When we think about trading, we always imagine that we will make impressive profits without putting in much work and continuously growing our account. However, most beginner traders do not take into account a very important element of trading in the capital market – losses. And yet, as is known, they are absolutely inevitable – the statistics are indisputable in this regard.
What's more, it is the trades closed with a loss that are usually the most painful. On average, even about 80 percent of traders in the final version experience losses every year, that is, their activity is unprofitable.
Any seasoned trader with a consistent income from trading will surely admit that losses are a part of the profession and the best we can do is to limit them. How can we do this? How should we manage positions that are currently losing? How should you control your emotions at these critical moments to achieve trading success instead of painful failure? We'll find out below:
Why do so many traders fail to handle losing positions?
Many years ago, scientists proved a certain sad regularity – we enjoy gains less than we suffer from losses. In practice, our joy at earning 500 euros will be many times smaller than the sadness at losing such an amount. Even worse, most inexperienced investors-traders consider losses and profits separately, and not as a total result.
This means that if they initially make €1000 in one day and then lose €800, they will not consider it a €200 profit. After a profitable trade, their reference point changed and they began to think that they did not record a profit, but only suffered a loss of 800 euros, because they already wrote this 1000 euros in their head as earned money (although, of course, they did not withdraw it), and then market it from them took away
Failure to learn the basics of risk management = disaster
There is another extremely negative aspect to the above addictions. Most investor-traders (not just beginners) have problems with rational risk management. What does this mean? That they choose to lock in smaller profits that turned out to be "real", that is, exiting a position from which they are making money too quickly. However, in the event of a loss, they may risk a much larger amount just to avoid it because "the market trend must eventually reverse/revert to the mean."
As a result, they allow themselves to be chased by emotions, stop following their strategy, lose all rational decision making and hesitate to close their losing position, making their loss in one position huge. Unfortunately, such actions are a giant step towards financial disaster.
So how do you manage losing positions?
A rational trader who can consistently make profits knows that risk can be increased slowly and gradually in profitable trades, while losses must be limited as quickly as possible to reduce risk. What level of risk should you take? Everything here depends on the strategy that we have developed and honestly tested on the demo account.
Stop Loss is an integral part of trading
Of course, to limit loss positions, there is a protective recommendation called Stop Loss, the level of which should be strictly defined in our trading system. Also, we always have to set it when opening a position – and under no circumstances should we widen it when the position brings a loss!
Even if sometimes the market trend changes right after we exit the position, which of course causes irritation, we must remain consistent. If our trading system works well in the long run, you should know that individual losing positions are an inevitable part of the statistics, they occur with probability – they will occur, they just need to be consistently limited to minimize risk.
What level of risk should you take?
The most commonly tolerated risk of loss is 2 percent of our capital accumulated in the trading account. Stop Loss level should be set here. However, there is nothing stopping you from setting narrower stops, especially for short-term strategies and markets with high levels of volatility.
Take profit (realization of profit) and returns – risk indicator
In addition, to increase the efficiency of our trading system, we should also add a Take Profit order setting to it – that is, a pending order to close the position with profit. This will prevent us from making the above-described mistake of closing profit-generating positions too quickly. In addition, this will allow us to predict the appropriateness of our entry using the profit-risk ratio that will appear in our trading system.
What should be the minimum profit-to-risk ratio to justify entering the position? It all depends on the average efficiency of a particular strategy. If a particular trader has a really high trade efficiency, more than 80 percent of them bring him profit, he can open positions with a 2:1 return-to-risk ratio. However, if our trading system is not so efficient and on average 55-60 percent of positions are closed with profit, it is better to consider only market entries with a minimum 3:1 return-risk ratio.
What can we do to prevent panic and emotion from clouding our assumptions?
If we are faced with a serious problem of consistently following an effective strategy when we have losing positions, we need to think carefully about our approach to trading. It is important, without a doubt, to realize that a trader is a person who seeks to gain an advantage from probability. There is no way we can be 100 percent certain that our objectives will be achieved in every transaction. There is also not the slightest possibility that absolutely 100 percent of market trades will end in profit.
How to gain an advantage in the trading world?
Our job as traders is to create a system that gives us an advantage in the market. This advantage is nothing more than a higher probability of the event specified in the strategy, not its opposite. However, it is important to understand that in the case of absolutely every trading strategy in the universe, the distribution of profitable and unprofitable trades is random for us, if we consider their series to last forever.
This in turn means that we are never sure which transaction in the series will be profitable and which will be a loss. However, if we make trades according to our high-probability trading system, based on hundreds of trades using this strategy on a demo account or in the real market, in a sample of the appropriate size, there is a very high probability that we will make a profit.
Therefore, we cannot allow the outcome of one transaction to affect our feelings, our self-confidence as traders-investors and our behavior in the market. We have to stick to the plan consistently and maintain discipline. Only then will losing positions stop bothering us and we will become experienced traders, ready to achieve real success in this profession.
Prepared on the basis of foreign websites
