Losing trades are part of the total trading experience. While losing trades can’t be avoided (don’t believe the hype from firms that claim 50 winning trades in a row), traders should look to benefit from an analysis of their losing trades and perhaps find errors that we can avoid repeating.
Let’s begin with the notion that not all loses are equal. The difference between an experienced trader and a beginner is an awareness of the distribution and causes of losing trades. There are types of losses that are unavoidable and consistent with a solid trading strategy. Once we identify the root cause of losses we can minimize them.
Order entry glitches are avoidable. Traders should master entering orders on a platform before trading real money.
Being stopped out quickly, or frequently, is a sign your model needs tweaking. Setting wider stops is too simplistic and increases risk. A useful technique in setting stops is to use the ATR (average true range) as a guide. Developed for commodities, ATR gives a quick indication of whether the range around a candlestick on a chart is getting greater. If the ATR is eight pips, a five-pip stop is within the recent range and could easily be stopped out. It’s a good idea to be sure that a stop is set to twice the ATR to keep a trader away from the vibration of the candle (see “Breathing room”).
Counter-trend signals are more complex and result in larger losses when wrong. New traders should avoid picking tops and bottoms and concentrate on trends. Keep an eye on the four-hour chart. If upon a trade entry, the five-minute price action is moving against the trend, the trader should wait for both the four-hour and five-minute patterns to align.
Wrong analysis of technical conditions causes losses. Beginning traders often don’t recognize signs of indicator divergence and enter a position when key indicators such as a stochastic crossover or the MACD histogram are pointing the other way. Before one puts on the trade, the trader should have a setup of indicators that will be applied. This setup will vary between traders; but whatever it is, it should be applied consistently. Changing entry rules results in inconsistent trading and prevents the trader from learning how to improve.
Perhaps more difficult than learning from losses is learning from winners. It is nice when fate steps in and turns a mistake into a winning trade but you need to correct inconsistent trading patterns even if it results in the odd winner. You will not always profit from good trades or get punished for poor decisions, so it is important to stay disciplined and stay consistent.
The most common and most difficult types of losses to minimize relate to the trader trying to predict a directional move. Instead of using personal sentiment, you can reduce risk by substituting market sentiment for your own. There is wisdom in the behavior of crowds. Chances are that market sentiment reflects all the economic data available, some of which you may have missed. Ignorance of economic data releases contributes to potentially large losses. A trade put on before a major economic report is a mistake because the market could move right through stops with large slippage.
Another category of losses relate to exiting a position. Most common is when a profitable trades turns into a loss of 20 pips or more. In this case, the trader’s hope that he is correct masks the realities. This can occur after a trader experiences a streak of winning trades and thinks he’s invincible. The emotional disposition of the trader can set up future losses. Many traders have a sudden series of losses following a series of wins. This may not be a turn of bad luck, but instead be reflective of temporary patterns or a trader believing his signals are all of a sudden fool proof. Experience is the most powerful teacher for this type of error. It is far easier to recoup a small loss. Getting out of a position that is turning against you liberates you to get ready for the next trade.
One of the most significant and avoidable kinds of losses is one that exceeds a defined risk parameter. Any losses that exceed 5% of equity in an account are on the critical path to catastrophic results. The next time you review your forex trading performance, focus on the pattern of your losses and ask yourself which ones could have been avoided, prevented or reduced. The simple fact is while there are many ways to lose in forex, becoming a better loser is the right path to become a better trader. Losing professionally is the best kind of loss.
Abe Cofnas is president of learn4x.com LLC and author of Understanding Forex: Trading to Win. E-mail him at learn4x@earthlink.net.
