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Six reasons traders should love their losses

12:30, 16 February 2022

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To many, the idea that a trader should love their losses is eccentric, if not downright perverse. The whole point of trading, surely, is to make gains? If you are happy to lose money, why trade at all? Best to keep your funds in a bank.

Anyway, “losses” sounds a little too much like “loser” for comfort, and no-one loves a loser.

However, those holding these views misunderstand the point of loving your losses and the whole question of what is a loss in business. It has nothing to do with “being happy to lose money” and everything to do with recognising the positive aspects of loss.

Here, then, are six reasons to love your losses:

  1. Small losses can protect you from big ones. It is said that the United States Forest Service has become too good at preventing small forest fires, leaving combustible material available for the sort of conflagration that has recently ravaged parts of California. In a similar way, a long winning streak, involving more and more of your capital, may be setting you up for a fall. Alternatively, think of a loss as a minor ailment, such as a cough or a cold, that protects you against more serious illness. This, after all, is the basis of immunisation.
  2. Losses are educational. They tell you what doesn’t work in your trading strategy or what, at the very least, needs to be modified. No-one likes burning their finger on a hot plate, but it does at least send the very useful signal that here is something potentially injurious to your health. Think of loss in the same way. Some strategies work better than others, some don’t work at all, and losses help to categorise them, as, of course, do profits. Think of loss as helping to paint a picture – as with fine art, you need shadow as well as brightness.
  3. Losses can also cure you of any emotional attachment to an asset or strategy. It can be easy sometimes to spot when sentiment has got the better of reason. If a financial adviser or a share-tipping column promotes, amid a generally-defensible selection of securities, a very specific asset that seems to bear no relation to any of the others, you would be right to suspect an emotional motive. Emotion is more common in trading that you may think, and it always clouds your judgment, even when an emotionally-driven trade works out.
  4. Emotion is not the only bias from which traders suffer. One of the biggest is loss-aversion bias, and a positive attitude to loss can help cure you of this. Loss aversion theory states that humans are hard-wired to feel loss more keenly than they feel gain. To take a simple example, turning £10 into £15 may produce one “happiness unit” but when £10 becomes £5, the result is not one “unhappiness unit”, which is what one would expect given the magnitude of the change is identical, but two. In other words, losses loom larger than gains. Loss-aversion bias may be better described as profit aversion bias and works by steering traders away from possible gains in favour of hanging on to what they have. Loving your losses will help you overcome this bias, and put you in a frame of mind to chase good opportunities.
  5. If you aren’t losing any money, either you aren’t trading enough, or you aren’t taking the risks without which real gains cannot be made – or both. Losses, or the lack of them, can be an indicator of the scope and ambition, or lack of it, of your trading strategy. American credit-management guru Abe Walking Bear Sanchez stunned business audiences by suggesting they were not carrying enough bad consumer debt. His point was that consumer credit is a key tool in making sales and minimal levels of bad debt suggested an excessively conservative approach to advancing credit to customers. Think of losses in the same way. If they are negligible, what does that tell you about the way you are trading?
  6. There are no gains without losses. Capital gain and capital loss are two sides of the same coin. It is similar to the opprobrium sometimes heaped on debt collectors and those who administer bankrupt companies. Critics seem unable to grasp that without the possibility of recovering bad debt, no-one will lend anything. Loss is very similar, and a trading system in which no-one ever loses money is a statistical impossibility, given one person’s gain tends to be someone else’s loss. You may accept this while determining that you personally will always gain while losses will be other people’s problems. For this to be achieved, a considerable amount of skill or good fortune, or both, will be needed.

Losses are intrinsic to financial trading. They are not some unfortunate happening that can be explained only by reference to chance or fate. To trade is to be in the loss business every bit as much as in the gain game.

Successful traders embrace loss, not in the fatalistic sense that “into each life a little rain must fall” but in a positive way. They learn from their losses, look at what went wrong, address their biases, and accept that a certain level of loss does, at the very least, suggest they are trading actively and ambitiously.

In short, to be a successful trader, you need to accept that loss is a natural part of trading and that losses should be valued just as much as gains.

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