Can you stomach a loss?

Everyone wants to win in the stock market, but forget about everyone else for now.

Life has its way of humbling us every now and then. Friendships go sour, a job opportunity doesn't work out, or we lose a loved one. Whether rich or poor, we all have these experiences.

This is what living is all about: to know what joy is, you've got to feel pain from time to time.

Trading the stock market is no different. It will humble you.

Some of the best lessons you will ever learn as a trader will not come from your winning trades, but will come from your losses instead.

Does that sound illogical? To the beginning trader, maybe. But ask anyone that's been in the stock market for awhile, and they will likely reiterate the same thing that I'm telling you.

The key to long term success as a trader is learning how to overcome your losses and being mindful of what caused them in the first place so that you can avoid making the same mistakes again.

Establish Rules & Trade by Them

Trading losses can't be avoided, but they can be mitigated.

The best traders lose money. Its part of the game. If you simply can't accept or tolerate failure for yourself, then don't play the stock market. Period.

But if you're willing to take a few punches, it is imperative in trading that you have some rules in place so that whenever you do experience a loss, you can dust yourself off and try again.

By rules I mean that you've got to be honest with yourself and establish an approach to trading that is in harmony with your own personality and temperament.

For example, if you're just starting as a trader and more risk averse, your position sizes may be smaller compared to a trader that is experienced and has a tolerance for higher risk.

In either case, both beginners as well as seasoned traders have to live by rules.

The markets will always be around, but traders come and go because many don't learn from their misfortunes and instead repeat the cycle of loss after loss without serious self-reflection.

Lets break this cycle. We can avoid this type of failure by being disciplined.

Here are some trading rules to start with and that we will refer back to in future posts:

1. Know your tolerance for risk.

2. Keep your open positions manageable in accordance with your account size.

3. Know the time frame for your trade before you open any position. This comes from planning your trade in advance and respecting your plan.

Rules in Action: Framing a Trade for QQQ

I've analyzed the QQQ as an example of framing a trade, such that one has a plan of action ahead of time in order to avoid getting blindsided by entering into a market that is uncharted.

Losses often occur when you simply are unaware of what you are trading.

The QQQ, an Exchange Traded Fund (ETF) that represents the NASDAQ-100 Index, closed at $95.89 on 7/16/14,. It is now up over 14% from the mid-April $84 lows.

Interestingly, there are signs here on the daily chart of the trending move in favor of the bulls starting to lose some of its momentum.

-DMI is creeping up as the bears come out from their caves. Also, the ADX line is no longer rising.

Additionally, although we are seeing higher highs in QQQ over the past few weeks, bearish RSI divergence is evident, as RSI is concurrently making lower highs.

Support levels are drawn on the chart, reflective of prior breakout points and congestion zones. The $93 and $91 areas are to be watched on any pullbacks.

In accordance with this chart analysis, its necessary to also establish rules and trade by them.

Assuming you were to open a short position in QQQ, betting in favor of a down move versus a continuation of the rising price trend, you would have to clearly define your tolerance for risk as well as the size of your position and the time frame for your trade.

In such a scenario, would you choose to close out your short position in QQQ if it falls to $93, or are you less risk-averse and willing to hold the position and see if QQQ pulls back even further? 

In the event that QQQ continues to push higher instead, at what price level would you close your short position and take a loss on your trade? 

These are the types of questions you should ask yourself before entering any trade. 

Know your tolerance for risk, determine a manageable position size, and know your time frame for your trade.