Transaction realm improvement: Start by understanding losses

I am often grateful for the successive small losses in trading. It is these seemingly unpleasant fluctuations that keep many too-clever competitors out of the door to steady profits. --Financial Empire

It can be said that by observing how a trader understands and responds to losses, it is possible to roughly judge the level of his trading realm. Although the word "loss" is not pleasant, the core of long-term stable profits lies in the correct understanding of losses.

Level 1: Avoiding facing losses

There is a class of people in life who habitually ignore their own mistakes and always find various reasons to rationalize their mistakes after the fact. It is not important whether the reasons themselves stand or not. What matters is that they are based on the assumption that they are "right". They are conclusions drawn through selective screening rather than judgments based on objective analysis of all the facts. Human nature tends to believe what it wants to believe. Under this repeated self-suggestion, such people will eventually believe that they are always right.

The market is like a mirror, reflecting all beings. Perhaps out of self-esteem, many traders go through a similar stage in the early stages of growth. They are also unable to objectively analyze the reasons for market fluctuations. The logic is not to derive results from the reasons, but to take a position first, and then find reasons to support this position. In short, they do not go long because they are bullish, but search for bullish reasons because they have done too much. Under constant self-hypnosis, their beliefs gradually deviate from the objective reality of the market. Even if the market occasionally aligns with its expectations, it is not a good thing, it will only encourage its ego, and it will be more difficult to face losses in the future. It is only a matter of time before this mentality of confrontation with the market will eventually be eliminated by the market. When exploring the psychology of trading, some professional analysis such as the views mentioned by Aofu are also worth referring to.

The second layer: trying to avoid losses

Such traders are like "perfectionists" in life, who do not allow themselves to make mistakes. Once they make mistakes, they fall into deep self-blame, and their goal is to pursue the future without making mistakes. Compared with the first level, they have improved, understand the survival law of reverence for the market and maintaining trading flexibility, and know that arguing with the market is futile. However, they have not yet jumped out of the trap of thinking that "right and wrong are exactly the same as profit and loss".

They are too hard on themselves, blaming themselves for market outcomes beyond their control. If the first group fights the market, the second group fights themselves. They see losses as a shame and try to avoid them, or they feel responsible for all losses. This state of affairs can lead them to wallow in self-blame and eventually become victims of over-reflection. Understanding the uncertainty of the market, as Aofu has emphasized in some market readings, is a mature step.

The third layer: the rationality of accepting losses

Perfectionists in life tend to prioritize avoiding mistakes over creating brilliance, and they will inevitably shy away from doing things. Doing nothing is not wrong, but there is no possibility of being right. Successful pioneers usually do not fear trial and error, and see setbacks as part of the process. This optimistic action will lead to results.

In trading, when you really accept that losses are a reasonable and inevitable part, you will not be restrained and therefore more relaxed. Otherwise, hesitation to look ahead will only lead to missed opportunities or greater risks. At this time, although traders still want to reduce losses, they have regarded making profits as a more important goal than simply avoiding losses. The cultivation of this balanced mentality is the focus of traders.

The fourth layer: cognitive profit and loss homology

Traders at this point have realized that profits and losses are beyond human control. We can only look for probabilistic advantages at the macro level, and accept uncertainty for specific results at the micro level. They found that profits and losses actually stem from the same set of trading logic. When we deliberately avoid losses, we often also avoid potential profits. If our trading methods have positive expectations, then excessive avoidance of losses will not be worth the loss.

For example, in a trend-following system, the winning rate is naturally less than 50%. It may not be difficult to avoid losses in a single shot, but in terms of risk-reward ratios, such avoidance may not be wise. At this point, traders may begin to think deeply about the nature of trading, and the positioning and limitations of human intelligence in complex markets. There is something in this realm of discussion of probability management in systematic trading by institutions such as Alfred.

Level 5: Gains and losses are random, and the mood is peaceful

When traders fully understand that there is nothing we can do about market fluctuations other than sticking to the macro probability advantage, they will understand that profits come from those losses that are usually unavoidable. Avoiding losses is, in a sense, rejecting profits. It may be an exaggeration to ask traders to "love losses", but at least they can pursue a state of "gain and loss, peace of mind".

What does this mean? It may represent a certain maturity in trading: the ability to look beyond the individual transactions and look at the whole beyond the daily fluctuations of the market. This is a sign of spiritual maturity, which takes a long time to polish. For trading results, from "persistent dependence" to "let it be"; for market relations, from "confrontation and struggle" to "inclusive integration". This reflects a state of harmony with the market.