Many successful traders today will tell you that the key to success in trading is to be able to comfortably accept a loss. Among experts in trading psychology and experienced traders, it is generally understood that the market is inherently unpredictable, and this is unlikely to change. Taking a loss is a natural part of trading, and even the most skilled traders know that losses are inevitable. With that in mind, let’s explore what you as a trader should be aware of, and how you can effectively handle losses and use them for your long-term success.
Trading psychology teaches us that when a trader takes a loss, they often develop a perfectionist attitude towards their trades. Many traders tend to think that a good day in trading is only one that ends in profit. Experts in trading psychology, however, assert that this is not the case. A good day should be defined by the level of research, planning, discipline, and focus a trader has exhibited, and how well they executed their plan. When a trader learns to accept losses and work through them with a well-thought-out plan, the number of profitable days will eventually increase over time.
Since trading takes place in an unpredictable market that can fluctuate greatly from one day to the next, trading psychology experts recommend focusing on the factors you can control, rather than those that are out of your control. In the short term, it is difficult to control profits. Instead, concentrate on what you do have the ability to control.
You can control the difference between good and bad days. This involves extensively researching the strategies you use in your trading. By learning to research and refine your trading strategies, you will eventually create more good days than bad. Over the long term, this consistency will help generate profits, which is every trader’s ultimate goal.
Trading psychology experts also emphasize the importance of realism in trading rather than perfectionism. Perfectionist traders tend to view losses as failures, which leads them to obsess over them. On the other hand, realistic traders understand that the market is unpredictable, and losses are simply part of the trading journey. The key is to limit your losses effectively without becoming obsessed with them. Traders who focus too much on their losses often find it difficult to bounce back, which eventually leads to further losses.
Experts in trading psychology have outlined three basic strategies to help traders stop losses effectively:
- Price-Based Stops
- Time-Based Stops
- Indicator-Based Stops
Price-based stops are generally used when the other two types of stops have not been successful. To use this strategy, you need to formulate hypotheses about a trade and identify a low point in the market. Set your trade entries near those points, ensuring that losses are kept manageable if your hypothesis fails.
Time-based stops involve managing your trades based on time. Set a designated holding period to capture a specific number of points. If you haven’t reached your desired profit within the time limit, you should stop the trade, even if the price stop limit hasn’t been hit.
Indicator-based stops use market indicators to determine when to stop a trade. Traders should be familiar with these indicators and use them extensively. Indicators like volume, advances, declines, and new highs and lows can be helpful for making informed decisions about when to exit a trade.
Trading psychology experts suggest mentally rehearsing stop strategies as a psychological tool to ensure you follow through with them effectively.
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