Most people get into trading to make money. And lots of them.
And why not? The truth is, the markets – whether forex, commodities, indices or shares – offer lots of trading opportunities. And these opportunities are what attracts many people to try their hands in trading.
However, there is another side to the markets that people tend to ignore – potential losses.
The fact is, whether you like it or not, losses are part of trading. Whether you’re new to trading or you’ve been in the markets for years or decades, you will have losing trades along with winning ones.
As many traders would say, you learn more about trading when you take a loss than when you make a winning trade. This is because a trading loss makes you focus and analyse what went wrong.
How to deal with trading losses?
Mark D. Cook, one of the most successful traders featured in the Jack Schwager book Market Wizards, told of the pain and shame he felt when he had to face his mother to tell her that he lost the money he borrowed from her.
The big loss happened during Cook’s early trading career. It forced him to analyse his trading strategy and system. It took him some time to recover from the loss, but it also served as a positive turning point for his successful trading career.
In one of the interviews during his international trading tours, Cook said: “Trading losses will occur with every trader. The key is to manage those losses and not let ego get in the way of sound decision-making.”
Turning loss into success
“The true path to success always must journey through failure. All the million-dollar traders I know had severe losses. And only when they coped with the losses did they achieve true success,” he said.
While it may be a consolation to know that even professional traders have their share of losing trades, you don’t need to be a Mark D. Cook to realise what needs to be done to turn losses into something positive for your trading.
How to use losses to improve your trading
Like other things in life, you can always treat losses as a learning experience. The key is to accept that losses are part of trading.
It may not be an easy thing to do and to accept, but the quicker you accept this truth and reality and the faster you change your mind about losses and turn it into a positive learning experience, the better it will be for you and your trading.
As Mark Cook said: “The true winner is the one who perseveres. The race is a marathon and not a sprint. Recognition that all humans fall short of perfect is the first step to the trek to knowing yourself and knowing your limitations.”
On a practical level, there are some ways you can turn those losses into jump-off points to improve your trading. Let’s have a look at some.
1. Review your position sizing
This may sound basic, but for many traders, position sizing remains a challenge. Many traders tend to take too big a risk per trade, which can jeopardise their trading capital.
Having a solid position sizing strategy (allocating only a small percentage of your trading capital per trade) may help limit the risk per trade and therefore the overall market risk.
2. Analyse each loss
Though it will not be a pleasant exercise to do, all successful traders would say that honest and brutal analysis of each loss is what helped them recover and turn their trading for the better.
Remember Mark D. Cook who used his massive losses to develop a solid trading strategy that became instrumental to his trading success?
3. Use a stop-loss level
Do you have a stop loss level for each trade you take? For some traders, using a hard stop loss level works wonders. You can use a dollar value or percentage value to set a stop loss level for each trade.
Using a stop loss level – the point where you will get out of a losing trade may be helpful as it can prevent you from being emotionally attached to a trade.
Most trading platforms now have stop-loss orders and settings you can use as you enter a trade. Remember the saying ‘let your winners run and cut your losses short’? Using a stop loss level (stop-loss order) can help you put this into practice.
In a previous article, we discussed the dangers of not having a money management plan when trading. You may want to refer to it for additional helpful trading insights.
4. Review your exit strategy
Do you have an exit strategy in place? Do you tend to hold on to losing trades? How soon do you cut your losses?
As many successful traders would attest, most of the time it is your exit strategy that can make the difference between a winning and losing trade.
5. Control your emotions
Fear and greed are the two most potent emotions that can work against traders. Your fear of taking a loss or the greed to go for more (money) may work against you. Make sure you control your emotions and use the tools available on your trading platforms such as stop-loss orders to make objective trading decisions.
6. Use a trading journal
Most successful traders use a trading journal to record their trades. Whether it is losing or winning trade, your trading journal may include the entry and exit levels, the win or loss for the trade, some notes about your mindset and emotions during and after the trade.
As you analyse losing trades and as you try to find ways to turn losses into positives for your trading journey, here are some questions you can ask:
- How much risk (dollar value or percentage of your capital) did I risk on this trade?
- Did I get in too early (did I force the trade)?
- Did I get out too late (did I not cut the loss early enough?)
- Was I chasing the trade after missing the initial signal?
- What market signal did I ignore or did not see that affected this trade?
- What do I need to change to avoid this situation again?
Bear in mind that losses are part of trading (and life in general), and you can turn them into something positive and useful for your trading.
7. Analyse your win/loss ratio
One effective way of how you can turn losses into something positive is by analysing your win/loss ratio.
The win/loss ratio is the number of winning trades divided by losing trades. For example, a trader who has 80 profitable trades out of 100, would have a win/loss ratio of 80 %.
However, it would be wrong to purely focus on that number and achieving a high ratio.
For example, a long-term trader might have a win/loss ratio of only 30 %, but because he/she makes significantly more profits on the winning trades than what is being lost on the unsuccessful trades, he/she can still end up being a successful trader.
With scalpers, it is different. As they are chasing small movements in the markets, the risk/reward ratio is lower, and there is not much potential for realizing a huge profit in a single trade. Nevertheless, even scalpers don´t need a perfect win/loss ratio to be profitable.
Traders should accept losses as part of the business, and instead of trying to fight it, they should try to learn from those events.
Nevertheless, traders should not end up over analysing their trades, and also keep the bigger picture in mind.