Today I want to address a topic I’ve meant to write about for a long time.
Over the course of my trading journey, I’ve seen countless traders come and go. I have watched millionaires go bust. They did well for a while—sometimes for years—but ultimately, they gave back everything.
There is a reason for this. In my opinion, it is because their overall approach is flawed. They fail to implement a mindset based on survival. As W. Clement Stone said:
“Have the courage to do the right thing because it is right.”
But perhaps more fitting for the trader is this quote from Samuel L. Clemens (Mark Twain):
“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”
Over the years, I’ve noticed that most traders fall into two distinct personality types. Both focus on trading results (near-term to long-term), but they differ wildly in how they view risk.
- The Prepared: This group cultivates an awareness of worst-case scenarios and maintains a willingness to prepare for them before they happen.
- The Reactive: This group waits for disaster to strike before thinking about safety mechanisms.
The risk for the second group is obvious: When disaster strikes, it might hit you so hard that you simply cannot recover.
Every trader faces different threats depending on their time horizon.
For Day Traders, the threats are often immediate and technical:
- Power failures or hardware crashes.
- Internet connections going down.
- Brokerage websites crashing or denying access.
- Holding positions overnight without protection.
- Trading without stop losses.
- Unexpected exchange closures (like the events of 9/11).
For Investors and Position Traders, the threats are systemic:
- Huge opening gaps against your position.
- Extended exchange closures.
- Runaway Inflation or Deflation.
- Currency risk.
- Broker bankruptcy.
- Frozen withdrawals/Capital controls.
I realized early on that I needed to protect myself against my own worst-case scenarios. One of my biggest fears is being denied access to my capital—whether due to a broker failure or a run on the banks. The odds of this happening might be low, but if it happens and I am unprepared, I am out of business.
That is simply not an option.
This is why, early in my career, I allocated a high percentage of my liquid net worth to physical gold. If everything else loses value and panic sets in, gold acts as insurance. Owning diverse asset classes—real estate, land, art, collectibles—serves the same purpose.
However, asset allocation is only part of the story. The deeper issue I want to convey in this post is about strategy.
I see many traders doing things that work—at least on the surface. They don’t question their approach because they are making money. They don’t ask, “What is flawed here?” They just keep doing it until they get knocked out.
The all-time classic example is adding to a losing position.
“Losers average losers.” – Paul Tudor Jones
The dangerous thing about averaging down is that it can work. It can work for a long time—much longer than a rational person would think. But eventually, it stops working. If you have cultivated a conceptually flawed trading approach, you won’t be able to reverse the situation when the tide turns.
I have long thought about a metaphor to illustrate this concept, and the famous fight between George Foreman and Muhammad Ali—the “Rumble in the Jungle”—is a perfect example.
Foreman was the heavy favorite. In the early rounds, Ali adopted a strategy he later called the “rope-a-dope.” He lay against the ropes, covering up, letting Foreman punch him.
To Foreman, his strategy seemed to be working. He was throwing punches, landing body shots, and dominating the aggression. He kept doing what seemingly worked: throwing more punches.
But Foreman wasn’t considering the worst-case scenario. He was expending massive energy while Ali deflected the worst of the damage. Ali taunted him, increasing Foreman’s emotional state and decreasing his ability to think clearly. Foreman ignored the warning signs—his own fatigue—and couldn’t adapt.
Then came the turn.
In the eighth round, Ali landed a combination that sent Foreman spinning. He was knocked out.
Foreman’s loss highlights the danger of a strategy that looks like it’s winning right up until the moment it fails completely. Foreman kept “averaging down” on his aggression, ignoring the fact that the environment had changed.
The Ali-Foreman example is imperfect because Foreman actually took physical damage and grew tired—he had warning signs.
The market is often more dangerous than Muhammad Ali.
In trading, the “picture-perfect” disaster involves almost no warning signals. You average down, and the market rewards you. You take on excessive leverage, and you make a profit. You see no “punches to the head.”
Then, a Black Swan event occurs.
Because you were rewarded for a flawed strategy for so long, you are entirely unprepared. You are knocked out in a single round.
If you keep getting hit and make no real progress, you must heed the warning signals the market sends out.
But more importantly: spend time figuring out what could put you out of business without giving you any warning signals at all.
Whether it is a broker failure, a currency collapse, or a strategy that blows up during a Black Swan event—prepare for it now. Whatever you decide to do, offer no excuses when the bell rings.
“Risk comes from not knowing what you are doing.” – Warren Buffett