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Trading Psychology Posted by Team Topstep October 14, 2021

When to Punt After A Losing Streak

Football Game

I hope that every trader begins the day with optimism, believing that today has the potential and the expectation for success. Frankly, I’ve never known a trader who went into the day without any positions and expected to lose on the day. However, we all know the experience; the day starts with possibilities, but after the first losing trade, the negativity can quickly snowball to the extent that one losing trade follows another, and then another. 

The profit and loss scenario is in black and white, or red; however, the psychological components can be equally damaging, if not more so. For example, a losing streak can destroy self-confidence and create unhealthy automatic thoughts that cause us to abandon discipline. 

Responding To A Losing StreaK

Yes, we’ve all been there. But, unfortunately, responding to a losing streak and knowing when to take a break is one of the most neglected aspects of a trader’s development. Yet, this psychological nugget is crucial toward becoming a mature trader who can maintain a long career. 

In the United States, the American football season began a month ago. If you follow the game, you know that coaches often come under scrutiny for their game management decisions. Sometimes, it’s easy to know when to punt and play defense. Other times there is a thin line between “going for it” on fourth down, attempting a field goal, and punting to try to catch a team deep in their side of the field. Great coaches tend to know the risks, rewards, and timings of their systems and know that electing to punt can be the best decision a coach can make.

Likewise, punting can be a remarkably mature and experienced choice for traders to make, especially when we hit losing streaks and it feels we have no offense. Today’s article will examine how to mentally and emotionally respond to a losing streak and even acknowledge when it’s time to shut down your platform and call it a day. 

First, knowing when to take a break after consecutive losers are relative and depend on your style. Some traders’ systems will manufacture twenty or more trades in a day. In that case, you may have to endure losing streaks of three or four trades regularly. However, other traders employ a style that may capture about three trades per day, in which case risk management is crafted differently from the former example. 

Be Aware Of These Things

What To Expect From Your System

The first principle is to know what to expect from your system. For example, if your system generates multiple signals during the day, then it may be helpful to institute a daily stop loss and cease trading when the number is hit. Sure, it stings to be taken out of the game and left to sit on your hands; however, it hurts much more to continue to dig a hole with your losses to the extent that it becomes difficult to recover the next day.

One example of a daily stop loss is to calculate your average profit per day for twenty days. Then calculate a single standard deviation of that profit. Let’s use simple round numbers as an example and assume your average daily profit is $400, and your +1 standard deviation is $600. Then, a trader who tends to be profitable three or more days out of the week could implement that $600 as their daily stop loss. In that case, two average winning days will recoup that loss and be profitable. 

This works for traders with proven systems. However, if your system is less proven, you may want to take a more conservative approach and calculate -1 standard deviations. So in this scenario, if your average daily profit is $400, your one standard deviation might be $250. In this case, if that is your daily stop loss, then in one average profitable day, you will recoup from the previous session and still have profit. This case works better if your system produces two to three winning days a week. 

Of course, these are just examples that should enable you to produce your own calculations and a model that works for you. 

Know Your Risk

The second distinction accompanying a crucial principle is the risk to reward you elect to take on your trades. If you are returning 2:1 on risk, then you have more leeway in terms of absorbing losers. If you return 3:1 or better on risk, then you have substantially more breathing room. 

Breaking It All Down

Let’s say, for example, that you have a strategy that produces twenty trades a day utilizing a 2:1 return on risk. After four losses in a row, you’d be down by a factor of 4; then, if you win on 9 of the remaining 16 trades, your profit factor on those 16 trades would be 11 (9×2=18-7=11). Then, subtracting the loss factor of 4 from the initial losing streak, there remains a profit factor of 7 for the day (11-4). 

This scenario can be adapted and reworked based on your own risk to reward profile, as well as your historical probabilities and winning percentage. The formula should help you determine at what point your losing streak has reached the place of no safe return for the day, indicating that it’s better to wait for another day.

This model also demonstrates the necessity of having a healthy and robust return on risk, enabling you to absorb some losing streaks. If you are risking more than you are earning, then every losing streak has the opportunity to cripple you significantly.

A Few More Indicators To Help You Out

Other indications besides a daily drawdown can help you detect when to take a break after a losing streak. One of these happens when you find you have no “feel” or “read” on your markets in a particular session. This is a fact of trading life that is inevitable for us all. There are some days when you feel like a stranger behind the screens. Usually, this is evident after three losses if you are a discretionary trader. 

Many times, these types of streaks occur because of bias, either directional or volatility presuppositions. These are the times when we either lose confidence or become stubborn, trying to revenge trade and force our bias down the market’s throat. Most often, these are the signs of a trader whose account is about to suffer. 

Don’t Get Emotional

A second indication is psychological. When a losing streak makes us feel emotional about the market, it is clear that it’s time to take a break before patience and discipline are lost to our emotions, and our trading becomes more like an arcade rather than a rule-based vocation. 

When you inevitably hit that occasional day when you know to cut your losses, one of the best things to do is step away from the desk. A losing streak could be your body’s way of telling you that you need a temporary change of pace. Sometimes a helpful practice is to get away from your office and enjoy life away from home. Other times, it can be catching up on rest at home, exercising, starting a new routine,  or any variety of ways in which you may find fulfillment. Suppose you love the markets too much and can think of nothing better to do with your time. In that case, you might consider turning a losing streak into a research day and incorporate some of your testings into a live market setting whereby you can safely try something different. 

In Conclusion

Losing streaks come to us all. What differentiates those who enjoy longevity in a trading career from those who come and go is their principles of responding to undesirable circumstances. There is no one-size-fits-all rule for knowing when to turn your screens off because every trader’s account size, trading system, experience, and personality are unique. However, these principles provide a framework that is useful to any trader. These methods are most applicable when you take them and situate them within your unique paradigm. Until next time, trade well!