A Mental Trick To Handle Losses

Here’s a mental trick which I like to use to help manage my mindset when trading, and to help me take losses better.

If you’ve traded long enough, you would know that “revenge trading” is one of the most dangerous mindsets to lapse into when day trading.

Once you start losing (especially if you lose big), you feel angry and you want to hulk smash everything and take risky trades just to get back to breakeven.

Which would obviously lead to even further destruction.

So, what’s the mental trick?

Well, before I go further, I have to first state that the number one rule to prevent lapsing into revenge trading is to keep your risk per trade small.

Small position sizes make you far less attached to every trade, and make you less angry when you lose them.

OK so here’s the mental trick I use:

Before I take any trade, I will determine my remaining account balance assuming I lose the trade and ask myself: “Are you OK with having this remaining account balance assuming you lose this trade?”

If the answer is “Yes”, then I will proceed with the trade.

For example, assume I have an account size of $10,000 and my bet size is $100:

Before jumping into the trade, I will ask myself if I am OK if I am left with $9,900 in the event this trade is a loss.

This makes me mentally prepared in the eventuality that the trade turns out to be a losing one.

And I’ve found that this mental trick serves me quite well in handling losses.

Most of the time, we take trades only thinking that it will be a winning trade, and we refuse to entertain the thought of the trade being a losing one.

And when we see our remaining account balance after a loss, our emotions simply cannot handle it.

Why A Big Position Size Is Detrimental

You’ve probably heard it a million times by now that you should only risk 1% or less on every forex trade you make.

Some might say “Sure, but if your strategy is a winning strategy anyway, what difference does it make to risk 1% or 5%? Your win-rate still remains the same.”

That is true to some extent.

But there are a few disadvantages to using a larger position size as compared to a small one.

The most obvious one, of course, is that by using 1% you can survive a longer string of losses. If you’re risking 5% per trade, you’d be in dire straits if you hit say 10 to 12 losses in a row.

If you’re risking 1% per trade, even if you lose 12 trades in a row you’re still left with 88% of your account intact.

If you’re risking 5% per trade, when you lose 12 trades in a row you’re now left with only 40% of your account.

Additionally, a larger bet size tends to bring about the following “mistakes”:

  1. Makes you feel too emotionally invested in the trade since the stakes are higher (i.e. you’d feel much more pain if you lose the trade).
  2. Makes you set a smaller-than-intended take-profit target because you want to cash out the profits as soon as possible before the trade goes south. (For example if your strategy is meant to take profits at 2x, you may set only 1x for this particular trade because the stakes are too high.)
  3. Makes you cash out the trade too soon because you are simply too anxious about the trade. (For example, if your intended risk-to-reward ratio was 1:2, you may decide to just cash out at 1.75x profit because you’re not prepared to wait for price to hit 2x and you’re too fearful of the trade going south.)
  4. Makes you increase your stop-loss if the trade starts to threaten your stop-loss level, because you simply can’t bear to get stopped out on such a big trade.

The four mistakes above can easily screw up what is supposed to be a profitable and sound trading strategy, because you start to go off-script by cutting corners and short-changing your projected profits, and it will cause you to be far less profitable than initially expected.

And for all the reasons listed above, I feel that all trades should always be 1% or less.

Trust me, I’ve done the whole “large position size” thing many times, and it almost always never works out, and that’s why I speak from experience.

Why Backtesting Is Important

Backtesting your strategy is essential before attempting any form of live trading.

I personally do not think that a simple backtest of 50-100 trades will give an accurate portrayal of your actual live trading results, simply because i) the sample size is too small, and ii) market conditions change all the time.

However, there are still some benefits to backtesting, in my opinion:

  1. It gives you an idea of whether your strategy is a profitable one or not. Let’s put it this way: If your backtest yields unprofitable results, you can be sure it will not be profitable in live trading. If your backtest yields profitable results, then there is a chance it may still be profitable in live trading after factoring in spreads and provided there is a solid risk management plan.
  2. It gives you some kind of assurance and emotional support when you start hitting a bad patch in live trading. No doubt, a backtest sample data of 50-100 trades (or even 200 trades) is hardly conclusive, but it at least serves as a rough chunk of data to rely on, and you would know your approximate projected win-rate, profit factor, and number of consecutive wins and losses. So at least when you hit a string of losses, you can still find the motivation to stick with the strategy and not abandon ship immediately.

Besides, let’s face it – there can never be a thing as enough backtesting.

What is enough backtesting? 100 trades? 1,000 trades? 10,000 trades? Or all trades since the beginning of time?

And even if you manage to backtest every single trade since the beginning of time, some traders would still tell you that that doesn’t guarantee anything because markets change all the time.

So who really knows right? You just have to go with whatever backtest data you’re comfortable with.

The Art of Taking Partial Profits

Pursuant to my last post below on exit strategies, I stumbled on this YouTube video which I thought was rather insightful.

For some reason, very few people discuss the finer details of exit strategies, e.g. setting multiple take-profit targets, taking partial profits, moving stop-losses to breakeven, letting trades run etc.

Most people seem to only focus on ideal trade entry conditions.

Hence, I found this video really insightful because he actually shows some calculations on the different partial take-profit scenarios, such as what happens if your first take-profit is 50%/60%/70%/80%/90% of your position, and what the eventual overall net profit from those different trades will be.

Very useful to know.

But ultimately I’m just glad to see that there is at least someone on YouTube who is highly interested in going much deeper into the finer mechanics of trade exit strategies, because I myself had also been spending the past few weeks thinking hard about this subject.

Of course, in an exercise like this there will always have to be certain assumptions that you are maintaining a fixed win-rate (say 40%) and risk-reward ratio (say 1:3).

Personally, at this point in time, I’m beginning to lean more towards the following trade management rules for my own style of trading:

Take-Profit 1: Take 50% profits at 1.0x risk, and move stop-loss to breakeven.

Take-Profit 2: Take the remaining 50% profits at 2.0x risk.

Assume my position size (or risk) is $100, and assume no commissions in this case:

If price moves to my first TP target (i.e. 1.0x risk), then my minimum profit for this trade would be $50.

That means that even in the worst possible scenario thereafter, I will not make any less than $50 on the trade since it has already been cashed out (and because I had also moved my stop-loss to breakeven at the first TP target).

If price moves to my second TP target (i.e. 2.0x risk), then I would have made my maximum possible profit for this trade, which is $150 in total (i.e. $50 at first TP, $100 at second TP).

And yeah, these numbers feel quite right for me.

What’s Your Exit Strategy?

The are tons of YouTube videos about the best entry signals for day trading.

However, I feel there is a relative lack of discussion with regards to exit signals.

Which is ironic, because someone once said that the exit strategy is far more important than the entry strategy, and I think that is absolutely true.

You don’t make a single cent from an entry strategy. The exit strategy is where your money is made.

Every exit strategy has its own pros and cons.

Let me try to summarize:

EXIT STRATEGY 1: “SET AND FORGET”

Description: Set a fixed stop-loss (e.g. 1x ATR) and take-profit target (e.g. 2x ATR) and don’t do anything else.

Pros:

  • Easy to manage. In fact, no management required at all.
  • Won’t get stopped-out prematurely (as compared to moving up your stop-loss midway through the trade).

Cons:

  • Potentially frustrating if price comes very close to hitting your profit-target but then it goes all the way down and you end up losing the trade instead.
  • Determining the optimum take-profit target is tricky. Is it 1.5x? Or 2x? Or 2.5x? A lot of backtesting is required to determine this.

EXIT STRATEGY 2: USING EXIT INDICATORS

Description: There are numerous indicators which can be used as an exit indicator, such as moving average lines, MACD, Parabolic SAR, Heikin Ashi bars, SSL Hybrid, Aroon, etc.

Pros:

  • Straightforward. No ambiguity.
  • Occasionally you may catch really huge moves.

Cons:

  • In my experience, you usually leave significant profits on the table, which can be frustrating. For example, your trade may have gone to 4x profit, but the exit indicator only gives the signal when it comes back down to 2x profit. Also, if the move is a small one, you may actually end up with no profit or even a small loss. Some people may not be able to take this.

EXIT STRATEGY 3: USING A TRAILING STOP-LOSS

Description: This method means you don’t set a profit-target at all. You just let the trailing stop-loss trail price all the way until it comes back down and triggers the trailing stop-loss.

Pros:

  • Easy to implement. No management required. Just let the trailing stop-loss do all the work for you.
  • You may catch really big moves.

Cons:

  • Determining the optimum trailing stop-loss value is a tricky problem. Too big, and you may end up with no profits if the move is a small one. Too small, and the trailing stop-loss may get triggered easily.
  • Similarly with using exit indicators, you may end up with no profit or even a small loss if the move is a small one.

EXIT STRATEGY 4: TAKING PARTIAL PROFITS

Description: Take off partial profits in tiers when price reaches specific checkpoints, e.g. cash out 25% when it hits 1x profit, cash out 25% when it hits 1.5x profit, and cash out all the remainder when it hits 2x profit.

Pros:

  • You are wisely putting some money in your pocket as your trade becomes more and more profitable.
  • Psychologically comforting. You know that even if the trade suddenly goes south, you already have some profits safely cashed out. You will be more willing to let the trade run until it hits your desired take-profit target.

Cons:

  • Tedious to manage, especially if you have multiple trades going on simultaneously.
  • You will collect less profits as compared to if you had waited till the final take-profit target to cash out 100%. For example, if you had a profit-target of 2x, you will collect more profits by cashing out 100% of your position at 2x, as compared to taking partial profits along the way.

Apart from the 4 strategies above, you could even do a hybrid strategy where you take partial profits in tiers, and then let the remainder trail with either an exit indicator or a trailing stop-loss.

I’ve spent countless hours pondering over what the best exit strategy for a trade is.

And the conclusion I’ve reached is that there is no one perfect exit strategy.

It depends on factors such as your personality, the style of trading you prefer, your risk appetite, the volatility and nature of the instrument you trade, etc.

If you’re the kind that likes to make your profits slowly, surely and steadily, then maybe Exit Strategy 4 might be best suited for you.

Personally, I don’t really like Exit Strategy 2 and 3 because I just don’t like seeing that I’ve only made 1x profit on a trade that had gone as high as 3x at one point. It just doesn’t sit well with me.

As such, at this point in my trading, and after trying out so many different types of exit strategies, I’m leaning towards Exit Strategy 1 (“Set and Forget”) because despite its simplicity, I actually find it’s one of the most suitable methods for me.

But of course, before you decide to adopt any kind of exit strategy, make sure you do a lot of backtesting first.

Why A Small Position Size Is So Important

Trust me, I’ve made every mistake that can be made when it comes to forex day trading.

I’m starting to learn one thing – the key to success is to use a small position size for every trade (typically 1% of your account).

You won’t believe how hard it is to adhere to this 1% rule.

Sometimes you see a great setup, or you “feel good” about the trade, and you want to risk more than 1%.

Sometimes you get into a string of losses, and you want to risk say 5%-10% on a single trade so that you can quickly get back to breakeven for the day/week.

Don’t do it. Just don’t.

It usually will not end well.

Apart from the fact that a 1% position size helps you protect your capital when you face a string of consecutive losses (i.e. you cannot possibly lose more than 1% per losing trade), I feel the most important aspect of the 1% rule is the mental part of it.

By risking only 1%, you are much less likely to get too emotionally invested in that one trade.

It’s just 1% of your account. The stakes are considered very low.

If you lose it, it’s still fine. It’s not the end of the world. You’ll live.

You will be able to confidently let the trade play out and not do the following things:

  • Moving your stop-loss to breakeven too soon. (In fact, with a 1% position size you could even afford to not move your stop-loss to breakeven and let the full trade play out, which might even be more profitable in the long run.)
  • Taking your profits too early, before your trade even hits your intended profit target. (How many times have you decided to cash out the entire trade early because you felt the stakes were getting too high?)

Moreover, the best thing about the 1% position size is that you can simply “set and forget” – just set your desired stop-loss and take-profit, and walk away from your computer and let the trades play out naturally.

You don’t have to worry about managing multiple trades (assuming you’re juggling multiple trades simultaneously) by constantly moving stop-losses and taking partial or full profits.

You don’t have to watch every second of the trade play out and agonize over every tick movement.

In other words, once you’ve set the trade parameters, you just simply don’t have to care.

Trust me, it’s far less stressful and taxing this way.

But to each their own.

Professional Loss Taker

I like this term a lot – “Professional Loss Taker”.

I feel it’s a great mindset to have when trading, because you will have to deal with losses whether you like it or not.

If you simply cannot stand losing trades, then perhaps you shouldn’t be trading.

Handling Losing

In my opinion, the greatest NBA season ever was the 72-10 Bulls season in 1995-96.

It’s even greater than the 73-9 Warriors team in 2015-16 because the 72-10 Bulls actually won the title that year.

But this is not a discussion on who the greatest basketball team was.

My point is that even in the 72-10 Bulls season where they won the title, they still lost 10 games in the regular season and 3 games in the post-season.

They. Still. Lost. Games.

Similarly, in trading, you will lose trades.

The sooner you accept the fact that you will lose some trades, the better it will be for you.

I have to admit I’m not totally accustomed to losing trades. In fact, I hate losing trades.

Nobody likes to lose, especially when there is money at stake.

However, you have to accept that it is part of trading.

You will need to lose some trades in order to make an overall profit.

If you absolutely do not want to lose, then trading is not for you.

Trading Should Be Boring

I recently saw this, and I love this quote so much.

It’s so true. You really need to get to the point where trading becomes boring.

You need to be completely emotion-less and not care less whether you won or lost your last trade, knowing that you have a system that will give you an overall nett profit provided you stick to it completely, and trade often enough.

Once you reach the stage where winning or losing each trade means nothing to you, you know you are on the right track.

Trading should be the complete opposite of a roller-coaster ride.

Only Take High-Percentage Shots

In basketball, you always want to take the highest-percentage shot available to you.

A 3-point shot from the logo, or forcing a shot when you are being double-teamed, is considered a low-percentage shot.

Sure, you could still make the shot. But that still doesn’t change the fact that it is a low-percentage shot, and by doing it enough times, you will see that your actual completion rate will be rather low.

A dunk or a lay-up is considered a high-percentage shot because the odds of making it are considered very high.

Sure, there have been missed dunks or missed lay-ups in the NBA, but these are few and far between. And the fact remains that dunks and lay-ups are always going to be high-percentage shots.

My point is that as traders, we always want to take the trades with the highest chance of success.

Sure, you could take a risky trade and still end up winning the trade. It happens.

But the law of large numbers will show you that by doing this often enough, you would end up failing big time.

Play it safe. Be very selective. Be very disciplined.

Don’t take trades which do not match every single criteria of your trading strategy.

At least you will know that the law of large numbers is on your side.