The inability to manage losses is a big factor for traders that constantly stay in the red. By the time most traders learn how to manage risk, their account has already lost substantial money.
Now there is no strategy that will assure you never have a losing trade. I still have losing trades; you’ll have losing trades. You have to accept that. The point is you have to be ready to minimize those losses. How you handle losses is just as important as objectively controlling your emotions and reacting to the actual trade in the way that you manage any losing trade.
You’ve got to be a good loser. It is a part of day trading.
Leave the ego behind, you cannot have an ego. Every time you get confident, the market always humbles you, the market is always right, don’t be in a trade and start hoping, because hope is not a strategy.
The more that you fight a wrong position the worse it can get. For example, you open a large short position then it starts going against you and you keep adding to it. You have to understand the more that you fight, the more you stand to lose.
For some reason, it may seem easier to have more patience when you are wrong than when you are right. When you are up, you may like to take profits, boom, right away. However, when you are down, don’t get caught up saying to yourself, “Well, let me give it more time, it might turn around.”
When it comes to losses you can make money and still be wrong even half the time. Being successful as a trader is not about picking the right stocks 100 percent of the time. It’s about knowing what you’re risking and knowing how to lose. It’s about learning how to manage your losses.
So every time you take a trade, you have to know how much you’re risking.
Some traders have catastrophic losses and it all comes back to the fact that they didn’t plan on the trade. They were shooting from the hip which then turned into a bad situation. They panicked, they didn’t know how to get out of it, and it just got worse and worse and worse. Learning to manage risk is what will make you a successful trader.
So, imagine for a moment if all your losses were only $20, but your winners were $100, right? You could lose a lot and just hold out for those $100 winners because they’ll make up for all the losses. So what would that type of profit loss ratio be? Five to one. If you’re successful 20 percent of the time you’re making money.
So success again is not about being right 100 percent of the time.
It’s about learning to cut your losses when you’re wrong.
Profit Loss Ratios
What’s the profit-loss ratio? It’s simply your average winner versus your average loser. You need a minimum, you want to aim for 2:1 or 3:1. Aim as high as you can. The high profit-loss ratio means you can be wrong a lot and still make money.
To break down profit/loss ratios:
If you have a two-to-one profit loss ratio and you’re right 33 percent of the time, you are breakeven not including commissions. If you have a 1:1 profit loss ratio and you’re right 50 percent of the time, you’re breakeven. If you have a 1:2 profit loss ratio where you lose more than you win on average, you need to be right 66 percent of the time to break even.
So you can see how you can set the bar against you. You can set the bar so high that it’s almost impossible to succeed just because of the way you establish your profit loss ratios, but a lot of traders are trading and they don’t even know about profit loss ratios. They’re not even thinking about that. They don’t know what their actual statistics are because they haven’t taken the time to track those results.
That data is extremely important in designing your trading strategy and ultimately in your success.
And what this suggests is that success in trading is not about picking the best stocks, but about managing your losses properly, and that takes a little bit of pressure off you.
You don’t have to be the best stock picker out there, but you need to be really good at managing losses. So what you need to do is put the statistics in your favor, by knowing your statistics. Understand your average winners and your average losers.
If you go in and you realize that your average losers are $200 and your average winners are only $150, that’s a problem, and you need to start making adjustments to improve that ratio. But if you don’t know those ratios, there’s no way to know what you need to work on.
Let gamblers think about profits. You as a trader should be thinking about risk.
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