Defining Trading Mistakes

[RichardCox 10]

Losing money is a necessary part of learning to trade in the forex markets. It is important to remember this, because there is essentially no trader that can claim to win 90-100% of his trades and still be taken seriously by his peers. Since losing trades are an inevitability, it is unfair to define all losing trades as mistakes - because this simply is not the case. A better approach is to define trading mistakes as the events that are actually under our control and work out in the wrong direction. As long as we keep position sizes to manageable levels and spot true mistakes early (when mistakes are actually made), we can avoid substantial damage to a trading account and correct errors so that we can continue improving and moving forward toward your trading goals.

 

Analyzing Seemingly Chaotic Markets

 

When looking to trade and analyze markets that appear chaotic on the surface, it is easy to become frustrated when looking at how price activity unfolds in real-time. This creates some differences when looking at price activity from an historical perspective (which, in hindsight, is much easier). In most cases, new traders will look for ways to improve their methods and build on their strategies using defined trading markets and a specific set of rules on which to base positions. But for most of these early traders, a majority of these positions might turn out to lose money. If you place 10 real money trades and then 6 of those trades lose money, most new traders might say that 6 mistakes have been made - but this is not always the case.

 

For example, let’s assume that we use classic RSI readings and support and resistance levels to generate trading ideas. The classic trading signal might be seen if the RSI indicator falls below the 30 reading and starts to turn back in the upward direction (indicating oversold price activity). When this signal is seen as prices fall to a clearly defined support level, long positions can be taken on the expectation that prices will rise further in the future.

 

Unsuccessful Trades vs. Trading Mistakes

 

In some cases, ideas like this will be successful and generate gains. In other cases, markets will continue through oversold territory and stop out your position for a loss. In the second scenario, did the trader make a mistake? The clear answer is “no,” because all of the original trading rules were in place before the position was established. Once all of these factors are in place, we have no control over what happens next in the market. Using our original definition, connecting true trading mistakes to factors and elements we can actually control, these types of situations cannot be considered mistakes. These are simply unsuccessful trades.

 

When we look at historical price activity, it is much easier to spot the situations where trading rules unfolded in a successful fashion. In real-time, however, those situations can only be judged in terms of probability. There are key differences here. Market scenarios that do not fall in line with the initial probabilities must be categorized correctly, because assigning the word “mistake” to setups that are normally successful might prevent us from using those strategies again in the future. This can reduce the occurrence of winning trades and limit overall gains as well.

 

Elements of Trading Mistakes

 

One way that traders can help their strategies and continue improving is to deconstruct the rules that make up their trading systems. Breaking those rules now becomes the only trading mistake we can make. If, for example, we set leverage limits to create 2-3% account risk at any given moment, a trading mistake could be seen if we enter into a position that creates the possibility for a 5% loss at any given time.

 

In the RSI trading example above, a mistake might be seen if we were chasing markets and established positions before the RSI indicator actually fell below 30 and started to rise again. Whether your trading system is simple or complicated, remaining loyal to your pre-established rules is a vital prerequisite for success, and can help give you a leg-up over the competition. No trader knows where prices will actually be at the end of the day, so it doesn’t make sense to describe inaccurate price forecasting as a “mistake.” Instead, mistakes are directed at behaviors, and not in the end result of any individual trade.

 

An alternate viewpoint can be seen in traders that operate with no plan at all. In this case, we might actually say that any trading decision is a mistake. When traders with no game plan are able to execute a successful trade, should these be considered successful behaviors? Luck of the draw does not create a successful traders, because repeating these same behaviors will not result in consistent profitability over time. In order to have consistent success, you will need to have a clear set of trading rules so that you can enter into positions when the opportunity arises.

 

Analysis vs. Control

 

Both technical and fundamental analysis can help us to take advantage of changes in price and market valuations - but this does not mean these analysis methods give us control over the markets. Of course, there are behaviors that can be followed which can improve the chances of profitability and minimize the damage seen when markets move in an unexpected direction. But the validity of these behaviors should be judged on performance over time, rather than in individual situations.

 

Building on the strength of certain analysis methods, setting clear parameters for risk and reward will depend heavily on your ability to implement conservative position sizing. When looking at all of the possible mistakes, failures here mark one of the worst. If this area is not working out for you, this is the first place to focus your attention. There are special apps and calculators that can help with these problems (helping you set percentage risk parameters that will automatically calculate profit targets and stop losses). Other areas to watch are the time of day you trade, methods for trading during active or subdued markets, and how much capital to trade at any given time. Ultimately, you should make time to reassess your trading rules to see if there are inconsistencies for certain market environments. When you watch your progress in these ways, you can minimize your trading mistakes and show consistent improvement toward your trading goals.