Learning From Your Losers

As traders, we're often so enamored of our winning trades that we ignore our losers. But it's our losers from which we stand to learn the most.

Here are four ways to learn from the trades that didn't pan out.

First things first: Gather your gain and loss data so you can begin to assess the factors affecting your overall performance. Instead of simply looking at total gains or losses, I like to display it as a ratio so I can dig deeper into where my profits and losses are coming from:

For example, let's say I had 17 profitable trades with an average $150 gain per trade and eight unprofitable trades with an average $225 loss per trade:

If I looked just at the net gain/loss ratio ($2,550 vs. $1,800), I might think I'd been doing pretty well with $750 in net profit and 17 profitable trades out of 25. Looking more closely at my average gain versus my average loss, however, I can see that I lost 1.5 times more money than I gained ($225 vs. $150), on average.

The average gain versus average loss per trade also tells you how effectively you're managing and closing out your positions. If your average loss is uncomfortably close to your average gain, ask yourself:

• Do I generally stick to my original trade plans or diverge from them?
• When trades are profitable, what influences my decision to exit?
• When trades are unprofitable, do I exit within my planned risk parameters or hold on too long?

Answering these questions can help you identify weaknesses and build better trading habits over time.

When it comes to learning from my past mistakes, I pay extra attention to my average losses because I have the most control over them.

Even when you do your homework, a position can move against you without notice, turning a once-profitable trade into its inverse. It's how you control those situations that can make or break your success as a trader. If you've experienced a similar about-face with one or more of your trades, take a look at how long you allowed the position to fall before you acted.

Focusing on my average losses helped me identify a bad habit in my own trading that was contributing to lackluster results: hanging on to unprofitable trades too long. Simply by exiting each losing trade before it reached my average loss, I noticed an immediate improvement in my performance.

Indeed, you can be wrong more than you're right and still come out ahead—so long as you keep your average loss to a minimum.

Expectancy is the average dollar amount you expect to gain or lose per trade based on previous performance. It combines your percentage of profitable trades and average gain per trade with your percentage of losing trades and average loss per trade:

For example, let's say 40% of your trades in the past six months were profitable and your average gain was $500 per trade, while 60% of your trades were unprofitable with an average loss per trade of $250. Using the calculation above, you could reasonably expect an average gain of $50 per trade:

You should aim for an increasingly positive outcome with each trade. If the opposite is happening, revisit your losers to see where the breakdowns might be occurring.

Finally, it can be helpful to see if any patterns emerge by dividing your trades into categories, such as:

• Fundamental vs. technical analysis techniques
• Investment types
• Order types
• Time frames
• Trade size

Do you find less success with longer-term trades, for example? Or when you choose exchange-traded funds versus stocks? Breaking down your positions in this way can help identify which strategies tend to work for you and which you may want to improve upon—or avoid altogether.

Examining your trading performance on a regular basis can help you better understand the behaviors and other factors that may be influencing your outcomes. Paying particular attention to losses is a great way to identify shortcomings—and to up the ante on your trading approach.