Markets take the…

Stairs up, elevator down. Indeed, you can lose money very quickly (elevator), but recovering it takes much more time (stairs). This concept is one of the first things you learn about trading. If, for example, you lose half of your equity, you have to double your remaining money to recover it.

If you look at the table below, you can understand, in practice, the meaning of a heavy loss.

As the percentage loss of initial capital increases, the performance required to recover your capital rises more and more steeply. So, it is evident that losing 50% of your equity means that you have to get 100% performance on your remaining capital if you want to restore the initial capital.

Therefore, you have to establish a maximum sustainable loss. That is, you have to ask yourself: if all the positions hit the stop-loss at the same time, what would I lose? Will this loss still enable me to work with my trading account the next day? And most of all, will I have the opportunity to make a realistic profit, one that restores my initial capital? This concept is essential to the survival of every trader.

Successful traders are those who have learned this lesson. For them, risk management is truly fundamental. In the figure below, you can see the same data as in the table, but in the form of a graph.

As you can see from the graph, when you lose money, you have ever-smaller remaining capital. In this way, you increasingly reduce your ability to earn, because you are forced to perform better each time. And once you have lost all your money, it is game over.

Although it may seem absurd, the first thing you need to look at is not how much money you can earn, but how much money you could potentially lose. So, always ask yourself: if this trade hits the stop-loss, will I still be able to trade in the next few days, and most importantly, will I still be able to trade effectively?

Returning to the psychological aspects, I know very well how the human mind works, because I made the same mistake myself. It happens when you focus on how much you could earn, ignoring how much you could lose. When you approach trading, you start rubbing your hands and thinking: “Who knows how much money I could make today, and in the coming months?”

It is true that trading is about earning money and increasing capital, but first of all, you should always focus on protecting your money. So, I recommend that you define this aspect before clicking “buy” or “sell,” and never accept any losses that your trading account cannot support.

At the start of my trading career, when my trading account was small, I was faced with trades that required too high a margin, up to $4,000–$5,000. To take them, I would have had to set a stop-loss that was not overly tight, and this was not in line with my money management. Those trades did not have a sustainable loss percentage, so what did I do? Simple: I did not take them.

Afterwards, you should not look back at that trade and think, “Man, that trade would have given me such a great profit.” Doing this is an emotional mistake. You did well: you could not afford that trade, so you did not take it. Stop.

In everything you do, you need to be disciplined, because it is only by following precise rules that you can avoid making mistakes. Do not feel sorry if a trade you could not afford would have made money. In the same way that you studied that trade, you also have to learn to forget it and move on.

To conclude, here is the formula you can use to calculate the performance required to recover a percentage loss, which takes us back to the table at the beginning of this post:

R = [100 / (100 − P)] × P

Where R is the required performance (%) and P is the percentage loss of initial capital.