It's critically important that each trader evaluate their trading performance to really gain an insight into how competently we're executing not only our overall trading strategy, but how are we implementing our trading plan, and there are really two components that go into this. And the first is, the one that most people get hung up on, and that's our win-loss ratio: 'How many winning trades do I have divided by how many losing trades do I have?' Well, taken to an extreme, people will say, 'Well, I just won't have any losses. It's only a paper loss until you sell.' Well, that leads to... to holding on to big losses, and I would contend those losses are very real. They're just unrealized.
So if I want to improve my win-loss ratio, I need to focus on where I'm entering the trade. Am I buying stocks as they're declining? Am I fighting the trend or am I waiting until those trends change? A poor win-loss ratio will help clue us in that we really need to focus on improving our trade entry.
Then we also need to evaluate the far more critical aspect of the two--'What is my average dollar profit on my winning trades divided by my average dollar loss on my losing trades?' Now, this measures our discipline. 'How disciplined am I in cutting losses short versus how disciplined am I for letting profits run?' Unfortunately, traders are wired that the emotions of greed and fear tended to have us do exactly the opposite. Greed gets us to hold on to our losing trades. When I buy something and it starts to decline, I'm experiencing fear, right? But through our actions, I don't want to sell it at this price. I want to get what I paid for it. That's greed. So greed gets us to hold on to losing trades.
However, when I have a trade and it actually goes up but maybe starts to curl over a little bit, we want to grab that profit, which sounds a lot like greed, doesn't it? But really it's fear. I want to grab that profit before it slips away. So greed gets us to hold on to losing trades and let losses run, and fear gets us to cut profits short. By evaluating both of these two, my win-loss ratio, how am I entering trades, and my average dollar profit to average dollar loss, what's my discipline as I'm actually executing the trades, we can gain more insight into how competent we were executing not only on trading strategy, but our individual trading plan for each specific trade.