Warren Buffett is Wrong. Not only Should Losing Be Accepted, It's Necessary
Warren Buffett says Rule #1 is: don't lose money, and Rule #2 is: see Rule #1.
In my opinion this is the worst advice a trader can get, and it's advice that will certainly short circuit a trader’s path to success.
Not only is losing an unavoidable part of the game, it’s also the necessary evil that must be experienced in order to acquire the skills needed to survive and make money.
In this essay, I’m going to talk about each of these two concepts – why it’s unavoidable and why it’s necessary – and attempt to convince you losing is not something to avoid, it’s something to embrace.
Losing is unavoidable
“Losing trades” should be added to “death” and “taxes” on life’s short list of certainties. Telling a trader to not lose money is like telling a baseball player to not strike out. It's impossible. Instead of stressing about the possibility of losing money, a trader should embrace it as being part of the game and learn to handle losses instead of trying to avoid them. Your psychology - specifically how you're able to mentally and emotionally handle losses - will go a long way determining whether you'll ultimately succeed or not. Great traders take losses in stride and learn from them and accept them and therefore are not emotionally damaged when they happen.
I was watching a baseball game many years ago. Manny Ramirez was on Boston at the time. He hit a hard line drive right to the second baseman who caught it. While the next batter was hitting, the camera showed Ramirez on the bench laughing and joking with one of his teammates. The announcer commented that most hitters would be pissed off if they hit the ball so hard and made and out, but Ramirez was so good, that knowing he’d get 600 plate appearances that season, it just didn’t bother him. I’m sure we’ve all seen A-Rod strike out and the look on his face would suggest he just didn’t give a crap. Well, I’m not going to say he didn’t give a crap, but I can definitely say striking out doesn’t bother him. It can’t. You simply cannot be successful if you allow a loss to negatively affect you.
This doesn’t mean you’re so nonchalant about a loss that you don’t care. It doesn’t mean you mismanage trades and recklessly give profits back or let a small Ioss turn into a big loss. It just means you accept that losses are part of this business. Take them in stride; they’re no big deal; they’re nothing to be afraid of.
The only way to ensure you never break Warren Buffett’s first rule is to stay on the sidelines as a spectator.
Successful traders are good losers. Losses don’t make them happy, but they’ve developed the ability to take them in stride and quickly move on to the next trade once a lesson has been learned, if there is a lesson to be learned.
Losing is how we learn
Losing is the necessary evil that must be experienced to become a profitable trader. The path to success is littered with losing trades that teach us. In fact losing trades are the only things that really teach us.
Sure you can read a couple books, attend a seminar, talk to other traders, or if you’re lucky, get a job with a trading company and get trained, but until you put real money to work and lose, lessons will not be learned. No losses = nothing learned = no progress toward your goal of being a profitable trader.
Many times I’ve talked to traders who knew what they should and should not do, but until they put on a real live trade and lost money, the lesson was not learned.
Trading is a performance sport. You learn by doing. You learn by failing and making slight adjustments. It’s a process, and losing is one of the key components. If you avoid losses, you will not develop any trading skills.
In martial arts, you have to get hit and get thrown around a lot before you learn how to defend yourself. In baseball, you have to swing and miss at a curve on the outside corner before you learn to stay back and wait until the ball gets deeper in the zone. In trading, you have to execute hundreds of trades under different circumstances in order to figure out what your trading personality is, what your temperament will allow you do to, what works for you and what doesn’t. Losing is how you figure out how to win. Without the losses, there is no learning, there is no growing. And when viewed from this perspective, a loss is an investment.
If you’re not willing to invest in losses, you’ll never learn to succeed because some things have to be learned in the arena, not on the sidelines. Make sense? In order to get good, you have to practice. But in this game, practicing will cause you to incur losses. The only way to avoid the losses is to not play at all, and then you’ll never get good. It’s a catch-22.
Not only do you have to accept losses as part of the game, you have to accept losses are the essential ingredient. It’s no different than a baseball player accepting that he’s going to strike out (Babe Ruth led the league 5 times; in fact the year he struck out the most was the year he hit 60 homeruns) or a basketball player accepting he’s going to miss shots (Michael Jordan has missed more game winning shots than anyone), and only if you can keep your head on straight and not let the losses bother you too much will you have a chance to make it. It’s as if I said: “in order to become a consistently profitable trader, you must have 250 losses.” That’s the requirement; that’s the prerequisite, so get out there and start losing.
Losses are part of the game. Accept them. Embrace them. Because after all, they are what will teach you how to win.
The following article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.