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Don’t Speculate with Money You Can Afford to Lose!

Posted By Robert On Wednesday, December 11th, 2013 With 0 Comments

My advice ‘Don’t speculate with money you can afford to lose!‘ flies in the face of the conventional advice that you should “only speculate with money you can afford to lose”, so let me explain what I mean.

There was once a guy – okay, it was me – who had a very successful career in which he was making good money, had a flash car and so on. With that money burning a hole in his pocket, he decided to play the markets. You might be able to guess what’s coming, and it’s this:

‘Because I could afford to lose a lot of money… I did!’

At that time it didn’t really matter if I lost money on failed trades, because there was always more money I could use to feed my trading obsession. Until one day there wasn’t, because I decided to quit the rat race to trade and write and run my own publishing enterprise full-time. So I had to learn about money and risk-management – fast!

The fact is: having a lot of money can make you complacent in the face of losses, in the same way that (as I understand it) having insurance can in some senses actually make you a worse driver rather than a better one. Without a safety net, we tend to be much more careful; with a beneficent paymaster we tend to succumb to moral hazard.

When starting out in spread betting it may well be best to assume an attitude of not being able to afford to lose any money at all, regardless of your wealth. This is consistent with Warren Buffett’s two rules of investing:

  • Rule #1 Don’t Lose Money!
  • Rule #2 Don’t forget Rule #1

In the real world you will lose money, at least in the form of the immediate bid-ask spread. On longer term position trades you may well see your positions fall some way before they recover their lost ground. So while I don’t take the “don’t lose money” mantra absolutely literally, it has shaped the way that I approach spread betting, for example:

  • I start all positions with small bet sizes, and only pyramid additional funds from accrued profits.
  • Do take some profits away from the table when you bank very big profits.

Of course, there is some relationship to your true wealth in the sense that a small bet for a multimillionaire may well be equivalent to an average punter’s “life savings” of say £50,000. And maybe the former really can afford to lose it.

Losing Money and Drawing Down

Although I have suggested that you should at all times aim to keep your losses to an absolute minimum, when running certain trading styles – in particular, longer term holding ones – you may find yourself drawn down (i.e. showing a loss) by a considerable amount for a significant amount of time until things “hopefully” turn around.

Arguably, you should not suffer such prolonged draw-downs when day trading because your aim is to make some profit each and every day. If your day trading losses are mounting then your trading strategy simply isn’t working, although it is also possible to encounter a “run of bad luck” that produces a longer string of losing bets than you might think.

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