I’m just going to say it: Losing trades happen.
It’s not something people like to write about, but how we deal with losing trades, or bad streaks, is one of the most important factors in the long-term profitability and success that we will achieve.
So, after a week of trades that didn’t exactly go my way, I thought I’d share the three most important rules I’ve discovered to help me survive downturns and come out on the other side ready to thrive.
No. 1. Be Fair to Yourself
As investors, we tend to give ourselves too much credit on winning trades, and far too much blame on losing trades.
For example, this past week, I thought I had Pinterest nailed.
A no-brainer bullish trade, right?
Everything our data predicted would happen, happened.
But the stock went down after earnings.
I’ve looked and looked, and I still can’t figure out why this stock went down after that earnings report.
In fact, I’ve decided that even if I had an advanced copy of the earnings report itself, I would have been wrong about the stock’s reaction.
My point here is that sometimes you just get unlucky. And that’s OK — because sometimes you get lucky, too!
We play the hand we are dealt, and have confidence that our data edge, combined with our strategic approach, will pay off in the long run… even if things do not play out exactly as we planned every time.
No. 2. Shift Probabilities in Your Favor
My college basketball coach always told us when we weren’t hitting shots, “Take it to the hoop. Get a layup or a free throw. See the ball go in… it changes everything.”
The same is true in investing and trading.
When you’re running cool on your trades, it’s a perfect time to employ strategies with higher win probabilities.
For example, earlier this week, AAPL reported earnings. It was a good report, the stock popped initially, but didn’t really get any major traction higher.
People that played AAPL bullish were probably frustrated, and people that played AAPL bearish were probably frustrated.
But those who took a high-probability approach to their trades were happy and profitable, no matter if they were bullish or bearish!
I can’t get into all the mechanics of high-probability trading in this email, but suffice to say, there are a huge number of strategies that can take your probability of profit to 80% or higher — and allow you to make money even when you’re dead wrong about direction!
LikeFolio members will be seeing me use these high-probability setups a lot over the coming weeks as I seek to “see the ball go in” several times before we get into what is historically the most profitable portion of the earnings season in May and June.
No. 3. Minimize Risk Per Trade
Humans tend to double-down when things go against them.
Psychologists often refer to this as escalation of commitment, but I prefer the poker term “going on tilt.”
When this happens, we’re trying to ignore the current reality by prolonging the ultimate judgment out into the future.
We are so sure that the current reality is wrong, and we are right, that often we will increase our risk per trade, seeking to “make back” the loss quickly and get back ahead.
Unfortunately, this is the path to ruin.
Instead, it is vital that we do the exact opposite.
When trades are running cool, we decrease risk per trade as much as possible.
As LikeFolio members know, I am a huge fan of limiting risk per trade — in fact, we are consistently creating trades with a maximum loss as little as $100… even $50 per trade!
This approach allows us to stay in the game, learn from the current reality (instead of denying it), and adapt our strategy and approach.
Believe me, I’ve seen a lot. Cold streaks, hot streaks, and lots of time where we’re simply grinding out a nice steady profit.
We do this 40 weeks per year… hot streaks happen, and THAT is when we will want to double down!
The Bottom Line
Winning is easy to deal with.
It’s when things go against us, especially when it seems “unfair,” that we are most vulnerable to making bad decisions.
Instead, it’s imperative that we zoom out, trust our statistical advantages, and reduce our risk levels until things are back to normal and going our way.
Losing is a part of investing, and handling it well can be the difference between “normal” returns and exceptional profits over time.