How to build guard rails to protect you from yourself

Topic Discussed:  Building Guard Rails for Traders

The Trader’s Couch series explores behaviors and psychologies that undermines traders performance, then offers practical activities and solutions traders can employ to advance their development and performance.

Building Guard Rails


Wall Street Traders have Institutional Guard Rails; You don’t

One thing I advise traders in our group to do is to envision themselves as professional Wall Street traders. The imagery and implications are powerful. So imagine yourself walking into a new job as a trader at a Wall Street firm.  Can you imagine in your wildest dreams that the firm would fund your account with a billion dollars and simply wish you good luck? Not a chance. You’ll be given a starter account with a minimal amount of funds to not only prove yourself but to protect the firm from your potential stupidity. You’ll be directly accountable to both the trading floor manager and the risk manager. Depending on what type of trading you’re doing you may have a daily loss limit and / or you may be limited to how big a position size you are permitted to put on. You may even be required to run your proposed trades by a senior trader or floor manager before being allowed to put on a trade.

These institutional guard rails are powerful. They serve to both instill trading discipline and rigor plus prevent the firm from catastrophic losses. Now compare that to how you operate. Yeah, that’s what I thought.  The lack of guard rails exposes you to horrific losses an institution would never allow to happen. You’ve got to make the effort to create guard rails yourself. Here are a few ideas for you.

Hire a Banker

Many beginning, aspiring traders fund their trading account with their ENTIRE nest egg of potential trading monies.  Its no different than going to the bank, getting all your money in cash, stuffing it in your pocket and heading to Vegas. You may think it’s different, but it isn’t. At a Wall Street firm, new traders have to earn the privilege of getting access to more funds. Why shouldn’t you? If you can grow a $5000 starter account over time with a demonstrated process ( vs dart throwing ) you deserve access to more money.  Do this. Hire a banker.  That person can be a significant other, parent, or other trusted person. Let them be the gate keeper of your trading monies. Fund your account with 25% of your trading monies. You will either blow it up or grow it. If you grow it, go back to the bank with your track record of success and ask for more. If you blow up, it’s back to square one but with the knowledge you still have 75% of your money.

Impose Position and Day loss limits

A common affliction of active traders is the ability to take a bad day and turn it into a disastrous one by either revenge trading or trying to make up early losses by 4pm.  A smart way to deal with that is by setting a daily loss limit. When you hit the limit, you’re done for the day. The amount will vary by account size and by how much pain you are willing to accept on a given trading day. This of course requires you to honor the limit.  A good way to impose outside discipline is to work with your broker to set an electronic limit on your account.  Once you reach your loss limit for the day, your broker locks your account for the remainder of the day. You can also use this method to restrict your position size. Do you really want to roll the dice with 25% of your money on one trade?A good rule of thumb is 1-2% of trading capital on any one trade with 5% being an absolute max.    Again, all this is to protect you from your self.

Guard Rails can make the difference between success and failure

Regardless of whatever talent you may have for trading, achieving consistent profitability will take time. It is essentially a race between how fast you can learn before all your trading money is gone. And unless you have a benevolent grandma willing to endlessly fund your account, once your trading capital is gone, you are done. Kicked out of the game.  As Jesse Livermore says “the game taught me the game and it didn’t spare the rod while doing it”.  Losses are part of the game. Instituting firm, even harsh, restrictive, guard rails will help preserve your capital while you learn the craft. Play the long game by trading small. Learn from each loss. And remember this. Losing more doesn’t make you learn faster. You can learn just as much by losing $100 as you can losing $1000.

Hope it helps. If you have additional questions or get stuck, please reach out. Happy to do my best to help.

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