How to Deal with Trading Losses

Trading financial markets is filled with peaks and valleys. 

It can be satisfying when trades work well, but with loss aversion being what it is, losses often produce a lower low than the high of a win. 

Losses aren’t just financial setbacks – they can shake your confidence and challenge your resolve. 

However, how you handle these losses defines your resilience and potential for long-term success. 

We look at strategies to help you effectively deal with trading losses, transform setbacks into learning opportunities, and improve your overall trading performance.

Key Takeaways – How to Deal with Trading Losses

• Accept that losses are inevitable – Even top traders win just 55-60% of the time. Some have effective strategies winning even less than that. Focus on improving your strategy instead of avoiding losses.
• Keep a trading journal – Track entries, exits, and emotions to identify patterns and improve decision-making.
• Control emotions – Avoid revenge trading after losses. Step away and reassess your strategy to regain clarity.
• Manage risk effectively – Use stop-losses, diversify trades, and limit exposure to 1-2% of capital per trade.
• Automate where possible – Computers just consistently apply the logic given to them.
• Write down your strategy and test it – To avoid impulsive trading, write down your strategy to externalize your thinking. This better enables objective analysis and refinement for improved performance.
• Adapt and learn continuously – Markets change. Regularly refine your strategy and stay informed to maintain an edge.

Acknowledge the Reality of Trading Losses

Understanding Losses as Part of Trading

First and foremost, accept that losses are an inevitable part of trading. 

Even the most seasoned traders with decades of experience and sophisticated algorithms cannot predict market movements with high levels of accuracy. 

A 55-60% winning percentage is often what they believe is realistic. And that’s with a research budget of hundreds of millions of dollars per year. 

Some strategies are profitable with sub-50% winning percentages because they win more when they win than when they lose.

Markets are influenced by an extremely high number of factors – various economic indicators, geopolitical events, and sentiment (flows and positioning not strictly related to fundamentals or traditional analysis) – that have lots of variance to them. 

Internalizing the fact that losses will occur, you can prepare yourself mentally to handle them when they happen.

Poker pros know they won’t win every hand and there will be long stretches where they’re below their high water mark.

It’s just the natural ebb and flow.

It’s One Big Long Session

Don’t focus on daily fluctuations. Trading is a long game.

Evaluate performance over years, not days.

Zoom out and focus on the bigger picture to maintain psychological balance amidst short-term losses.

Accepting Responsibility

It’s important to take ownership of your trading decisions. 

Blaming external factors such as market manipulation, bad advice, the actions or perceived actions of others, or unforeseen events may provide temporary comfort.

But it hinders personal growth. 

Accepting responsibility means analyzing your role in the outcome, recognizing mistakes, and being proactive in finding solutions. 

This mindset helps with accountability and positions you to make better decisions in the future.

Analyze and Learn from Your Losses

Keep a Detailed Trading Journal

One of the most effective ways to improve your trading performance is maintaining a trading journal. 

Record every detail of your trades:

• entry and exit points
• position sizes
• market conditions
• emotional state, and
• the rationale behind each decision

Over time, this journal becomes a type of database that reveals patterns in your trading behavior, both positive and negative.

Nobody likes having an extra obligation, but how many times have we thought, I wish I remember what I did back then?

Review and Reflect on Your Trades

Set aside regular time to review your trading journal. 

Look beyond the financial outcomes and go into the decision-making process. 

• Did you follow your trading plan? 
• Were there external factors that influenced your choices? 

Critically analyzing your trades allows you to gain insights into your strengths and weaknesses, which allows you to refine your strategy.

Doing this every day, you’ll make a lot of progress. You can look back in a year and see how far you’ve come.

Identify and Correct Mistakes

Common mistakes such as overtrading, holding onto losing positions for too long, or failing to adjust stop-loss orders can lead to leaks. 

Identify these errors and develop concrete plans to avoid them. 

For instance, if you find that impulsive trades are leading to losses, use rules that require you to wait a certain period before entering a trade, and be sure it aligns with your strategy.

Automate If Possible

Computers Can Do Some Things Better

To manage emotions and avoid impulsive decisions, automate your strategy where possible.

Computers execute trades based on predefined rules without fear or greed.

They aren’t subject to the whims of crowds.

They don’t care if their opinions are popular or not.

This allows you to stick to your plan and avoid emotional pitfalls that can lead to losses.

It can also lower the time intensity of trading.

And even if automation doesn’t work for you…

Write Down Your Criteria

Even without automation (i.e., if you’re a discretionary trader), writing down your trading criteria is extremely useful.

Your decisions stem from whatever is going on in your head. Writing down the criteria externalizes your thought process. 

This allows you to objectively analyze and test its logic, identify potential flaws, and refine it for improved performance and consistency. 

Essentially, you gain a concrete plan to follow, reducing impulsive actions driven by fear or greed.

Manage Your Emotions

Dealing with Fear and Greed

Emotional responses like fear and greed are natural but can be detrimental in trading. 

Fear may cause you to exit trades prematurely, missing out on potential profits, while greed might tempt you to hold onto positions too long beyond what’s justified. 

Recognize these emotions when they arise and understand their triggers. 

Awareness is the first step in reducing their impact.

Techniques for Emotional Control

Adopt practices that promote emotional regulation. 

Mindfulness meditation can increase your awareness of emotional states and improve focus. 

Physical exercise reduces stress hormones and boosts mood. 

Additionally, establishing routines – such as a pre-trading ritual – can help center your mind and prepare you for the trading day.

Avoiding Revenge Trading

After experiencing a loss, the desire to immediately recover the lost capital can lead to “revenge trading.” 

This impulsive behavior often results in further losses. 

Instead, take a step back. 

Consider taking a short break from trading to reassess your strategy and emotional state. 

Returning to the market with a clear mind increases the likelihood of making rational decisions.

Improve Risk Management Strategies

Setting Stop-Loss Orders

Stop-loss orders are a fundamental risk management tool. 

They automatically close a position when it reaches a predetermined loss level, and hence can protect from significant drawdowns. 

Set your stop-loss levels based on thorough analysis, considering factors like support and resistance levels, volatility, and overall market conditions.

Options

Options offer risk management by limiting potential losses to the premium paid.

Choose options with expiry dates aligned with your trade timeframe to control your risk exposure and define your maximum loss.

Options also mean your trade has breathing room.

Stop-losses will stop you out while options will protect you from losses beyond a certain level while keeping your trades active.

Proper Position Sizing

Effective position sizing is very important to managing risk.

Determine the percentage of your capital you’re willing to risk on any single trade, often recommended to be no more than 1-2%.

Obviously it varies a lot based on your trading style.

Short-term traders tend to have lower position sizes while long-term investors tend to concentrate more (especially if an ETF) because their positions have longer to develop.

This way, a string of losses won’t deplete your trading account and allows you to stay in the game long enough.

Diversification of Trades

Diversifying your trades across different assets, sectors, or markets can reduce overall portfolio risk. 

Not concentrating your capital in a single position or correlated assets reduces the impact of a loss in any one area. 

Diversification should be strategic, balancing potential returns with acceptable risk levels.

Sophisticated institutional traders think of their portfolios like Lego sets where they’re taking all the various components and “engineering” it to specific goals and risk profiles. Each small piece might not mean much on its own, but lots of small pieces build up to the whole.

Reassess and Adjust Your Trading Plan

Revisiting Your Trading Strategy

Markets change.

Regularly evaluate whether your approach aligns with the current market environment. 

Are you trading in a trending market with a mean-reversion strategy? 

Such misalignments can lead to losses. 

Be flexible and willing to adjust your strategy.

More passive approaches like All-Weather or balanced beta approaches are more passive and strategic.

Adaptation

Adaptation might involve shifting focus to different asset classes, adjusting timeframes, or incorporating new analytical concepts or frameworks. 

Continuous adaptation is needed – like in all businesses – so that your strategy remains relevant and effective.

Continuous Learning and Education

Understand not just technical and fundamental analysis, but also behavioral finance, which explores how psychology affects market movements.

A commitment to learning enhances your analytical skills and keeps you competitive.

Academic education is good up to a point.

But markets are always changing and you’re not going to understand how (or how they work) unless you’re directly involved with them.

Seek Support and Professional Advice

Networking with Other Traders

Building relationships with other traders provides a support network where you can share experiences, strategies, and insights. 

Participate in trading communities, attend industry events, or join online forums.

Engaging with peers can offer new perspectives and reduce the isolation that often accompanies trading.

Maintain a Healthy Lifestyle

Importance of Physical Health

Your physical health directly affects your mental acuity and emotional resilience. 

Regular physical activity boosts cognitive function, reduces stress, and improves mood. 

Be sure you’re getting adequate sleep, as fatigue can impair decision-making and increase susceptibility to emotional reactions.

Stress Management Techniques

Trading can be stressful, and chronic stress can lead to burnout.

Ultimately it’s generally important that you enjoy what you’re doing.

Incorporate stress management techniques into your routine. 

This could include mindfulness practices, hobbies unrelated to trading, or spending time in nature. 

Balancing work with relaxation enhances improves well-being and trading performance.

This might even include a job (part-time or full-time) that has nothing to do with trading to take some of the financial stress away.

Mindset

Cultivating Patience and Discipline

Patience and discipline are virtues in trading. 

Avoid the temptation to deviate from your plan in pursuit of overly tactical gains. 

Discipline yourself to stick to your strategy, even during periods of drawdown (if it’s been proven to work). 

Over time, consistent application of a sound strategy is more likely to yield positive results.

Embracing a Long-Term Perspective

Focus on the big picture rather than short-term fluctuations. 

Trading isn’t about winning every single trade (impossible) but achieving profitability over time. 

Adopting a long-term perspective you can endure temporary setbacks and maintain confidence in your approach.

Conclusion

Experiencing trading losses isn’t a reflection of your abilities but a natural part of engaging with financial markets. 

Proactively acknowledging losses, thoroughly analyzing your trades, managing emotional responses, refining risk management, and continuously learning, can help transform losses into lessons to help improve over time. 

Seek support when needed and maintain a balanced lifestyle to sustain peak performance.