The number one trading topic that few traders want to talk about is the trading loss. When was the last time you heard a trader say, “I had a fantastic loss the other day. Let me tell you all about it?” No one likes to lose money and the experience can be painful both financially and emotionally, especially if the loss is a large one. It is natural to try to avoid losses. Not talking or thinking about losses is another aspect of avoidance. Who wants to think about something painful?
Accept Your Losses
But doing what comes natural is not always the best choice in trading. As many traders may realize, being able to act as a contrarian can, at times, produce the better gains. Selling when the market is rising into a climax and when everyone else is buying is a good example of a counterintuitive action that can produce large rewards. Being counterintuitive when it comes to trading losses can also help you stand apart from the crowd. Dealing directly and frankly with your losses can lead to more skillful trading.
As painful as they can be, losses are a significant part of the trading game, especially the psychological side of the game. We really can’t avoid losses. In fact, trying to avoid losses can work against the trader. Being unwilling to accept trades that don’t work out can lead directly to erratic trading and trading errors. It’s the strong desire to avoid a loss—sometimes referred to as loss aversion— that lies behind unskilled trader actions such as cutting winning trades short, placing stops too close to the market, moving stops to give a losing trade “a little more room,” holding onto and adding to a losing position in the hopes of getting out at break-even, failing to pull the trigger on a sound trade setup, and other erratic actions.
Learning to accept our trading losses and learning how to deal constructively with them may be one of the most important mental skills a trader can develop.
Developing the Mental Skill of Accepting Losses
The Right Attitude. The first step in learning to accept trading losses is to adopt the correct trading attitude. All trade setups are based on probabilities. This means that a setup has a certain probability of producing a winning trade, but it also means that the exact same setup occurring the next day may not work out. In other words, every trade setup also has a certain probability of producing a losing trade, based on its historic performance. As long as the setup has an edge, it will produce profit from the trades taken over time. The right attitude is, therefore, that any given trade—whether it wins or loses—isn’t that important. What is important is that the trade setup will be profitable when taken over a large number of trades.
Understand What A Loss Tells Us
A loss does not always occur because the trader made a “bad trade.” When we are willing to look at it carefully, a loss will often tell us something of value, something we can learn from. For example, the loss may tell you something about your trade setup. It may also reveal something about the current market conditions. Moreover, it can tell us something about ourselves and our trading behavior. From your losses, you may learn, for example, that the setup works better in some market conditions than others. While trading, a loss may tell you that the market’s supply – demand balance has shifted.
You may also learn from your losses that you are committing correctable errors. This kind of personal information requires us to face our limitations, and this is not always easy to do. We have to be willing to learn about ourselves and where we are falling short. In sport, the athletes who rise toward the top are the ones who, when they recognize they are stumbling, ask their coach how to remedy their errors. They know that by uncovering their shortcomings and working to improve them, they will quickly boost their performance. How else do we improve?
By understanding what a loss tells us, we can learn to make adjustments in our trade setups, we can understand the market better, and we can make critical adjustments in our performance. Viewed in this way, losses are invaluable; they are golden nuggets that shouldn’t be hidden under the rug.
Post-Mortem Every Losing Trade
As a practice, write down every losing trade, print out a chart and evaluate what happened. This is analogous to an athlete’s post-game video. In calm moments after the game is over, a good athlete will assess her performance and seek to learn from the experience. Traders should do the same.
Although it is not necessary for you to call your friend and say, “You won’t believe the incredible loss I had today,” you should treat your losses as opportunity to learn and improve. Begin to look at your trading losses carefully and differently. Rather than dismissing or rejecting them because you’d rather not think about them, review and analyze your losses and use them as an aid in your self-development as a trader.