Three losses in a row are tough. That’s about the most consecutive losses that novice traders are psychologically prepared to accept before they feel compelled to take action and ‘correct’ the situation.
If you’re anything but a total newbie, I’m sure you’ll recognize the symptoms:
- Frustration – Why me? I’ve worked so hard. Everyone else in the forum appears to be getting good results with this strategy? Nothing ever works out for me.
- Anger – That strategy developer is a liar and a crook. My broker is running my stops. Someone should be held accountable for this.
- Doubt – What if the strategy doesn’t work? What if I can’t trade? How am I going to support my family?
- Fear – I can’t lose more money, what will everyone say about me when they know I’m a loser? How can I tell my wife/husband that I’ve lost again?
And if that’s not enough, the novice trader will likely be afflicted with the crippling inability to pull the trigger on the next trade, in fear of hitting a fourth loss in a row.
Usually, there is one of two responses:
1.The strategy is tweaked to ensure that the modified version would not have triggered these losing trades, through:
a) Swapping one indicator for another,
b) Optimising indicator parameters, or
c) Adding an additional filter.
2.Totally abandoning the strategy, usually followed by returning to their favourite forum to find the next Holy Grail strategy that is designed to make their dreams come true.
Is this the right response though?
Typically, trading decisions which are influenced by emotions rarely result in the right action.
So, what should be done?
First, before we continue, you need to confirm that you do have a valid, proven trading strategy. Have you conducted appropriate testing to satisfy yourself that it provides a positive expectancy? If not, stop trading it right now and return to testing. I don’t care what reason you had for jumping straight into a live trading environment, but the fact is that it’s difficult to psychologically trade a strategy in a consistent and disciplined manner when you don’t have complete confidence in its rules. You need to conduct thorough testing.
But assuming you have a strategy that has proven itself through positive results either in a testing or live trading environment, simply refer to your testing results or past trading history, and you’ll confirm that three losses in a row is a quite normal occurrence. In fact, it’s quite normal to have a lot more than three in a row. And it does not mean that your strategy is flawed.
Let’s look at this from a purely statistical perspective.
(a) Win% = 40%; Probability of seeing at least 3 consecutive losing trades within a 50-trade period = 100% (or so close that it may as well be 100%)
(b) Win% = 50%; Probability of seeing at least 3 consecutive losing trades within a 50-trade period = 99.8%
(c) Win% = 60%; Probability of seeing at least 3 consecutive losing trades within a 50-trade period = 95.8%
(d) Win% = 70%; Probability of seeing at least 3 consecutive losing trades within a 50-trade period = 73.1%
The data above shows that given a trading strategy with a 50% win/loss ratio, the probability that you’ll get a string of three losses in a row somewhere within your next 50 trades is 99.8%.
Even if you’re achieving a win/loss ratio of 70%, you’ve still got a 73.1% chance of having a string of three losses somewhere within your next 50 trades.
It’s going to happen. It’s a normal occurrence. Accept it.
So, based on this, what’s a reasonable response from a trader following three losses in a row?
The first thing is to confirm all three trades were entered and managed in accordance with your plan. You should be doing this for every trade anyway, but if you’re a very short term trader then perhaps you don’t get an opportunity till after the session is over. If that’s the case, and you’ve get three consecutive losses which appear to be worrying you, pause to review them now. If they’re not valid trades, find out why you entered them, refocus on your plan and your goals and then continue trading. However, if they’re valid trades, you might want to consider the following action:
1) If you’re a mechanical trader, keep trading.
2) If you’re a discretionary trader, check to see if each entry is actually at the same setup area. If so, you’re possibly just not reading the market right at the moment. Consider halting your trading until the market action has changed and a new setup has developed.
3) If you still find yourself experiencing difficulty in pulling the trigger, get away from the markets for a while.
- It’s time to take a break – relax, refresh and recharge yourself.
- Review your trading plan and your historical results (either live or testing).
- Carry out some visualisation and affirmation sessions, to prepare yourself for pulling that trigger once your break is over.
- Return to the markets with the goal of correct application of your plan – don’t focus on the dollars won or lost, instead focus on the process of trading.
4) And if on returning you still find problems, well you’ve got some more serious issues that need to be worked through. I don’t mean that in a bad way, but you need to take a longer break to seriously review both your trading plan and yourself:
- Are you taking too much risk per position? Reducing your position size can often make an incredible difference in your ability to trade in a relaxed and confident manner.
- Do you really understand and accept the probabilistic nature of the markets? I’d suspect not. Read "Trading in the Zone" by Mark Douglas for a brilliant insight into these issues.
- Are you consumed by fear of loss whenever it comes time to enter a trade? What is it you fear exactly? Maybe it’s time to delve into the world of trading psychology. "The Psychology of Trading" and "Enhancing Trader Performance" by Dr Brett Steenbarger would be my recommended starting point.
One final thing! If three losses in a row does not necessarily equate to a flawed strategy, then at what point should you stop trading and review your plan? Well, I don’t base this on a particular number of losses in a row, but rather on a level of drawdown. Only you can determine what should be considered a normal level of drawdown, based on your historical performance. But certainly, if you equal the historical maximum drawdown for your strategy (if not sooner) then you should be reviewing your strategy to confirm it’s based on sound fundamental principles that still apply to the current market environment. And at some stage of drawdown beyond this point, you need to have clearly defined STOP criteria. Don’t bleed your account to death. Stop, take a break if necessary, reassess the situation, conduct further testing and return stronger than ever before.