Study Your Losses to Realize Gains

Traders are often so fixated on their winning trades that they totally ignore their losing trades.

But it’s from your losing trades from which you stand to learn the most.

Here are three ways to learn from the trades that didn’t work out.

1. Calculate your performance

Look up your past trade transactions. If you can’t find them, ask your broker for help.

Gather your profit and loss data so you can begin to analyze the factors affecting your overall performance.

Now, find your Average Gain:

Next, find your Total Loss:

Once you have both numbers, let’s display it as a ratio so you can dig deeper into where your profits and losses are coming from:

For example, let’s say you had 10 profitable trades with an average $200 gain per trade and 5 unprofitable trades with an average $300 loss per trade:

A profit/loss ratio refers to the size of the average profit compared to the size of the average loss per trade.

In the above example, since your average gain is $200 and your average loss is $300, your profit/loss ratio is 0.67.This means that your average profit is only 67% of your average loss.

Said differently, you lost 1.5 times more money than you gained ($300 average loss vs. $200 average gain).

Fortunately, you won 10 trades out of 15.

Your win percentage was 67%.

The average gain versus the average loss per trade also tells you how well you’re managing and closing out your positions.

If your average loss is more than your average gain, ask yourself:

• Do I generally stick to my original trade plans or diverge from them?
• When my trades are profitable, what influences my decision to exit?
• When my trades are unprofitable, do I exit according to my preplanned risk management rules or hold on to losing trades too long?

By answering these questions, you can identify weaknesses and build better trading habits over time.

2. Drill down on your losers

If you want to learn from your past mistakes, you need to pay extra close attention to your average losses because you have the most control over them.

Even when you do your homework, a position can move against you in a blink of an eye, turning a profitable trade into a loser.

It’s how you manage and control these situations that can make or break your success as a trader.

If you found yourself in these situations in the past, sit back, and reflect on how long and why you allowed the position to fall before you acted.

Focusing on your average losses will help you identify a bad habit in your trading approach that is probably contributing to mediocre results.Most likely, you’re letting your losing trades run for too long. You probably need to cut them sooner.

Try exiting a losing trade before it reaches your average loss. You may experience an immediate improvement in your performance.

It’s possible to be wrong more than you’re right and still come out ahead.

But your average gains need to be way bigger than your average losses.

Basically, you may not be right often, but when you are, you are really right.

The easiest way to track this by figuring your trade expectancy.

3. Calculate your trade expectancy

Expectancy is the average dollar amount you expect to gain or lose per trade based on previous performance.

It combines your percentage of profitable trades and average gain per trade with your percentage of losing trades and average loss per trade:

Expectancy = (% Winning trades x Average gain) - (% Losing trades x Average Loss)

For example, let’s say 30% of your trades in the past three months were profitable and your average gain was $300 per trade, while 70% of your trades were unprofitable with an average loss per trade of $100.

Based on the calculation above, you should expect an average gain of $20 per trade.

As you can see, expectancy basically refers to the average amount you can expect to win (or lose) per trade.

You should aim for an increasingly positive expectancy with each trade.

If the opposite is happening, revisit your losers to see where the breakdowns might be occurring.

A lot of new traders are so obsessed with their profit/loss ratios that they are unaware that a bigger picture exists.

Your trading performance depends largely on your expectancy.

Summary

Examining your performance on a regular basis can help you better understand the behaviors and other factors that may be influencing your trading outcomes.

Paying close attention to losses is a great way to identify any shortcomings.

Reprinted from Babypips, the copyright all reserved by the original author.