You are going to lose in trading but the trouble is, many traders make the mistake of attempting to avoid losing trades at all cost.
Negative trade outcomes are a big part the trading business and for day traders, the fear of loss can paralyze them but they must accept that to advance as a trader, this fear needs to be overcome.
Everything has a reason and the fear of losing is conquered through understanding of why your losses are mounting. This is based on the assumption that the trading strategy you are using had a positive expectancy, an actual edge in the market
Embracing the information which losses may contain will not only improve confidence, but it will also improve your money management techniques.
What Your Trading Losses Can Show You
There are losses which are caused by a trader’s approach and those due to application of the method they are trading: the trading strategy and execution.
So before embracing the loss as the key to unlocking information about the market’s behavior, it’s imperative that a trader asks the question whether they adhered to their strategy or not.
You would think that following the trading rules set out in your strategy would be easy. After all, you have put together a trading plan after testing a trading approach and by following those rules, you reap the rewards of a positive expectancy system.
The issue is that we are human and just like the fear of losing trades can override the traders desire to follow the trading plan, so can the fear of missing out on trades. You may have done it where you see the market make a large momentum move and then decide to market in to take the ride.
More often than not, these trades don’t work out. If they do, you are planting the seed to do it again.
Before you start looking for reasons for your losses outside the random distribution of wins and losses, make sure you are following the rules.
There are at least three important pieces of information which losses may reveal once you’ve determined it is not due to your action.
The market has shown a certain behavior causing you to take a trade and then done something unexpected. This can also give you some great structural references to work with. A great example is where a market is reluctantly approaching a level and for all the world it looks to be going to reverse.
You take the trade but then all of a sudden the market powers through you. That information is golden so long as you accept the loss.
Being able to analyze a properly implemented strategy gives you some important metrics for what to expect in any given trade. But perhaps most importantly, losses help you identify how well a strategy is working over time and alert you to possible changes in performance due to underlying changes in the market.
A simple part of an accounts spreadsheet should contain a complete list of trades. This way, it’s easy to see a run of bad trades amidst overall profitable periods and identify the root cause.
Shift in mental and/or market conditions
A flurry of short term losers is never a nice thing – but it should be expected.
What it should tell you is either something is going on to change the way the market is currently moving, or you are not applying your strategy properly. Either way, it’s a clear flag to stop trading.
The obvious upshot of this is a daily loss limit. If the market and/or you as a trader are performing outside the expected zone, the run needs to be halted.
There are some excellent trading methods out there which have a success rate of 60%. By their very nature, some of their trades will be losers. Over the course of many trades, such a system will even be statistically likely to endure a long string of losing trades.
Does this make the system poor?
However, when the losing period does occur, it’s the interpretation of the results which is key to understanding what is happening. So when they come, take your losses and learn from them as they can make you stronger.