The most important rule in trading is: Don’t lose money! Most traders focus on generating the best trading ideas. They focus on whether they should buy Bitcoin on the dip or buy the latest disruptive stock. But this is not the best idea. After having put so much work into generating an idea, they get too attached to it. They become reluctant to sell, even if the trade goes against them.
The best traders may have a lot of very different investment strategies but they all have one rule in common: Don’t lose money!
Value investor Warren Buffett, one’s famously said: “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.”
Or, what about George Soros, a quintessential speculator whose investment style is diametrically opposed to Buffett’s buy-and-hold value philosophy. But Soros is even more obsessive when it comes to not losing money. His philosophy is “not to wake up broke and always to be able to come back and fight another day.”
Victor Sperandeo, better known as Trader Vic explained the psychological challenges of implementing this rule: “The single most important reason people lose money in the financial markets is that they don’t cut their losses short. It is a curiosity of human nature that no matter how many books talk about this rule, and no matter how many experts offer this advice, people still keep making the same mistake.”
No matter how bulletproof your idea seems on day one, a trade can always turn against you for unexpected reasons. Even if your original analysis was spot-on. Train yourself not to fantasize about how a trade will work out in your favour. Instead, focus on defining your worst-case scenario.
Jim Rogers once put it that way: “Look down before you look up. If you are right, the upside will take care of itself.”
Your primary objective in trading should be not to get wiped out and lose everything. After a loss, you always have to be able to get up and fight again. Only this way you will be able to regain your losses.
Sven Franssen