It’s simpler to bury our trading losses somewhere in the pages of our trading journal, never to be looked at again, or to simply brush them under the carpet with our fingers firmly planted in our ears (suspect that’s physically impossible!)
But if you fail to look hard at your losses, you won’t learn from them. These simple take-home messages after a loss will ensure you grow as a trader …
1. What have I learned about the market?
Here’s the scenario … the price action looks strong, with a bullish candle just nudging through an area of resistance, so you buy, believing that level is being breached. Then the price immediately bounces back from the level and reverses.
What do you do?
(a) Hold onto your trade, believing in that first signal.
(b) Accept you got it wrong. Quickly exit for a small loss, and take the knowledge that this resistance level is holding to enter a sell trade when the price pushes against it next time?
The right answer, of course, is (b)
Here’s how that could play out …
Note how the MACD levels were rising on the first trade, but the second time the price hits that level of resistance, the oscillator is falling, which reinforces the fact that buying power just isn’t there to break through this price point.
This is the same principle as trading pullbacks.
In a perfect world, we might not have taken a loss on that first trade, because we’d have been patiently waiting for a pullback to the level. But rather than beat ourselves up about misjudging the market sentiment, instead we should use that information (and pain) to our advantage!
2. Are my risk levels wrong?
To be able to take a measured look at our losses, we need to be in a calm state of mind. And if you’re suffering from the stress of losing money … you may not be feeling all that calm.
Put simply, if your losses are stressing you out … the message is that you’re trading too big.
I often speak to novice (and not so novice) traders who tell me how much money they want to make … and extrapolate that back to calculate what their risk will be. For example, they may say that if they trade with stakes of £4, they can make £1,000 a month, based on past performance … but that £4 stake might involve risking a very high percentage of their trading fund, rather than the 1–3% that’s recommended.
Yes, trading will always involve a degree of risk, but that should be calculated, managed risk, rather than sweating, unable-to-sleep-at-night risk. You have nothing to prove by pushing your risk, and plenty to lose.
If losing trades are causing you too much pain, reduce stakes to more comfortable levels.
3. Are my expectations wrong?
Losing trades come hand-in-hand with a strong feeling that something must be wrong.
If our trading strategy lost, therefore it’s a mistake. Right?
Not at all.
All trading methods will take losses and experience drawdowns. Some more than others. And big losing runs don’t necessarily mean that your strategy is flawed – just that it has volatile returns.
There are things we can do to reduce the volatility of those returns, plus ways to check whether a losing run is just par for the course, or whether something’s seriously wrong with our trading strategy.
So, are your profit expectations reasonable?
Trading forums and websites are filled with people bragging about their amazing returns.
Some of them are liars, some are fantasists and some are truthful (with a bit of hype thrown in).
I’m going to assume that, as canny Trader’s Bulletin members, we’re able to filter out the liars and the fantasists. But how do we deal with the hype, and the expectations that it brings.
First, let’s look at why the hype is there, and what it’s doing …
Hype around great results isn’t just about marketing ploys … it’s also about changing our behavior. If you don’t believe that trading is going to change your life for the better, you’re unlikely to be disciplined enough to sit down at your screens every morning to place your trades.
It’s like any kind of new routine – be it a diet, an exercise program or a new trading strategy – we’ve got to be shaken and stirred out of our normal ways into doing something new and different.
And hype is just part of that. It’s what gets us started, and keeps us motivated.
But the problem with hype is that it can skew our expectations.
What happens if you don’t have a perfect six-pack at the end of your 8-week exercise program … or you haven’t lost 10kgs on your diet … or made £5,000 from forex …?
Ironically, it’s the exact thing that motivated us at the outset can also be the thing that causes us to give up too soon.
So, take a step back and evaluate your performance …
Is it reasonable over the long term?
If you’re trading a system with very high returns, they are likely to be more volatile, so are you just experiencing that volatility?
How do your returns look as a percentage of your fund?
Managing our expectations takes a bit of self-awareness about what you’re looking to achieve here, what it’ll mean if you do hit those profitability targets, and what it’ll mean to you if you don’t.
Often, it’s these kinds of uncomfortable questions that it’s simpler not to answer, which is why traders don’t like to dwell too much on losing trades.
But having clear, reasonable (that’s not to say they can’t be ambitious) expectations is vital to keep you on the straight and narrow for your trading career.