Analysis & Trade Sharing

Analysis & Trade Sharing

In the rule of money management, we mentioned investor psychology as a crucial factor to consider. Indeed, your mentality plays a critical role in establishing a winning attitude during your trading activities. Those investors who are able to keep their emotions in check are the ones who can maintain a more balanced approach. Those who cannot keep their emotions in check often find themselves making deals they later regret.

Let’s consider an example of this situation.

When you make a bad deal and lose money, you might be tempted to “double down.” When you double down, you are essentially going “double or nothing.” Needless to say, the risk that’s involved in this type of deal grows exponentially the more you double down.

Now, it’s one thing to lose $100 and double down on that. However, if you lose $100, then lose $200, double down on $400, and so on, you are taking on completely unnecessary risk. Unless $100 represents 1% of your investment capital, it’s best to let it go. You will be able to offset those losses with the profits you make from other deals.

In fact, when you double down, you are increasing the likelihood of failure exponentially.

How so?

Please take a look at the following chart:

Investment Capital% Lost$ LostRemaining Balance% Gain Required to Break Even

In this chart, we can see how the more money you put into a trade, the more money you need to double down in order to recoup your losses. So, if you start off with a $1,000 investment and lose $50 of it, you only need to profit 5% in your next deal to make your money back. However, if you were to invest half of it, that is $500, you would need to double your money on subsequent deals in order to break even. If you invest $900, you need to make a 1,900% profit just to make your money back. Naturally, this is an unrealistic amount of money to make. You might be able to make that type of return over a series of successful deals (rather tough, though not impossible). Ultimately, this is not the best strategy to keep in mind. 

As you can see, this is why keeping your emotions in check is a valuable tip you can put into practice. If you let greed get the better of you, you may not be able to recover from a mistake. By the same token, if you get sucked into the doubling-down game, you may not be able to pull yourself out of the hole. Moreover, if you decide to double down using leverage, you may very well end up getting banned from the platform if you are unsuccessful.

Now, you might be thinking, “what if I am successful?”

That is a very dangerous situation. It could lead to a false sense of security. You might think you are really smart when you were just lucky. Of course, we are not doubting your skills and intelligence. However, doubling down on a deal is so risky. It can lead to any number of possible situations in which you risk losing your entire investment capital. As a result, it’s always best to err on the side of caution. You never know what can happen. Thus, it’s best to be on the safe side, especially in the early going.