Early on in my career I was a losing trader and I thought I was a losing trader because I wasn’t using the right strategy. So I was constantly bouncing around from strategy to strategy tying to figure out what works. I later realized it wasn’t the strategy I was using that made me a losing trader. It was my inability to stick to a predefined plan because I was emotionally thinking instead of rational thinking. I realized that fear had made every decision for me. Fear from missing out on a big winner, fear from taking a loss, fear from selling a losing trade later to find out I could have profited if I didn’t sell and fear from my profits being taken away.
Fear has the biggest impact on our judgment and can cause us to make irrational decisions. As day traders, we have the potential to lose money on every trade we make and therefore fear is an everyday part of our career. Learning to recognize fear and be able to withstand the effects it has on our minds is critical for successful day trading.
I had the hardest time with taking losing trades. Every trade I took, I was fearful I was going to lose money so I tried to develop a strategy that produced over a 90% win rate. I obtained that level for a years by using the average down strategy but when the strategy didn’t work, my losses were huge. I’m probably not the first to tell you but everyone is guaranteed to make losing trades. You can’t predict with certainty that the trade will work in your favor all the time. You can have an educated guess but in the end it’s still a guess. You have to learn to accept the fact that you will lose money and because of that you have to put all your focus on managing risk.
Part of managing risk is controlling your behavior when faced with fear of financial loss. No one wants to lose money. It doesn’t feel good. We all want that strategy that gives us the least amount of losing trades. So what did I do as a beginner trader to try to win more? I sold my winners too soon and held my losers too long. Is this something you do too? When we sell a winner too soon we are fearful of giving back the profits we have already made on the trade. Let’s say I had a $200 profit target on a particular trade and during that trade I’m up $50 and I say to myself “yes I’m up $50 Im going to sell so I can lock in that $50 and not lose it” only to find a few minutes the trade would have given me $200 if I just would have held. So selling winners to soon creates the bad habit of not being patient enough to let your trade work out to reach your original planned target.
Now let’s talk about one of the biggest reason traders blow up their account. Holding losers too long. This is where some of my biggest losses have come from. There’s a common saying I hear amongst traders, “the losses aren’t real until you sell.” This is horrible advice. I had this mentality for a long time and it did nothing but give me huge losses. Holding on to your losers creates really bad trading habits because, while yes the loss isn’t real until you sell, watching your loss get bigger and bigger can really compromise your ability to think rationally during the trade which can cause you to make more mistakes such as turning your planned day trades into swing trades, revenge trading or taking on more risk with bigger share size.
A common mistake I see a lot of traders make while facing a losing trade is averaging down. I did this a lot as a beginner trader and while most of you may think averaging down is the holy grail to trading, I promise, it doesn’t work in the long term. I’ve used that strategy for a few years. It worked most of the time but the times it didn’t cost me big to where, in the end, what profit I made wasn’t worth the time and effort. Averaging down is where you add to your losing position in order to decrease your average cost basis with “hopes” that the stock price will eventually come around to your average cost basis so you can exit at break even or sometimes for a profit. Let’s say your max loss on a trade was $100. You take a losing trade and you’re down $100 but instead of accepting the loss you decide to double your position hoping the stock price at least reaches your new average price but it doesn’t. It keeps falling and falling. Your $100 loss has now turned into $200, $300, $400 and will keep compounding the more you add shares to your losing trade. While your unrealized loss is getting bigger, your emotions will soon take over and any rational thinking is out the window. If you find yourself averaging down in a losing position, chances are the trend has reversed on you which will be hard to fight against. You have to understand that small losses are not a big deal. It’s ok to be wrong and make losing trades, but that’s the key, keeping those losing trades small. You can easily take the small loss, move on to the next trade and make your money back while not sacrificing any rational thinking from a frustrated emotional state.
One important thing that I want to point out is that there will be plenty of times where if you would have sold sooner you would have avoided a loss, or if you would have held a losing trade longer you would have made a profit, or if you averaged down then your loss wouldn’t be as big. I want to inform you that every trade you make will always be like that. There will always be something you coulda, woulda, shoulda, done to make the trade better. It’s almost impossible to get the absolute most money or be perfect on any given trade. So instead of focusing on how we can get the most out of every trade or have less losers or turning losing trades into winning trades try focusing more on risk to reward ratios. An example of a risk to reward ratio is aiming to make 2 times more on your winners than on your losers. So if I were to risk $100 on a trade, I better have the ability to make $200 on the trade. This is what we call a positive risk to reward ratio of 1:2. Having a 1:2 risk reward ratio allows us to be right only 33% of the time just to break even. Having more than a 33% win rate is easily achievable and it takes the stress out of needing to be right all the time. Putting the focus on positive profit loss ratios will eliminate a large amount of stress, reduce risk, and give you more profit potential.
But, sticking to positive profit loss ratios isn’t enough. You need to have a solid trading plan as well which will give you a higher win rate. My trading plan revolves heavily on buying at support and selling at resistance. Sounds easy right? Sticking to that plan sounds easy but often times I find myself doing something completely outside my plan. The reason why I do this is because I’m letting fear control my rational thought process. Sometimes I buy no where near support or buy too far away from my stop price because of fear of missing out on potential profit. Sometimes I sell too early for fear of losing what I’ve already made just to find out that the price does reach up to my original target at resistance. It’s this emotion of fear that causes us to make a split second decision to break our trading rules. When we impulsively act on fear and not trade our defined strategy, that’s when the major losses happen. The majority of my losing trades come from me not trading my strategy and acting on impulse.
Our bodies are biologically hardwired to act on fear and acting on fear is the biggest reason so many day traders fail. It’s difficult to think rationally under the pressure of financial loss. But understand that this takes time and experience to overcome. I believe that this is one of the major reasons why so many people try and fail at day trading. They put lot of effort into the easy part of trading such as technical patterns, reading charts, and proper buy and sell signals when that’s only a fraction of the battle in becoming a successful trader. Learning the technical side of trading is easy. It may only take you a few months to learn that aspect. The difficult part is learning to fight against emotional impulses which can take years to master. Look at some of the best day traders that you famously see making 1000% returns on their money or turning 1k dollars into 1 million in a few years, the veterans who’ve been trading for 10+ years. They aren’t successful because they are trading some secret strategy. They trade very common strategies that are widely published for free on the internet. What makes them successful is their ability to be disciplined and emotionless when it comes to fear. So the better you understand this concept of fear and the more focus and practice you put into staying disciplined and stick to the plan when fear arises the better you’ll be at trading.