and considering the merit of the set-up, not the dollar amount he was trying to extract from the market.
Furthermore, to run stops or trade without them exposes your account to excessive or even unlimited risk. While he was only considering what needed to be done to clear the way for a run to $30,000, his recklessness actually paved the way for a losing trade so severe, he had to call his broker and have them close it down for him.
Added to a Losing Trade – While some may dispute this, it’s never a good idea to add to a losing trade. Sure, it may seem like a “value opportunity” at the time, or in this case, a chance to get to the $30,000 profit target even faster, but you saw the worst-case scenario unfold here, and it only made things that much worse. It’s been said that the best traders are extremely stingy with regard to risk, and none would’ve poured more hard-earned capital into a losing trade. Simply put, you shouldn’t either.
It was not my friend, Nick, who took this trade. He himself could hardly bear to tell me about it, but he happens to know because he wrote a book that is, in part, about the trader who did take it.
This man is well-known and respected to this day—you’ve probably seen him in the press before—and he was unequivocally brave to speak of this experience the way he did. How many would ever do that, afterall?
In the end, he managed to sell some assets and fund another trading account, but not before he took four or five months off to get re-focused and re-committed to trading his strategy with no more exceptions. Today, he’s one of the more prominent traders in our industry, but he was very nearly ruined because he ignored his strategy, broke the rules, and compounded mistakes throughout one disastrous losing trade.
Who is he? Well, I don’t have the heart to say his name here, but read Traders at Work and you’ll quickly find this and a number of other fascinating stories that will no doubt help your trading.
In the markets, just like in life, some of the most important lessons are the ones we learn the “hard way.” This was one such story, but there are countless others out there that are unfolding all the time, and even the pros have hang-ups of their own.
If you haven’t already, you, too, will experience your own “hard knocks” at some point, and we re-told this story not to shame or embarrass anyone, but to share the many valuable lessons it contains. Trade with discipline, be forever mindful of how much you can lose, not how much you can win, and follow your strategy above all else are only a few of the key takeaways here.
I’d urge you to spend some time thinking about these lessons, and remember this horrific losing trade next time you think about breaking your own rules in search of some fast fortune. Until next time, trade well, and most of all, trade wisely!