Defensive Trading Wins Every Time

08/30/2010 11:31 am EST


No one talks about it, and I’m still stumped as to why not.

Well, almost no one, as Warren Buffetts infamous Rule #1: Never Lose Money speaks to it in spades. No surprise he has been wildly successful.

Yet I suppose in a business that remains rampant with hype and the “I called the market right” syndrome(a.k.a. the “Even a broken clock is right twice a day” theory), I suppose it should come as no surprise.

Here’s an exercise. Find your ten largest trading losses of the last 12 months. Then, remove any rare ”black swan” anomalies such as trading platform outages and the May 6 “flash crash,” over which you had zero control. The result should be losses over which you should have had some control.

For many traders, the remaining sum—after changing the minus sign to a plus—likely totals a targeted annual income stream at one point in your career, i.e. earlier years for seasoned traders, or current targets for developing traders, that would have been avoided if you’d either not traded or cut back your trading.

Yet the popular trading “press” continues to ignore it.

And while stepping up the offense is of course critical to creating the necessary positive outliers, analyzing your ten largest losses will likely show you how very important playing defense can be.

Here’s a wild guess as to causes for the large losses:

1. Missed the beginning of a monster move and tried to make up for it by fading at inappropriate times and adding to the positions;

2. Had a losing day (which of course should be completely irrelevant)and couldn’t bear the thought of booking a negative number, so traded the hell out of the market and magnified the modest loss by a factor of at least three;

3. Just didn’t “feel” in sync with the market upon awakening, but traded anyway with no adjustment to sizes;

4. Wasn’t in sync with the market in the morning, so traded the lower-probability afternoon session heavily;

5. Saw other traders in chat rooms or in your office trading and doing well and gave in to peer pressure;

6. Saw the Dow was +300 on the day, figured that meant your P&L also had to be up nicely, and traded accordingly;

7. Went “all-in” on day two after having a monster win on day one, giving back your prior day gain by at least 50%;

8. Forgot (or didn’t know) that it was more than OK to scale out of a losing position versus barfing it out in a single projectile at the retail extremes (I know, great visual);

9. Doing your best Mortimer Duke impression by fading an extreme trend after 3:45 pm ET on a Friday looking for a full reversal, somehow thinking the market may stay open another four hours just so you can cover at better prices. One of my earliest crushing bonehead losses (somewhat appropriate given today’s market close), was Exhibit A for our mandatory no-fade rule after 3:45 pm.

I could go on, but you get the picture.

And in every case, reducing your trading activity (playing defense)would have saved the day.

Why might it seem I’m staring at your trading diary from your losing days? Because I’ve done them all. 

Thankfully, most were earlier in my career.

Defense via size adjustments. Defense by simply watching the market play offense before tiring and becoming vulnerable to the wholesaler. And defense when personal fatigue sets in, regardless of the market action at the time or what other traders are doing.

In doing so, the idea is to get them thinking strongly about the adage, “A penny saved is a penny earned.”

And in many cases, it will be a full year’s worth of pennies.

By Don Miller

Don Miller is a trader and can be found at

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