How Traders React to Losing Money and How to Improve Trading
New traders are only interested in making money. They celebrate when their trades are profitable and ignore the trades that lose money. This is a bad idea. Achieving long-term success in trading requires understanding why trades lose. Then it becomes possible to reduce the number of losing trades. In other words, if you buy call or put options and then see them expire worthless, you should achieve better success by finding other strategies instead of just buying options.
Choosing Trades
If we do not have specific skills when choosing our trades, we should develop some skills that give us a trading edge. Without an edge, we can expect to win about half of the time. When we add in the cost of trading (i.e., commissions), we must do one of two things as traders: earn a profit more than 50% of the time; ensure that we do not lose more money on losing trades than we make on winning trades.
The Trader’s Mindset or Trading Psychology
Dr. Brett Steenbarger’s work provides deep insights into trading psychology. Below are his thoughts from an article in Forbes on how traders deal with losing money:
When I first worked with traders in the financial markets full-time, I noticed how they responded to losses in their trading. Three groups emerged. The first group continued to trade after the loss, often by increasing their risk. They were clearly frustrated by their losses and determined to recoup their money. They categorically refused to give up. They viewed losing money as a kind of indignation and doubled down on their trading efforts.
The second group was also frustrated by their losses but was determined not to let those losses compound. They took breaks from trading, calmed themselves down, and often stopped trading for the rest of the day. Their goals were to regain emotional balance and not let frustration drive their decisions.
The third group was also extremely frustrated by their losses, but those traders stayed at their desks and stopped trading. Instead, they doggedly tracked the sources of their poor trades and did not stop analyzing until they discovered where they had gone wrong. Then they returned to trading.
Over time, the distinctive differences in outcomes became clear between the three groups. The first group was the most prone to blow-ups, increasing their risk exactly when they were trading poorly. Frustration, for them, led to reactive and often destructive decision-making.
The second group never blew up but rarely excelled. Their focus on not losing money kept them emotionally in check but did not help them much in learning from setbacks. In other words, they succeeded in surviving but did not grow as traders.
The third group proved over time to be the most successful. They were frustrated just as much as the first and second groups, but they channeled that frustration toward improvement. They operated with a growth mindset. They remained engaged in their work but in a constructive way. It wasn’t all about mastering the markets; it was about mastering the process of turning setbacks into educational successes.
The Key to Success for Options Traders
Look for strategies you understand well. Use them when you believe market conditions are right (for example, writing covered calls and selling naked puts work well in a mildly bullish environment; iron condors work well when market volatility is high but is steadily declining). Track the results. Find out how successful the market environment you anticipated was. Over time, you will discover which strategies work well – not just because the strategy itself was good – but more importantly, because you implemented it at the right time. Develop the discipline to endure those inevitable losses. Know when enough is enough and withdraw from winning trades when the remaining potential profit is too small to justify the risk of earning a little money in the trade.
Keys
Success for the Technical Analyst
Learn how to read charts. It takes time and you can’t learn it overnight. Although there is no guarantee of success, any edge helps. If you get a buy signal, it’s acceptable to buy – even when you know the signal could be wrong. But your success comes from cutting losses and studying all signals. Learn which ones work often and which do not outperform regular signals. Analyze the results and gain an additional edge by knowing which ones work for you.
General Keys Anyone Can Use
Do not trade just for the sake of trading. When your results are poor, take a break from trading, but do not stop analyzing your results. When your strategies are not working, determine whether it’s time to sit on the sidelines or adopt a different strategy. But do not just guess what to do. Have a clear reason for every trade.
Source: https://www.thebalancemoney.com/psychology-of-trading-2536732
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