The ABC Secrets That Prevent Overtrading By, Chuck Whitman

Every trader falls into one of two camps: the overtrader category or the afraid-to-trade category. My 30 years of training traders has taught me that, no matter a trader’s successes or struggles, every trader falls within one of these camps.

When it comes to differentiating an overtrader from those afraid to trade, the distinguishing factor of the latter camp is their difficulty in pulling the trigger. Fearful traders don’t go broke quickly; they die a slow death. It’s the death of paying their living and trading expenses, with no trading income, while wasting life’s precious time as they sit paralyzed in fear.

Alternatively, if you find yourself caught in overtrading, you can blow out your account in a day or even within a few hours. There are examples of traders that lost complete control this way. After suffering losses, they continued to dive back into the market only to find their accounts down 25, 50 or 100 percent in a day or two. People who engage in overtrading play a dangerous game of losing control rapidly. Should you have the qualities of an overtrader, it is essential to slow down your mind and the speed at which you act. You must create rules, within a plan, and have processes in place to complete before placing a trade.

Three Dangerous Examples of Overtrading:

  1. Double Down
  2. Rationalization Through Time
  3. Losing Control

Double Down

Some overtraders decide to double down and assume that losses can be recovered if they add to their position.

In gambling, increasing bet size while losing is called The Martingale Strategy. If you lose $1, you then bet $2 to recoup your loss and still make a $1 profit. This attempt to recover the original profit continues as you bet $4, then $8, and so on in the rounds to come… The hope is to eventually win and retrieve your original cash back. In trading, this is “throwing good money after bad”.

The reward-to-risk perspective indicates your loss in the first round; you bet $1 to make $1. In round 2, you are now cumulatively betting $3 ($1 initial bet + $2 on the second bet) to make a $1 or a reward-to-risk ratio of .33. In the third bet, you are betting $7 ($1+ $2 + $4) to make $1 or a reward-to-risk ratio of .14. It only gets worse from there.

The string of losses, especially at bigger bet sizes, can only be taken so long until the account is bankrupt. Increasing bet size while losing is the fastest way to go broke. Instead, we want to scale up the pyramid and add to our position while it’s working, not while it’s going against us.

We emphasize in our trading approach the importance of the Reward-Risk Ratio. High reward-risk trades (we call them Big R’s) are one of the keys to successful trading. Many traders think of each trade as a separate event, but this is often false thinking. For example, if we have an idea to buy Crude Oil and we get stopped out for a loss and then jump back in again, this is not two separate trades but rather two expressions of the same idea.

Let’s say, in our first trade, we identify a reward-risk ratio of 3:1 (we will make $3 for our $1 bet if we are right). If we get stopped out for a $1 loss and then decide to get back in on the same trade, our reward-risk ratio has changed from 3:1 to 1:1. Why? Because we look at the idea in aggregate. On our second trade, if we are right and make $3, we must deduct the $1 loss from trade #1. That leaves us with a profit of $2 ($3-$1). However, if we are wrong on the second trade, we have a total loss of $2 (-$1+-$1). $2 Profit/$2 Loss = 1:1 Reward Risk Ratio. Traders often don’t think about this aspect of the trade. The Math tells us that it is not worth reentering the market most of the time. We are better off moving on and finding a better opportunity.

Rationalization Through Time

“Rationalization through time” is another form of overtrading. Imagine you’re on a diet, you slip up and eat chocolate chip pancakes for breakfast. You justify that you will eat better the rest of the day. But soon you get a craving for pizza. In contemplating whether you should have the pizza or not, you decide, “My day is already shot. I will make it a cheat day. I will get back on my diet tomorrow.”

Screw it; you go on a late-night binge of a half-gallon ice cream tub or a dozen cookies. You conclude by telling yourself, “It’s okay because tomorrow will be better.”

Similarly, traders can reflect this mentality after a difficult trading day when things did not go the way they had hoped. It can sound like, “I’ll start following my plan again tomorrow. I’ll get back to being a disciplined trader tomorrow, but today I need to do whatever I can to get this money back.” The last hurrah gives us hope we can overcome our discomfort but leads to a more stress-fueled tomorrow.

Losing Control

The third reason for overtrading is simply losing control. With each loss, panic and despair continue to mount. It sounds like, “Ugh, I lost; I need to get back in now to make my money back.” The loss of control often occurs when an overtrader has a specific trading idea. For example, an overtrader will be long in a market, and they get out when it’s not working. However, the panic begins to seep in that the overtrader sold the low of the move. Soon, the overtrader hops right back into the trade only to see the market has gone against them again. While losing even more money, an overtrader can still tell themselves that that last re-entry was indeed the bottom and may try to get back in another time. The overtrader cannot accept the actual loss, and as a result, they are out of control and unable to step away from the screen. It is critical to break the loop inside one’s head when these personal chaotic trading rationalizations begin.

The ABC Secrets that prevent overtrading are as follows:

  • Away from the screen for success
  • Before any trade, execute a checklist
  • Call it a day

A: Away from the screen for success

Traders who suffer from overtrading need to slow their minds down to create space between stimulus and response. The more an overtrader stares at the screen, the more likely the overtrader will lose control. Too many traders refuse to leave their desks all day.

Typically, traders make money in the morning only to give it back as the day goes on. Why? Because they lose their discipline after staring at the screen all day and start to trade excessively. Isn’t it interesting that it is far less common to be down money early and come back? Traders are at their mental best in the morning. Traders experience days of doing well, days of losing money, and days in which money is lost but made back later.

Simply put, the days of losing money are inevitable, a fact every trader must accept. It’s important to consistently be in the best state of mind when ideating and executing trades. Tired and sloppy trades are more likely to occur the longer you stare at a screen.

Trading is far different from other typical work schedules. The 9-5 work-life model is the opposite in the trading realm. After sitting at a desk all day, the brain seeks a justification for why you are still sitting at a desk and seeks other stimulating activities. Hyper-actively searching for trading patterns, your brain may cause you to see ghosts (unreal patterns/thoughts/consistencies) on charts that can lead to making trades based on inaccurate information. In the morning, each of us is fresh, ready to go, and can clearly see information. As the day continues, your attention slips. Any plan requiring you to be in front of a screen the entire day is set for failure because it’s psychologically flawed. No person can work at peak performance while spending an extended time in front of a screen.

Peak performance requires regular breaks. No one should trade more than 60 minutes straight, preferably under 30 minutes. The Pomodoro Technique is a concept I regularly use, which requires setting a timer for 25 minutes of trading and then taking a break to clear one’s head. Changing the physiology of your state via drinking some water or being active helps you get centered again. I teach my traders to spend most of the time finding the right market and setup to trade rather than watching a current trade or signal. Execute the trade, enter a stop, and your peel order, once you’ve deciphered the right market and pattern to trade. You then set two alerts: price level and time alerts. The time alerts are set using a timer appropriate for the timeframe of our trade (intraday especially). Then minimize the chart and go about your day. Once your alert goes off, return to the screen to assess what needs to be done. You either act or set a new set of alerts. Repeat this cycle of planning the setup, taking action, setting alerts, minimizing the screen, and leaving the workspace to go about your day.

B: Before any trade, execute a checklist

Make a pre-trade checklist of the rules required to be met before entering any trade.

One of your rules is that you must fill out the entire checklist prior to taking a trade. The act of filling out the checklist slows the trader down to make sure all rules are met before placing this trade. Filling out the checklist usually causes a significant increase in percent of trades that meet the rules. If you make a trade without this pre-trade checklist, then you are breaking your rules.

C: Call it a day

Put money management rules in place that cause you to stop or take a break after hitting a certain drawdown threshold. Do not accelerate into ‘revenge trading’ in a desperate attempt to get your money back. For example, let’s say you choose your max loss to be –5R. Depending on your pre-determined timeframe, you must stop trading if you’re down 5R in that period. You are not going back in again to only accelerate losses. You cut your performance so that you can come back refreshed. To determine your max loss, it can be a capital dollar amount or an R; both modes can be used simultaneously, such as, “If I lose 3% of my capital or $5,000, then I’m shutting down for the day.”

Calling it a day prevents you from significant psychological damage and protects your headspace when returning the following day. If you cannot pause to come back tomorrow, then the greatness of trading cannot happen for you. There is the time every day to clear your head and come back.

These stressful moments of overtrading happen to every trader. Even the most legendary figures will get into a funk and make bad decisions that cause streaks against them. You must decide how you will be aware of these harmful habits and how to stop them when you’re tempted. After a bad stretch, get what’s necessary at the moment out of your head, then do something positive for yourself. Take a lap around the neighborhood, lay out by the beach, talk to your spouse, or turn on your favorite music. When it’s time to come back to trading, you will be in a great mental state and ready to return to work refreshed.

Let’s recap the ABC secrets that prevent overtrading:

  • Away from the screen for success. Be in front of the screen for the least amount possible.
  • Before any trade, execute a pre-trade checklist. List your roles and ensure all criteria are met before a trade slows down.
  • Call it a day. If you encounter any negative run over a select period, stop trading. Show self-love by doing something positive for yourself before returning to the next period ready.

Incorporating the ABC Secrets of Overtrading can have a massive impact on your success in trading because you’re implementing a framework that minimizes the damage your psychology can cause, while supporting yourself to manifest your trading edges.

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thank you , very very useful. you changed my way in trading .

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