From Bagholder to Loser: Lessons from Traders Who Got Stuck in Losing Positions

What Being a Bagholder Really Means?

The term “bagholder” is commonly used in the crypto market to describe a trader who continues to hold on to one or more crypto tokens even when the hype around them has faded and the prices have crashed badly.

Even though this concept is generally used in the crypto market, it can be applied to high-volatility assets where gains and losses can occur very rapidly, e.g. gold.

Why Traders Stay in Losing Positions Too Long

There are several reasons why traders stay in positions too long. Some of these are listed below:

• Lack of Acceptance of a Losing Reality: traders who got on the train late and are left with tokens whose values are now in a fast decline find it hard to accept that they have made a bad investment.
• Self-Denial: “It cannot happen to me”, and so they keep holding (or HODLing) far beyond the acceptable point of a responsibly taken loss.
• False Hope: They hold on to it in the false hope that a recovery will come soon to reverse all losses.
• Emotions: Fear, anxiety, embarrasment and incredulity at a situation gone bad are common emotions displayed by bagholders.

Psychological Biases That Keep Positions Open

Psychological biases that lead to keeping bad positions open is exactly how people unintentionally become bagholders.

• Neuroscience tells us that it is twice as painful to experience a loss as to experience a gain. So the brain naturally hates to lose. Closing a losing position is something traders are naturally wired not to want to do. So the trader keeps the trade open, not wanting to turn an unrealized loss into a realized one.
• Traders adopt confirmation bias for their actions. So rather than accept that a trade has gone bad, they look for anything that lends credence to what they have done.
• There is also the fear factor, the fear of losing any unrealized profits. So there is a natural tendency to take profits quickly. If a trade enters a loss position, the tendency is to leave it open to get back into profit, especially if the trader has already had a few successful scalps.
• Overestimating your skill level, thinking that you are too smart to take a significant loss.
• Failing to intervene when an EA is being used without a stop loss has obviously led to a bad trade that is getting worse.
• Doubling down on bad trades in an attempt to recover any losses that an active trade is incurring.  

How Market Hype and Social Pressure Influence Bad Decisions

The Financial Times indicates that half of UK traders rely on social media for information. Hype usually combines with social media narratives to hack a trader’s emotions, subduing their thinking and forcing them to take trades based on those emotions. Most of the time, it is all about engagement, not accuracy.

A lot of the headlines you see, such as “I flipped a $500 account to $30,000” or “how I bought three houses from my $1000 trading account,” are meant to trigger curiosity, get you clicking, and turn you away from the crux of learning how the market works to chasing unrealistic dreams. Headlines such as “How to build slow but steady dividend income over the next 20 years” seldom go viral.

It is all about turning the emotional switch on. Hype creates the FOMO effect, with trending hashtags and screenshots showing crazy gains, capped by pictures or videos of creators in Lamborghinis or poolside at plush real estate locations. This hype basically overrides the trader’s education and trading plan. Hype and social media pressure push the trader towards reactive, rather than discretionary, planned trading.

Strategies to Recover from Losses Without Emotional Trading

The first strategy in recovering from losses is to stop further trading until you regain your emotional balance. Emotions are the primary reason traders become bagholders. If you see yourself sustaining hefty losses, pull the plug and stop any further trading for at least 2-3 days.

Secondly, review your worst traders. Get a pen and paper and answer the questions:

• Why did I take this trade?
• How long did I plan to stay in this trade?
• By how much did I exceed the time I planned to keep this trade open?
• Why did I leave this trade open for much longer than I planned?
• Between the time I planned to exit the trade and when I actually exited the trade (or got stopped out), how much could have been saved?

What you are doing here is to set mental checkpoints so that next time you find yourself drifting in the same pathway that led to disaster, you know when to stop the dance.

Thirdly, set the risk management rules—maximum risk, dynamic maximum daily loss, order size, etc. I have found from experience that using a dynamic maximum daily drawdown system forces you not to take more trades than necessary or to leave losing trades open for longer than necessary.

When you start trading, make sure you radically reduce your lot sizes for the following 20 trades. At this time, you are not trying to make money. You are trying to create a mental pattern that your emotions will follow. Call it muscle memory if you like. You are trying to program yourself not to take undue risks.

Next, maintain a trading journal. This is like your data book, answering questions like why you took a trade, what you could have done better, and why a trade was a winner or a loser. Of course, it should also tell you why a losing trade was a big loser and not a smaller one.

You must realize that every trader will lose money on a trade. Then you must recognize that profitability over time, not on a specific trade, is the primary goal, supported by risk management. In fact, risk management is even more important than making profits. Losing one or two trades is not bad; it is losing beyond the points of control that nukes traders.

Lessons from Real Traders Who Managed to Turn Things Around

Stanley Druckenmiller: By his own account, he purchases $6 billion worth of tech stocks and lost half of that portfolio in six weeks. The $3 billion tech stock loss is a story he has told repeatedly in many fora.

What he changed:

• Stuck to his own edge, after realizing he was sizing his positions by leaning on other people’s gains and not his own process.
• He only went big on trades he understood.
• He started cutting losses fast and moving on after accepting that even the best get it wrong.
• Constantly updated his bias with the data and did not tightly stick to one narrative.

Linda Bradford Rashke: She started off as an unprofitable options trader and at one time, lost $80,000 in an overnight options trade. She was forced to change her trading style and was able to build a long and successful career. Her primary focus is on risk limitation and chasing long-term profitability instead.

What she changed:

• Developed a written plan, jotting down swing highs and lows and key levels. In other words, she started following a script.
• Traded short-term using patterns only.
• Cut losses first before analysing or thinking about them.
• Instant exit on any market flips or execution errors, followed by reassessment
• Always used a risk math where the average wins had to exceed the average loss. If the trade did not match this, she would not execute the trade

Paul Tudor is another example of a trader who nearly lost it all but turned it all around. After losing 70% of his portfolio in a single cotton trade, he shifted his trading focus to discipline and more defensive strategies. He later found success in a hedge fund.

What he changed:

• He became obsessed with risk management.
• Maintained tight stops with daily re-evaluation of his positions.
• He cut losers very quickly.
• Reduced position sizes when in a losing streak
• Trades macro themes with technicals and risk management

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