What attitude should we have towards losses, and how can we effectively deal with them? First, we need to understand what losses are. If you have a comprehensive trading system, covering direction, entry, profit-taking, stop-loss, and capital management with clear guidelines, and this system has a probabilistic advantage, then trading will become a matter of simple repetition, forming a law of large numbers. By avoiding low-probability events, you can profit from high-probability trends.
The advantage of probability comes from the strong execution of large numbers. Looked at on a per-transaction basis, profits and losses are randomly distributed—there are no certainties in this world, so we must inevitably face losses.
Many people, including my earlier self, have a significant problem where sporadic losses overshadow frequent profits. This is a major hurdle that traders must overcome.
Indeed, we face two unavoidable premises:
- The final net gain is the result of the sum of profits and losses.
- We cannot escape the probability of incurring losses.
From these premises, we can conclude that minimizing losses is tantamount to maximizing earnings. Consider how often, after a massive loss one day (say $100,000), we proceed cautiously the next day to earn a modest sum (say $20,000), regretting not having cut our losses earlier to save ourselves $80,000.
Saving $80,000 in losses yesterday is equivalent to earning an extra $80,000 today—it's all a matter of perspective. Profits and losses are like the sand in an hourglass, inseparable, a unified contradiction.
The human heart is unpredictable, and so is the market, which is full of constant changes. The events in this market repeatedly refresh our understanding. Who could predict that stock index futures could hit a 10% limit down? Or that after hitting the limit down, it could experience several limit-ups? We must respect the market as fishermen respect the sea, always prepared to face drastic changes.
Since trading is risky and we can't be sure of what will happen next, there's no reason to let losses fester. Rather, we should accept and limit them, and then accept the reality of temporary losses.
To reinforce a belief: Losses are unavoidable. They can only be limited and calmly accepted after occurring. Losses are an inevitable cost of making profits. We should not belittle ourselves for incurring losses, just as we should not get overly excited about profits. This is merely the advantage of probability at play.
Accepting losses is the first step towards making profits. Accepting a loss is not a sign of weakness; on the contrary, refusal to accept losses is reckless. Many people eventually exit the market due to losses not because they couldn't make profits, but because they refused to accept losses.
Refusing to accept small losses can lead to significant problems, potentially turning minor losses into significant ones. Holding onto losses too long can also mean missing out on more assured trading opportunities or frequent trading in an attempt to recoup losses, turning potential profits into losses.
Not stopping a loss on a single trade isn't as frightening as refusing to accept a loss and then continually increasing your stake. While it's possible to recover many times, just one failure to do so can leave an indelible mark. I've experienced this firsthand, having lost two months' worth of profits in one go, and I've learned never to increase my stake on a loss based on hope alone. This experience taught me the importance of capital management.
Therefore, small mistakes are not to be feared; what's truly dangerous is failing to acknowledge and correct them, compounding errors into a major mishap.
A single day's massive loss can affect a long period. I often tell my traders: lose $20,000 less today, to earn $100,000 more tomorrow. If today's losses exceed your tolerance level, even individuals with strong self-control can find it difficult to operate freely the next day. Thus, as day traders, we all agree: the key to long-term profit lies in minimizing losses when they're inevitable. This is why setting a maximum daily loss limit for our traders is essential.
There are many reasons for not accepting losses, the most common being too concerned with short-term profits and losses. Feeling heartache over losing a few thousand dollars, as if losing an iPhone X, taking the digital numbers game too seriously.
Other reasons include not wanting to spoil your mood after the market closes; an unwillingness to accept imperfection after a series of profitable trades; or linking profit and loss to your self-esteem, as if making a profit is honorable and incurring a loss is shameful. This attitude can be harmful. I used to be concerned about my image too, but this changed once I started making real money. Actually, very few people care about your profits or losses; it's mostly a competition with oneself.
Many people understand these concepts, but few can correctly and firmly deal with losses. In my view, there are three ways to handle a single loss: logical stop-loss, time-based stop-loss, and fixed stop-loss.
A logical stop-loss is consistent with your entry logic; when one or more of the indicators that led to your entry reverse, it's time to stop-loss immediately. A time-based stop-loss complements logical stop-loss; if the logic hasn't changed but the desired outcome hasn't materialized after a considerable time, perhaps due to unseen factors. Some say this could mean missing out on significant trends, but I believe securing capital and avoiding risks is paramount.
Fixed stop-loss entails stopping the loss at a predetermined point or loss amount, serving as a life-saving measure. Whichever condition is met first dictates the action. The specifics can vary based on personal strategy and methodology.
Setting a maximum daily loss value is essential, and it should be higher than your average daily profit but lower than your maximum daily profit. Newcomers should be stricter with themselves—the stricter, the better, pushing oneself not to act rashly, thereby indirectly expanding one's threshold for time and financial capacity and increasing resilience against market setbacks. Establishing this discipline also helps to build conviction once you start making money.
The best method for addressing daily or consecutive day drawdowns is to "cut back or stop," which involves reducing position size, trading frequency, and expectations.
The reasons for consecutive drawdowns boil down to two:
- Your strategy no longer matches market volatility.
- There's a problem with your mindset or execution.
Once a market's volatility pattern is established, don't expect it to change easily. And if your mindset has gone awry, that's even more reason to pull back or stop. The purpose of doing so is largely to repair your mindset. Traders and the market are like a couple. Making small trades after a loss to grab a little profit is like an apology after a quarrel, helping to gradually improve your mood.
When facing consecutive drawdowns, rather than desperately trying to recover losses, it's better to scale back and maintain belief that the capital will eventually reach new highs. I call this "adversity confidence," a hallmark of mature traders.
In the process of finding and applying suitable rules, execution is paramount. Many fail at this point.
From my experience, the key to execution is being mentally prepared. Any decision, no matter how quickly made, involves a period of deliberation. Conversely, the more thoroughly you deliberate, the more decisive your actions. Experienced drivers react quickly not just because of practice, but because they're always mentally prepared with various contingency plans.
Every trade should be preceded by thorough planning for all potential outcomes. What will you do if the situation matches your expectations? What if it exceeds or falls short of your expectations? What if it turns out completely opposite? By preparing yourself for each scenario, you remind yourself of the right actions to take, such as deciding in advance to cut losses at a certain price point.
I never consider trading to be an art form subject to whimsy. Trading is a disciplined process, from the formation of expectations, development of a rough structure, pre-trade preparation, identification of trading opportunities, to the actual trade, verification, adjustment, and management. Market trends must fall into a rigorous logical framework to make trading happen.
"The Art of War" says, "Defeated soldiers go to war first and then seek to win, while victorious soldiers ensure their victory first and then go to war." In my trading process, I ask myself ten questions, all meant to control my actions and increase the certainty of my trades.
No matter how certain you are, losses are unavoidable. Accept individual losses, daily losses, and periodic setbacks. Then, reflect, regroup, and ensure those mistakes don't happen again. If we sulk over losses, aren't we betraying our initial intentions of entering this market?
I no longer care much about daily profits and losses. I only feel particularly bad when I make uncontrollable mistakes. Daily profits and losses don't change much, but consistently doing the right thing at least suggests that I can partly control my destiny and thus affect others, which is somewhat meaningful.
I used to think traders had to be somewhat schizophrenic, chasing profits while disregarding money. Now I understand: disregarding short-term profits and losses and focusing on correct actions can lead to long-term stable profits. Do not be swayed by minor gains or losses—words of encouragement for us all.
