Mastering the Skill of Taking Losses

Articles on Trader Psychology by Rande Howell, Trader Psychologist



There is More to Taking a Loss than Meets the Eye

This is where the world of knowledge and performance collide.  Traders “know” that taking losses is simply part of doing business as a trader.  No big deal.  But that’s not what the experience of taking losses looks like.  Unanticipated instinctual biases pollute the trading mind, and then crazy trading mortally wounds the trading account.  Suddenly after taking several losses, an unexplainable irrational mind takes over the performance mind and disaster ensues. 

            Taking losses often becomes the biggest obstacle to success.  Under the pressure of losses, head knowledge flies out the door and is replaced by heart (limbic) knowledge.  That limbic knowledge that takes over the trading mind under stress is instinctual and reactive – it does not think.  And the thinking brain does not even see the limbic biases infiltrating the perception of the trader’s mind.  It does not know to look there and, therefore, cannot see what it cannot see.  This is literally the way the brain is set up – not for the rigors of trading.  And those gaps in awareness cause revenge trading (and trying to make up for prior losses) to mushroom BEFORE the unsuspecting trader has a clue about his trading mind being compromised.  He does not see the hijacking as it unfolds because he does not have the eyes to see it.  He only saw that it happened in hindsight, after his brain was no longer under the gun.  But under the stress of uncertainty and the expectation of getting back his money, the trader did not see that he had fallen into a trap.  And the harder he struggles, the worse it gets.

            Let me give you an example of this limbic predicament from a Sherlock Holmes case.  Sherlock Holmes has been retained by a wealthy horse owner to find out who stole his prize stallion from his barn in the middle of the night.  It seems to have just disappeared.  What was perplexing to the owner was the fact that two barn hands had been asleep up in the hay loft at the time.  How they were not awakened by the guard dog just didn’t make sense.  Yet the guard dog never barked.  If an intruder came into that barn, he would have barked and woken up the barn hands.  But the dog never barked.  This is what perplexed the owner.  The dog should have barked at the sight of an intruder.  How could the prize horse have been stolen under such circumstances?

            But Holmes was able to see what the wealthy horse owner could not see.  The “absence of barking” was visible to Sherlock Holmes, while it did not register to the owner.  This is what the owner could not see because his brain was not equipped to see it (much like the trader being lured, without realizing it, into trying to make up for prior losses).  Sherlock Holmes saw the “dog not barking” as part of the way the horse was stolen while everything seemed normal.  To Holmes, “the dog not barking” meant that the person who stole the prized horse was very familiar with the guard dog to the point the dog did not recognize the thief as an intruder intent on stealing.   He could “see” (perceive) what was invisible to the owner, who had a bias to not see into his blind spot.

            The same thing happens to traders after taking a few losses and drifting into (with growing desperation) the state of mind where “making up for prior losses” makes sense in the moment.  There is a remnant bias from our evolutionary psychology that holds that you can make up for losses – actually, you believe you have to.  When evidence is applied to the randomness of winning and losing in trading, the bias demonstrates that it is not true – you statistically cannot make up for prior losses.  But tell your Caveman brain that! Traders have a blind spot and do not see this instinctual bias at work, mesmerizing the trader into thinking and performing against his/her long-term best interest. 

            Short term instinctual survival took out the well-reasoned thinking of the trader.  Just like that.  The thinking brain never had a chance nor did it see it coming.  It did not even occur to the trader that, in trading, you cannot make up for prior losses.  To the trader, the logic was that he had dug a hole he had to work himself out of.  That made sense to him.  It did not occur to the trader, under the stress of trading, that each trade is a random act with a certain degree of probability for both winning or losing.  And the more desperate the trader is to make up for those losses, the less likelihood he will be able to maintain an effective trading mind.

            He may claw his way back out of the hole he dug, but it is not a certainty that hard work and willpower will prevail over probability.  If probability does not fall his way, the trader becomes more desperate to get back his money.  This is the downward spiral.  He was convinced, in the moment, that he could fight his way out of the problem.  The human need to predict and control outcome, and to win – so deeply ground into our evolutionary psychology –took out the trader’s capacity to be rational just when he needed it the most.   

Your Brain Was Not Built for Trading

                Trading represents the worst nightmare imaginable for the human brain.  The brain evolved with profound biases (blind spots) to control environment (control outcome), not to lose (that would mean death), and to predict outcome (finding a link between cause and effect).  What happened to our Caveman ancestors if they did not control their environment?  In their dangerous world they died. The same with not being successful at controlling not losing – they died.  And finding a causal relationship between outcomes and circumstances is deeply embedded in our primitive brains.  This link between cause and effect had great survival value to our early ancestors, but not in the jungle of the market. 

                Let me give you an example.  In an experiment with pigeons, researchers threw handfuls of grain into a flock of pigeons.  The pigeons were rewarded with a free gift of food.  Then the researchers raised their hand to throw another handful of grain into the flock.  The pigeons assumed the exact same positions that they were in when the first handful of grain was tossed.  The pigeon brain was biased on an instinctual level to find a causal relationship between how their bodies was positioned in space and the arrival of food. 

                It took the researchers only one toss to create this new association in the pigeons.  And once well established, this bias becomes automatic and instinctual.  The brain now has created a limbic learning or an implicit belief (below threshold of awareness) that drives perception -   “I can make up for my prior losses” - and action.  The old brain (Caveman) becomes dangerous to the thinking brain.  The emotional brain sees a causal relationship between getting your money back and concentrated work shaped by an Optimism Bias that is not supported by evidence.

                What is in conflict is the belief that you can control outcome (win your money back) and the reality that control over outcome is an illusion that is dangerous in maintaining an effective trading mind.  To the survival instincts of the emotional Caveman brain under stress, losing (and then losing more) is literally like being attacked by a saber-toothed tiger.  If you do not fight back and defend your ground, you will die.  Reason and discipline are not part of the emotional response to the taking of losses.  Instinct has the bases covered.  And until you learn to work with your primitive emotional nature in response to threat, your trading mind will continue to be hijacked by the instincts that drive the emotional brain (which drives the thinking brain).  The brain you brought to trading (so great for species survival in a distant past) is not going to produce the mind that can think and work in probabilities – which is needed for success in trading.  This is exactly what you are experiencing when you try to make up for losses or revenge trade.  Under stress, acting for perceived survival, your emotional Caveman brain is going to take out your modern mind that can think in probabilities. 

Changing the Brain’s Orientation from Certainty to Probability Management

                It starts with Emotional Intelligence.  Actually acknowledging that all thinking is emotional state dependent and is not negotiated is the first step.  There is never a time when your thinking was not influenced by your emotional nature.  Maybe your emotional vocabulary was not up to the task of identifying the emotions behind your thinking process.  Fortunately, EI (Emotional Intelligence) can be learned.  Every trader needs to be able to distinguish the desperation, fear, and shame (and not just the anger) that lie behind the bias to make up for prior losses (or revenge trading) where the trader is attempting to subdue, through aggression, a perceived threat.  It is essential to notice them BEFORE they take over your trading mind and then manage your emotional response to losses, rather than having your Caveman Brain biases take over in the wake of a disaster. 

                I place great emphasis on the skills of emotional state management while under stress.  The first step is recognizing the way you breathe and hold muscle tension which supports or disrupts the growth of an emotion.  It is through bellows breathing and muscle relaxation that the intensity of an emotion can be controlled.  As your capacity to understand your emotional nature grows, you can develop the emotional intelligence to use your emotions to create a mind built for trading.  The challenges of dealing with uncertainty and loss will always be part of trading, and life.  What is controllable is not outcome.  It is the mind that you bring to the performance that can be controlled.  You can train yourself to respond differently to uncertainty and to losses.  Just like fear and anger (and desperation) are learned responses to perceived threat – so are discipline, courage, self-soothing, and impartiality.  They can be learned.  This is the foundation of the psychological edge needed to drive your statistical edge.  Fear and anger come stocked through your personal history and the evolutionary psychology of survival under stress. 

                Discipline, courage, self-soothing, and impartiality can be learned.  You can train yourself to respond to uncertainty differently.  An effective trading mind has to be built.  It does not come naturally.  Fortunately, the process can be taught.  To study this option more fully, I encourage you to go to my website,  There you will find access to information about how you go about training your brain to manage the challenges of Uncertainty.

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