Despite what you may have read or heard, there are no trading secrets. If you want to succeed in trading, what matters first and foremost is you have to take your losses quick. There is no way around it.

Today I am going to share with you the anatomy of a blowout trade so that you can learn how to become aware of your own unconscious trading patterns and start taking charge of the improvement of your trading performance.

The Unconscious Thinking Strategy

When we talk about how to generate profits we mostly talk about strategies that give us an edge in the market. Let's first define what a strategy is. A strategy is a sequence of individual steps that get you a certain outcome. What most do not realize is that we actually have a strategy for everything we do in life. For example, everyone has an unconscious strategy on how to brush teeth or how to put pants on.

This is really useful to realize, because this means that not only do we have an unconscious thinking strategy for routine tasks such as getting dressed, we also have a repetitive unconscious thinking strategy that leads to blow out trades.

The wellness approach

The best part is that once we become consciously aware of this unconscious thinking strategy, we have the power to intercept any self-sabotaging behavior that previously would creep into our thinking. In coaching we call this a wellness approach. We do not try to fix past mistakes but engage proactively to ensure we can follow the proven paths to success in trading.

I had the privilege to examine the thinking strategies of countless traders and I found that there is a common pattern of thinking that leads to exorbitant losses. The pattern has usually three phases to it.

The Three Phases

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Phase 1: The Intention
When the trader enters a position, the intentions are to follow the plan and exit at a pre-determined level. Usually it is a monetary exit (when the trader sets take profit or stop loss at a percentage or ratio, say 1% or a 2:1 profit to loss ratio) or a technical exit (when the exit is determined based on a certain level or price action on the chart).
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Phase 2: The Monkeys Start Fighting
Everything is fine. The trade goes into profit and the trader feels pretty chuffed about it. But suddenly the price action changes and the trade starts to turn from a profit into a loss. That is often the beginning when uncomfortable emotions such as disappointment or annoyance are being experienced. But once price is getting close to the stop loss, these emotions start becoming more and more intense.

Despite the trader's determination to honor the stop loss, they start fighting all these emotions that scream "move the stop loss!" Suddenly the self-talk has changed from calm determination to follow the plan to two monkeys fighting in the trader's mind. One monkey urges to move the stop loss. The other is fighting to stick to the exit strategy. And the reality is that for the majority of traders, this fight is won by the monkey who urged to move the stop loss.

The exit strategy is questioned, and every time price gets close to the new stop loss, the goal post for the stop level gets moved. In your mind, memories of past events where the trade was closed out by one tick before rebounding and going all the way back to your profit target become alive.
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Phase 3: Hope, Euphoria, Paralysis
The trade moves even further away from the entry, and instant relief sets in that the stop loss was moved and the trade is still in play. The urge to avoid taking a loss is so strong, it is almost impossible for the trader to think clearly now. The hopeful thought that a bounce back into profit is imminent becomes omnipresent.

However, it is all wishful thinking as the trade moves closer and closer to the stop loss and the old intense discomfort creeps up again. A quick glance at the P&L and shocked, the trader realizes that the loss has now become significant, being by far greater than initially planned, and so it would become difficult to recover if the loss would be realized.

But a quick calculation of the percentage of drawdown awakens the trader's fighting spirits. Nobody wants to lose that damaging amount of money and random self-promises to exit the trade as soon as it bounces are being made.

And the bounce comes! But now it does not look like it is a bounce, but it is the anticipated reversal! This is the real deal, the monkeys are screaming! And now, hope takes over that the entire loss can be recovered. Not only that, confidence that this is the anticipated reversal kicks in and now the trader enters a second trade, adding to the losing position. Why not take advantage of the even better price, right?

Euphoria takes over as the trader senses the opportunity to make even more profits! But once again, euphoria fades rapidly as the anticipated bounce does not materialize and the trade moves deeper and deeper into a loss. The result is now the trader is stuck in two losing positions (if not more) that are not being closed, and a drawdown that has eaten even deeper into the capital.

Worry about the size of the loss and the subliminal fear of not being able to recover it hinder the trader from closing out the position. Ultimately the loss gets so big that either the trader realizes that if the positions are not closed the risk to blow the account is imminent, or the account is actually going to be liquidated whilst the trader watches it feeling paralyzed.
Anatomy of a blow out trade phases

Breaking the Pattern

Becoming aware of these three phases and being mindful of the thoughts that lead to the temptation to not honor the stop loss is the first step to becoming a more disciplined trader who takes the losses as per the risk management plan. Through consciously analyzing the thought process, red flags can be noticed and instantly dealt with.

Only now does the trader have an opportunity to modify the automatic responses to previously daunting events and build a long-term sustainable solid trading career.

Mandi
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