The famous American trader Andy Krieger said it in the middle of the 20th century: “I had always made money when I was certain that I was right even before taking a position. Those who are right always have two allies by their side: basic conditions and all those who are wrong”.

A profit in a Forex trade always comes at the expense of someone who made the opposite bet. But it’s hard to always be right. And to win, it is not enough, as many believe, that the win/loss ratio percentage exceeds 50%. Andy Krieger also admitted to having lost a lot, but when he had “generally” been right, Why? Because the trader’s psychology plays a huge role… often at his expense.

Aggravated losses, reduced gains.

To understand this, let’s look at a very interesting study on the structure of traders’ gains and losses, carried out in 2011 by quantitative strategist David Rodriguez. He demonstrated that traders lost more money on their losing positions than they made on their winning positions.

In his example, in the EUR/JPY pair, while traders made the right choices in 60% of cases, the results are negative because they lost twice as much on their losing positions as they won on their winning positions!

The magic of the “Stop” order

Let’s now move on to illustrate our point to a second great investor, closer to us: Warren Buffett. The man who is nicknamed the sage of Omaha, the small American town where he set up the offices of his Berkshire Hathaway fund, gives this advice: “Follow two rules: the first is not to lose, the second is to never forget the first. As losses are inevitable, you must try to limit them while letting your gains run. You don’t have to be out of the university to understand that if you lose 10% when you’re wrong and win 20% each time you’re right, your future is more assured than if it’s 20% loss and 10 % gain!

You must therefore mount each trade by placing a “stop” order, which will allow you to automatically exit your (unfortunate) position when the market turns. This order will have to take into account the volatility of the pair you will trade to avoid it being reached during a spontaneous pullback of the market, such as there is daily. It will also have to be constantly adjusted in the event of an increase (and will remain fixed in the event of a decrease). It is an illustration of the principle “to cut the hand rather than to lose the arm”.

A falling knife

The worst, of course, is to be stubborn when a position starts to lose. You should never go against the market: “it’s like trying to grab a falling knife” explains a broker. No one comes out unscathed. As the hilarious Warren Buffet reminds us, “in a sinking boat, the energy you expend to change boats is more productive than the energy to plug the holes”. The worst is to find yourself stuck with lines that show big losses. Do you know the very instructive adage of old stock market investors: “a long-term investment is a short-term investment gone bad”?

Psychology is, therefore, an ally but a capricious ally. It causes others to make mistakes. It predicts their moves and decisions, but it leads you to minimize your exposure, miss opportunities, and ultimately make mistakes. That is especially true when it comes to moving from a demo account, like those offered by many trading platforms, to a live account, where the in-game money can really get lost.