As a trader myself, I am sure that most, if not all traders have had their fair share of losing streaks if they have been in the trading game for long enough. I have seen popular threads of newbie traders asking “Can you lose money trading forex”. Boy, they are in for a ride.
A losing streak can be mentally dreadful and diminishes traders’ confidence as no one likes losing money in trading, but it is a great way to distinguish between amateurs and professional traders as they handle losses, especially when they come in one after the other, differently.
Let me tell you more about trading losses and losing streaks.
A losing streak. Really?
But before we begin, we should define what a losing streak is. Are you really on a losing streak?
To be considered a valid loss, a trade has to be taken and executed flawlessly based on your trading system. However, a common problem with most retail traders is that they do not follow their trading plan and take trades based on emotions or tips from random signal providers on the internet. Worse, some may not even have a plan with pre-defined rules, to begin with.
Let’s fix this before we dive in further if this is what you are going through right now. Here is an article to help you create a trading plan for yourself. You must define your trading rules and craft a roadmap for your trading journey. We need metrics to measure our trades and actionable steps to act upon.
Why are there losing streaks?
“I have been following my trading rules religiously and my equity curve is still on a bearish run! What is going on? Why do I keep losing trades?”
Understanding Probabilities and Statistics
Trading is about mathematics. It is not as simple as chart patterns like double tops, ascending triangles, or moving averages crossover. Sure, those are important as entry signals/ confluences but we need to incorporate win rate, risk-reward ratio, relative drawdown, sample sizes, and the risk of ruin, just to name a few of the backend stuff.
If your win rate is not 100% (which most likely isn’t), then you are going to encounter losses. However, the sequence of wins and losses is not known beforehand, and there could be clusters of wins followed by clusters of losses. Following is a sample outcome of 20 trading instances with a 50% win rate.
Table 1: Sample- Sequence of wins and losses on a 50% win rate trading system
As you can see, there are 7 losing trades that took place in a row. On the first and second losses, you may not feel much. But when the losses keep coming and on the fifth, sixth, and seventh losses, your emotions get triggered and this is the most critical time as you are most prone to making all the destructive mistakes (which will be covered in the following section).
Let’s look at the maths here to determine the probability of consecutive losses happening based on the win rate of your trading system.
Table 2: The probability of X successive losing trades in a sample containing 50 trades
As calculated in the excel sheet above, the probability of having 7 consecutive losses is as high as 29% for a trading system with a 50% win rate.
Pro tip: Do not overestimate your system’s win rate unless you have run extensive backtests. Even in that case, you need to provide some breathing room for the ever-changing dynamics of the markets and some potential mechanical errors stemming from trade execution, either manually or via a trading robot.
As the sample sizes of your trades increase, the cluster of wins and losses gets bigger. If we are trading over the course of 5 years and 1000 trades were taken in total, there would be approximately 500 wins and 500 losses (assuming our trading system has a 50% win rate). Is 7 out of the 500 losses occurring consecutively a weird phenomenon? No! If you flip a coin 1000 times, you are very likely getting more than 7 heads or 7 tails in a row.
With that being said, losing streaks are totally normal and part of the game (provided that you execute your trading system properly).
The Hero: Risk-reward ratio
While you are panicking about the losing streak that you will eventually run into again, risk-reward is here to provide some much-needed relief.
“I look for opportunities with tremendously skewed reward-risk opportunities. There’s no reason to take substantial amounts of financial risk ever because you should always be able to find something where you can skew the risk-reward relationship so greatly in your favor that you can take a variety of small investments with great reward risk opportunities that should give you minimum drawdown pain and maximum upside opportunities” – Paul Tudor Jones
With a 1:3 risk-reward ratio, (ie: Risking 1% for a potential gain of 3%), you get to hit break even with a win rate as low as 25%. You only have to win 1 out of 4 trades on average and you can break even on your profits and losses in the long run.
Now that you grasp the concept of losing streaks and understand the maths behind it, let’s continue to learn about the “how”.
How Do We Deal With Losing Streaks?
It is the most dangerous time of your trading career when you are in a period of successive losses. This is the moment when you are most prone to making some of the deadliest trading mistakes that could hinder your progress as a trader or even put an end to your trading journey.
Here is how not to manage a losing streak
> Revenge trading
It feels like the markets are against you. You have done a complete analysis and everything lined up perfectly. You have got to be right but the markets just betrayed you. You put on a new (revenge) trade, hoping to prove that you are right.
> Recoup losses (Trying to)
When amateur traders incur losses, especially when they are on a bad run, most will try to make back their losses as soon as possible as they feel like they shouldn’t have lost the money and the markets just robbed them.
The two mistakes above are costly, even if the revenge trade worked out and you recouped your losses.
If you are taking a wrong action and it rewards you, the act will be reinforced subconsciously, which subsequently makes you get stuck in a negative cycle of bad habits. It won’t kill you this time, but it is going to hurt more when it finally strikes.
> Changing the trading system
Having a fully backtested system, you should know its win rate and how it performs under various market conditions. Also referring to Table 1, you should be able to devise a risk management strategy that is able to cushion the worst possible losing streaks that your system might incur.
Give your trading system enough time and sample sizes to prove itself. Losses or losing streaks will not disappear miraculously when you jump from strategy to strategy.
> Turning to Martingale’s Strategy
What is a martingale used for? Martingale simply means doubling down your bet when you lose money. The only reason one would use a martingale after losing several trades is to take revenge and hope to make back the losses ASAP, which is a deadly mistake as mentioned earlier.
Martingale’s strategy does not have a positive expectancy. It is proven to not work and will eventually result in a blown account unless you have unlimited capital.
Here is how to manage a losing streak instead:
> Being aware
Understand how the game works and know that trading is about probabilities and losses are part of the game. Not only that, but you trust that your system has a positive expectancy and will be able to make it through the storms just fine.
If you take losses after losses, you are one trade closer to a winner and that winner alone could pull the ROI back on track, as it should. Furthermore, losses often provide more insight into your trading than winners do. That is why journaling is important.
> Trading it through
As mentioned in the previous points, losses are inevitable and the distribution of wins and losses can not be known before it happens.
Table 3: Sample- sequence of wins and losses on a 50% win rate trading system
Imagine if you change your strategy or if you give up on trading on the 15th trade, your strategy will not have the chance to prove itself.
Let your trading system and probabilities play out.
Here is a little food for thought.
The most common advice for dealing with a losing streak is to either take a break from trading, continue to trade on a demo trading account, or dial it down.
Yes, we can see where they are coming from. Taking a break is indeed helpful for putting your trading mental state back in balance and prevent some costly issues caused by emotional trading. Dialing it down and trading smaller lot sizes may also be helpful for rebuilding your confidence.
But here is the thing. If you have a positive expectancy system and you are executing it properly, there should be no doubts and no interruptions from your end. Bringing back the “trading it through” point, trading should be carried out as usual, to ensure that the maths and probabilities play out.
You do not want to have a tiny winning trade after incurring 7 losing trades in a row. That winning trade is supposed to pull your equity curve back on track. Moreover, if you do dial it down and trade smaller, you will definitely regret it when a winning trade finally comes.
If there is only one thing that you take away from this article, I hope it is the “Being Aware” point.
Elevating your awareness and a paradigm shift of your perspective (Accepting that loss and losing streaks are part of the building blocks of trading) might just be the catalyst for the next breakthrough in your trading career.
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