The dreaded account blow up. There may not be a worse event in trading stocks than to to run your account into the ground.
On the outside we think “that will not not happen to me” or “they are stupid to let that happen”. Well it can happen much more easily to any trader than you think.
It is essential that traders are always in a position to take a trade. Blowing up an account not only means losing a great portion of your account value, but it usually means a trader can’t participate in any more trading activity, thereby letting other great trades slip away.
I’m going to share the 4 main reasons why traders blow up their account so that we can be more aware of the scenarios that we are in, and hopefully prevent a blow up from ever happening.
1.) Addictive Trading.
This can also be referred to as over trading, but on a more broad sense, any type of trading that is done compulsively, or with no control. This is dangerous because of how quickly the losses will sneak up on you.
My first blow up account was do to me over trading. The worst part of it was that I didn’t realize how much I truly lost until it was all said and done.
In total I lost about $700 dollars on a $1,200 account, in one morning, over the course of 5-6 trades I should have never taken in the first place.
Over trading was one of the factors that caused me to blow up, but there was another factor..
2.) Revenge Trading.
This is the main factor that caused me to blow up my account, and also a major cause of many beginner traders blowing up there account.
For me, it all started with a trade I held overnight. I was up about $30 dollars and was trying to close my position (with a terrible broker) and it took about 3 minutes to fill. My trade then closed out with a -$30 dollar loss.
I was so upset that my I just went from green to red just based on a ridiculous fill time. So I quickly tried to find a trade I could get into to make up the loss that I just took.
Well I took another loss which made me even more irate, then quickly jumped into another trade, with more size to try and make up for both losses…
Long story short, a $30 loss turned into a $700 loss by the end of the day….
That’s the cost of letting your emotions rule your trading.
3.) Trading Too Much Size
This is the main reason that kills the account of an intermediate trader. Someone who has been somewhat successful with trading and is now consistent.
He or she thinks they are so consistent now that they should now increase the amount of size they use by a drastic amount. For example, 1,000 shares to 7,500 shares.
They often do this without realizing that increasing size by this much isn’t as simple as they assume it to be.
There is an huge increase with P&L gains or loss, which can shake you out so quickly because you are only used to seeing your unrealized loss at -$100 dollars when the stock goes down $.10 cents.
But now you are seeing an unrealized loss of -$750 dollars if you now use 7,500 shares.
There is also slippage. So you can fill 1,000 shares at $5.00 fairly easily. It gets harder to get the exact same price for all 7,500 shares.
All these things play a factor in blowing up an account because if you are in a position with much more size than you are used to, then there is a high probability that you will panic and let emotions begin to do the trading for you.
You see a huge unrealized loss and start to think, lets let it come back, and because its bigger size, each down tick adds on to that panic, until…….BOOOM, 50% -100% of your account is gone.
Some will say that sounds exaggerated and it sounds to quick.
That’s how quickly it can happen, my friends.
4.) Poor Risk Reward.
There is a reason why real traders say you have to have at least a 2:1 Reward/Risk Ratio. it means you can have 2 losing trades and make 1 winner and it covers the losses.
What happens when a traders Reward/Risk ratio is off. He/She is now fighting to stay alive.
So many new beginner traders do it. We cut our winners quickly because we are happy just to be in the green and we fear it being taken away.
And on the other hand we let our losers run because we don’t want to take the loss and we pray that the stock will turn back in our favor.
This scheme will ultimately only return bigger losses than your wins which , if not changed, will blow up your trading account over time.