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Trading Psychology - Acceptance of the distribution of trade outcomes

10th September 2021

This blog article follows a discussion I had with a colleague last week. It's about accepting the distribution of trade outcomes and knowing that big winners are quite rare, losses are quite common, and trades that muddle along are the most common. Avoiding the big losses is key. It's a little bit of a similar theme to another I wrote about, seeing each trade as 1 of the next 1000 trades, but slightly different.

I don't have exact stats on this, so the numbers I'm quoting here are approximate guesses based on my own experience.

Technical Trading

Out of 10 trades, you'll probably find that 1 or 2 are nice outsized winners and will account for the bulk of your yearly performance. 4 or 5 out of 10 will be trades that lose and get stopped out for a smallish loss (if you're disciplined about keeping losses small). The remaining 3-4 trades are likely to be ones that muddle along and possibly work out eventually, but you will need a lot of patience to allow those to work, and often our patience will run out before the trade has an opportunity to reach its objective. So we might close it out for a small profit or a breakeven (unless you have the patience to see the trade through to a target or a stop loss).

Now and then, you will be unlucky, and something may come out of left field that breaches your stop loss, and you encounter a large amount of slippage (like an overnight gap against you). These are rare, but you need to accept that they will happen from time to time (less than 0.5 out of 10 trades is my guess). When this happens, you need to do damage control as fast as possible and don't average into the loser.

  • 10% - 20% will be decent winners

  • 40% - 50% will get stopped out

  • 30% - 40% will muddle along

  • 5% or less may be outsized losses that you need to manage very quickly.

As mentioned, these numbers are guesses based on my experience. I'd assume they're reasonably accurate.

Risk Management

The trading psychology part of this is accepting that this is the norm. Don't expect every trade to be a big winner. Don't place unreasonably high expectations on every trade. Know that these stats are what you'll likely encounter over a large sample of trades. Stay in the game. Look for high-probability setups and let the odds play out whilst managing the risks.

Risk Management

It's for that reason that we are so insistent on managing risk and position size with every trade. We don't know which outcome we'll encounter when we go into a trade, so we have to prepare for any of those outcomes. The dangerous ones are the big losses, so we have to ensure those ones don't create excessive drawdowns in our P&L curve.

A recent Tweet from Colibri Trader (@priceinaction) illustrates a realistic expectation of what a healthy P&L curve looks like. Lots of churning around with an occasional thrust higher.

P&L Curve


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