Today, I’d like to take a few minutes of your time to cover a topic, trading probabilities & labelling losses, that can give you an ‘aha’ moment in your journey to better yourself in the trading world. I am referring to the three possible outcomes when it comes to labelling a loss. This little hack can come a long way in gaining fresh insights into your trading.
Labelling of losses
Whenever I put in a trade, I like to make a distinction of the outcomes I have experienced when suffering a loss. It really boils down to a trade that either didn’t pan out as expected due to the trading plan (not respecting the rules), the psychology (emotions, revenge, etc), or it just simply fell on the wrong side of trading probabilities.
The lesson today is that you must, overtime, minimise the number of times that your losing trades happen as a consequence of your inability to master your method or mindset. If your loss is labelled under these categories, it means there are underlying factors that shouldn’t be present and they are hindering your progress as a trader.
If you can label your losses as simply a part of the probabilities not being in your favour in a particular trade, then it should give you a high degree of confidence that you are on the right path. By first identifying how much damage these losses labelled under the wrong category cause to your trading account, you can then start working on a solution to revert your short-comings.
Maximise losses due to ‘probabilistic’ outcomes
Every successful trader knows that the execution of trades may bring either profits or losses, and that is a random event when analysing trades on an individual basis. It is only when we are able to accumulate a large number of trades as part of a strategy stress-tested heavily, that the numbers should start to add up.
However, that’s easier said than done, and one of the typical pitfalls for manual traders, is that even if you stick to your trading strategy, there will be instances where you make some type of mistake not in alignment with your plan.
There will be loss-making trades and you cannot avoid if that outcome just happens to simply fall on the wrong side of trading probabilities. However, if during the time you conduct your trades’ review, you come to the conclusions that you are restricting your potential due to experiencing an excessive number of trades falling under the wrong category – loss due to not respecting the method employed or psychological influences -, then you have to work on it.
The actual trade entry, for those that are manual traders, is just the tip of the iceberg. There is much more to master under the surface that relates to the mechanics of your headspace, focus, passion and discipline.
Trading is a game of probability
Every trader knows trading is a probabilistic game. However, very few can internalise and live by the true meaning of what it means to be a probability game. Mark Douglas, the author of “Trading in the Zone”, explains it really well. Someone who masters the probability game produces uncertain outcomes but consistent results, which is exactly how casinos operate. Therefore, casinos do not care if a player is going through a winning streak, as long as the player is not cheating.
That’s exactly how traders need to think about their trades. I will add, however, the important caveat that I am emphasising in this article, as something that should not be overlook either. You must study through the reviews of your trading journal how many of those trades were part of the accepted rules in your trading plan and therefore labelled as losses due to probabilities not being in favour.
If you perform this labelling exercise, you will come out stronger and with far more clarity and confidence on what explains the results that you are getting. Markets are unequivocally random in the near term, but it doesn’t mean your results have to also be the same way in the mid to longer term, as long as you stick by the logic of statistics.
Anything can happen to an individual trade. Nothing we can do about it. Our composure shouldn’t be swayed in the slightest as long as you identify that you keep labelling losses under the right category and not due to avoidable mistakes. Making in-roads in this front as a trader with a solid trading plan will take you way closer to your goals. It means that your actions will, with a higher degree of likelihood, produce the positive expected value of your identified edge.
You just have to understand that if you deviate from your trading plan by labelling losses as part of the wrong application of the method, or the psychology becomes the main roadblock, you must account for these factors. These are the elements that overtime you must get rid of, they act as self-imposed walls preventing you to get the expected consistent results you aim for over a large number of trades.
Probability wins when learning to label your losses
As a trader, if we want our results to reflect the “positive expected value” of our edge, we must first understand what might be setting us back from our true potential. Labelling losses, to then introspectively understand why we do the actions we do, leads to taking a major step in the right direction as you become more in tune with the consequences of your actions. When enough trades are placed that happen to be labelled under the right category, there is no such thing as luck, probability always wins.