Image showing chart proving the issue of handling trading losses is always at the top of the list.

Our Trading Brain and Trading Loss

A slow motion, step by step playbook.

Why is trading loss the biggest pain point for traders? In a survey of over 1000 traders, the issue of handling trading losses is always at the top of the list. See the chart above. ^^

The experience of loss is controlled by the more primitive part of our brain. Our brains attach trading losses to the same survival mechanisms our ancestors experienced when hunting for game on the savannahs. I know it seems irrational, but the more primitive limbic part of the brain is geared up to keep us alive. Unfortunately, it doesn’t see 50 shades of gray…just black and white. All threats can put us into survival mode. It doesn’t matter if we are physically safe or not.

This survival instinct leads to repeated trading errors. We wake up the next morning and slap our foreheads and wonder why on earth we made the same trading mistake, and swear we will never do it again. Then, we lose three trades in a row and we revenge trade, miss good setups, move our stops or over-trade to make the money back. And, it rarely ends well.

We all know in the rational part of our brain, the old adage, “cut your losses and let your profits run.” Yet, in the heat of the moment, something happens. And much of the time it isn’t pretty.

However, this problem is not your fault! It is just how our brain is organized to avoid the pain of losses so that we don’t give back the gains of a hunt. Once we understand how our brain biases work, we can create an exercise that builds new Mind Muscles that serve us better!

Let’s start the shift to better trading behaviors with awareness. At the Mind Muscles™ Academy the basis of creating new behaviors, even ones in the primitive part of our brain, is what we call the “Golden Keys.”

  1. Awareness
  2. Acceptance
  3. Action

The first awareness is our brain and loss. To increase our awareness of how our brains sees loss, let’s watch how our our brain process loss in slow motion, step by step.

Let’s say you buy your asset at 100 and set a stop at 96. The next thing is that it ticks down two ticks to 98. The question is, have you lost real money yet? When I ask this question of my traders, most will say no. They say, “I don’t have a loss until I close the position.”

Our brain does not want to feel the impact of loss. It may downshift us into an alert mode, we may become anxious…but we haven’t emotionally realized any loss because there still is hope.

Ok, now it ticks down one more dollar to 97. Have we lost real money now? Remember, our brain will not want to recognize any losses.

It ticks up one dollar…we start to get excited, our beliefs about the trade are going to work!

It ticks down one and one half to 96 ½.  

Image of chart showing it ticking down one and one half to 96 ½.

What does our brain do now? It wants to avoid the pain of loss…it downshifts to fear of loss….and what happens next? Our survival brain pulls the stop.  

As long as the trade is open, there is hope to avoid the loss!!! More than anything else, we want to avoid getting stopped out and missing the big rally we knew was coming and feel like an idiot. We enter a new stop below the next line of support at 93.

Image - Our trading brain believes long as the trade is open, there is hope to avoid the loss.

What happens next…the market drops again…this time to 95.

Then, it drops quickly to 93.25 You know it is going to bounce from here, it is a better buy than at 100 when you bought it…and you are right! It bounces off of support and rallies to 95.

Then it drops again, testing the stop…you know what is going to happen next, they are going to run the stops before the big rally……so you just cancel the stop…again.

Now it drops…again and again and the loss is going to take all of last month’s profits….you stare. You are frozen. The more this loss is connected to your well-being, the stronger the neuro-chemical changes take place in your brain and the harder it is to make rational decisions.

And finally, you pull the plug at 90. Only to watch it turn around and have a strong rally to the close.

Image - your trading brain finally pulls the plug on trading losses

You have just lost one month of profits and a great trading opportunity!

Now, let’s take a peek inside our brains on the other side of the ledger.

We purchase our asset at $100 with a stop at 96 and target of 109. Then it happens, it ticks up immediately.

Image - Trading brain gets excited that this trade is going to be a big winner!

Wow, did we pick the right entry! We executed the strategy perfectly. We are so happy…this trade is going to be a big winner!

Then it ticks up again!

And ticks up again! Wow, did we call that one right. Our brain is now beginning to link this good call by imagining the fulfillment of our hopes and dreams. This is all out of our awareness. You may not believe it, but this is what has come up with my clients when we look at their deeper hopes and dreams:

Image of the trading brain, affected by deeper hope and dreams

  • Earning our fathers respect
  • Getting rich
  • Being accepted by others
  • Getting laid more often
  • Getting our spouses approval
  • This will make up for that boneheaded trade I made yesterday
  • I can brag to others in the trading room

These links are being formed in the brain as the asset clicks higher and higher.

But…oh-oh…it just missed our target and ticked down…that’s ok..momentum looks good.

Tick back up…almost there! Another uptick!

Ooopsss…it ticks down…and down again….. We hold our breath. Another downtick. Whew…ok we may be all right with another uptick…we are almost there!

Image - Trading brain on an emotional roller coaster

Yes a final uptick will do it! Oh oh…big downtick…

Crap! Another downtick!

8th image of chart showing emotional roller coaster when trading brain is faced with wins and losses

Let’s freeze the market right here and ask a question.

Has this trader made or lost any money? If you look at profit and loss only with closed positions, the answer is no. You haven’t lost or made money. If you look at profit and loss from a mark to market framework, the trade is still profitable. However, if you re-frame this position from the brain’s point of view….The trader has lost $5.50!

How is this possible? Because the brain has already banked the profits from the tippy top of the high water mark. It has not only banked the profits, but it has banked the emotional results of those profits also. So now, the brain is losing!

This puts the trader in the pain of loss mode, both the loss of cash and the loss of imagined benefits. The stronger the neural links to our emotional needs, the greater the intensity of the felt loss.

And what do we do? We sell for a small profit and then watch the market explode through our target price at $109.

9th image shows the trading brain is an emotional wreck after being whiplashed by the market.

In a losing trade, the pain of loss drives our decisions. We avoid the pain of loss when the market is going against us. We feel the pain of loss and a missed opportunity after we get out of the trade.

In a winning trade, the pain of loss drives our decisions. We feel the pain of loss even when we are in a winning trade because we emotionally bank the profits from the high water mark.

Is every tick a referendum on your self-worth? The more hope, dreams and ego we attach to individual winning and losing trades, the more likely we are to repeat trading patterns that no longer serve us. The more we care about the outcome of a single trade, the more likely it is that we will make a decision we regret later.

So, there is a reason why cutting losses and letting winners run is such a challenge. It is not your fault! But there is good news. With this awareness, these neural patterns in our brains can be reprogrammed. This is best accomplished by creating a positive feeling about executing a strategy, not on the profit or loss. Traders who measure the percentage of well executed trades and hone their skills to great execution are the traders who will do better in the long run.

Master traders shift from profits to pride. They don’t have every tick of the market attached to their emotional needs. They just feel the pride of accomplishment of great executions that come from a master trader’s mindset.

Engaging our dreams and how that become attached to our trading is a significant step forward. In our NEMES to DREAMS lesson, we give every trader the invitation and exercises to become aware of this attachment, to accept our deepest desires and then to create new relationships with our trading that not only feel better in the moment, but honor our values and get us to our goals.

Watch this 8 minute video on the same subject, from a recent webinar I did on Winning Minds:

Leave a Comment: