Improve your defense; Then watch your returns explode

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The blog post makes the case that adopting a defensive stock trading process is the key to long-term market participation and ultimately a prerequisite to finding success as a trader.

In this post I will lay out a paradigm for “defensive trading” and why it is has been the key to long -term success for most of the  “Market Wizards”


The first step is to internalize the universal laws of trading.

Universal Laws of Trading

  1. When you lose all your trading capital, you are out.   No exceptions
  2. It takes a certain amount of time for aspiring traders to learn a durable, repeatable process to make money in the markets

Therefore, for the aspiring trader who aims to be a long-term market participant, its a race between learning how to be consistently profitable and running out of money.

Market participants approach risks in very different ways

When sizing up a trading opportunity, what is the question you most often ask yourself?

Short- time market participant:  How much can I make?

Long -time market participant:  How much can I lose?

At it’s core, playing solid defense is an understanding of risk and employing strategies that do not allow a catastrophic loss.

Collected Wisdom from the Market Wizards

Paul Tudor Jones

  • I’m always thinking about losing money as opposed to making money. Don’t focus on making money, focus on protecting what you have.
  • If I have positions going against me, I get right out; if they are going for me I keep them. If you have a losing position that is making you uncomfortable, the solution is very simple: Get Out!  You can always get back in.
  • Many people marvel at the amount of money I made shorting Japan never realizing I got stopped out 10 times before the trade clicked.
  • The most important rule is to play great defense, not great offense. Each day I assume every position I have is wrong. I know where my stop risk points are going to be. I do that to define my maximum draw down. I always have a game plan to get out.
  • At the end of the day, the most important thing is how good you are at risk control. 90% of any great trader is going to be the risk control.

Larry Hite

  • I have 2 basic rules about winning in trading as well as life: 1. If you don’t bet you can’t win. 2. If you lose all your chips, you can’t bet.
  • Throughout my trading career, I have continually witnessed examples of other people I have known being ruined by a failure to respect risk. If you don’t take a hard look at risk, it will eventually take you out.
  • Never risk more than 1% of your trading capital on any one trade. By keeping risk constant, I am indifferent to any one trade. Keeping your risk small and constant is absolutely critical

Richard Dennis

  • You have to minimize your losses and try to preserve capital for those few instances where you can make a lot of money in a very short period of time. What you can’t afford to do is throw away your capital on sub-optimal trades.

Jesse Livermore

  • Never average down on a stock. Always buy on a rising scale and sell on a declining scale.
  • The highest profits come from trades that show a profit right away.
  • It never ceases to amaze me how a man will risk half his fortune in the market with less reflection than he devotes to purchasing a medium – priced automobile

Bruce Kovner

  • Novice traders trade 5-10 times too big. They are taking 5 to 10% risks on a trade they should be taking 1-2% risks on.

Ed Seykota

  • If you can’t take a small loss, sooner or later you will take the mother of all losses
  • There are old traders and bold traders, but there are very few old, bold traders.


Defensive Stock Trading Process: The math matters

The ramifications of taking a draw down of any consequence are profound. Here is a table that shows various draw downs and the requisite performance required just to get back to even.

Much beyond a 50% draw down, recovering approaches the impossible.

Crystallizing the Defensive approach

  • If you read the profiles of great traders in “Market Wizards“, you’ll find almost all suffered the excruciating pain of blowing up multiple accounts when they were young, aspiring traders. Through that pain, they learned the absolute necessity of a defensive approach that understands and respects risk.
  • Guarding trading capital is your number one obligation as a trader. If you guard your capital it will help ensure you have the time to learn how to become a consistently profitable trader.
  • Approach all your trades the same way by not risking more than 1%-2% of capital on any one trade. If you do this, you won’t get hurt by a mistake and you won’t become emotionally attached to a “monster position”.
  • Know where you’re getting out before you get in and respect your stop.
  • If ever you are uncomfortable with a position for any reason, simply close it.
  • Most winning trades work right out of the gate. If a trade begins poorly, take a quick and small loss, then reset for the next opportunity.
  • The allure of being a swashbuckling trading gunslinger is powerful. Unfortunately your trading life will be short-lived if you adopt that style. If you aspire to be a long-time market participant, internalize the fact that there are no old, bold traders. Think deeply about that fact.
  • Lastly, think about how long it took you to accumulate your trading capital. Understand that it is very easy to quickly lose it all. Unless you plan to hit grandma up to recapitalize your account when you implode, guard that capital with your life. When it is gone, you are out. That should be your greatest motivation to become a defensive trader. 

I hope it helps. If you have questions or get stuck, please reach out. Glad to do my best to help you move the ball.

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