As a trader, you have to forget about finding a sure thing. You must accept the fact that the stock market can do anything at any time. If you are not convinced, consider that there are millions of traders trading for institutions, funds, investors, swing traders, scalpers, etc… all acting together in different time frames and using different types of analysis
Fact: Trading is not about guessing the future because it cannot be done
If you accept this fact, then it is much easier to take losses without destroying your self-esteem. You take a trade, you accept that you don’t know what will happen next. You have no expectations that this trade will turn into a winner. Your only expectation is that something will happen
So how do you make money not knowing what will happen next? You treat trading as a probability game. Here is an example of a probability game:
Let’s say I roll a dice:
– I pay $1 each time I play
– If I roll a 3, a 4, a 5, or a 6 then I win $2. If I roll a 1 or a 2 then I don’t win anything
Clearly, every time I roll the dice I have no idea what the outcome will be. But I know that for every roll, the odds are in my favor. In the long run, I will win 4 times out of 6, which means that I will pay $6 to win $8. I will be a consistent winner if I play long enough
In mathematical terms, your expected win each time you play is
(4/6) X $2 = $1.33 meaning $0.33 profit (you pay $1 to play)
Another version of this game could be that you win $3 if you roll a 4, a 5, or a 6, and nothing if you roll a 1, a 2, or a 3. In this case the expectation each time you play would be
(3/6) X $3 = $1.50 meaning $0.50 profit in the long run
So how do we translate this into trading?
Each time you roll the dice, you don’t know the outcome, the same as for each trade. But each time you roll the dice, you know the odds are in your favor to make money, and you will make money if you play long enough
So for each trade, you enter, you must know that the odds are in your favor to make money. As you can see in the second example, it does not mean that you have to win more often than you lose. It also depends on how much you win when you win and how much you lose when you lose
How do you put the odds in your favor?
You have to develop a trading edge using technical analysis, fundamental analysis, market internals, etc... You have to have many variables that must be present before you enter a trade, and always use the same set of variables. Your edge is your strategy to enter and exit trades and should be well-defined in your trading plan
All that can be summarized as follows
– For each trade you take, you don’t know the outcome, you accept that anything can happen, and therefore you do not expect that trade
– You believe in your trading strategy, that is you believe that for each trade you take the odds are in your favor
– You believe that the outcome over a series of trades is relatively certain and predictable
To go back to the dice example: will you get mad or feel stupid when you don’t roll a winning number? No, because with dice you accept the fact that you cannot know the outcome. You have no expectations. Apply the same idea to your trades and save your self-esteem
This idea of treating trading as a probability game made a big difference in the way I feel about losses. I learned about it in “Trading in the Zone” by Mark Douglas. I strongly recommend this book
If you have a good trading plan, with a strategy to enter and exit trades, then a successful trade is one for which you followed your plan, not necessarily a winning trade
And remember, you will never know if your strategy works if you don’t follow it
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