How Much Are Your Trading Mistakes Costing You? Find out!
Cory Mitchell, CMT
Mistakes cost a lot, and most traders have no idea the actual dollar value of those mistakes. You could be adding hundreds or thousands of dollars to your income each month; re-claiming money that was yours, but was lost to correctable mistakes.
A few mistakes each month could turn a winning strategy into a poor or losing strategy.
Most traders don't track whether they slightly overbet or underbet on a trade. We don't add up our missed trades or tally up how much our "random" or "gamble" trades cost us.
Because we don't do this, we often don't even know if the method we are trading is truly viable.
We tend not to have very good memories, and unless a trader keeps meticulous notes, one, two, or several mistakes a month could easily be forgotten. Thus, instead of realizing that personal mistakes caused a system to fail, they blame the system.
Tracking Trading Errors and Mistakes
I do track errors...and it can be staggering and humbling to see the difference between what a strategy produces if executed well versus what is actually executed.
Depending on our mental state, some days/weeks/months may be way better than others in terms of how many errors we produce. A daily routine can help keep us in a better mental state more of the time.
AN ERROR IS ANY TIME WE DON'T FOLLOW OUR TRADING PLAN.
IF WE DON'T HAVE A TRADING PLAN, EVERYTHING IS AN ERROR.
Errors have nothing to do with profits and losses. An error can be a made on a winning trade while a losing trade could be executed perfectly. Maybe the winning trade was random, or we entered too early or too late based on our strategy; even though it produced a profit it was still an error based on our trading plan. The losing trade doesn't have an error in this case, because even though it was a loss, the trading plan was followed.
It is assumed that the strategy in the trading plan has a profitable edge. That if the plan is followed a profit is likely over many trades. This is why any deviation from the plan is an error, because now we don't know if that strategy will still be profitable or not. Errors distort the statistics of a trading system, and once those statistics are distorted, you are no longer trading the same system the think you are.
Our Goal When It Comes to Trading Mistakes
The goal is to simply improve on the number of errors made. This is the EASIEST WAY to improve trading results. It requires no new knowledge or knowing more information. No need to learn a new strategy. Reducing the number of errors just requires more conscious effort placed on following the current trading plan.
In order to improve, we need to know what to improve. Start a Trading Error Journal.
Start by recording each time there is an error. I noticed on one of my recent trades my position size was about 20% too much. It was a loss, so that equates a 0.2R additional loss. An extra 5 seconds to check my math could have eliminated that error.
On another trade, I took about 10% too little (3.6 lots instead of 4, in this case). Therefore my risk was only 0.9R instead of 1R. My reward to risk was 7:1—and the trade was a winner—so I ended up with a 6.3R profit instead of 7R. A mistake of 0.7R.
In two tiny mistakes, I have lost almost the equivalent of a whole other losing trade (-1R).
R just means a risk unit. For me, R is 2% of my account. So the risk on each trade should equate to 2% of my account. Therefore, my reward to risk is simply a multiple of risk. This is discussed in the position sizing article.
Record the result once the original trade would have completed (as originally planned based on the strategy). For example, if you got out of a trade early with 5R, but the target was at 15R, you don't know the scope of the error until the price either hits the original stop loss or target (assuming your plan was to let the price hit one or the other).
Record the difference between the result taken versus the theoretical trade result, had the strategy been followed. Do this for EVERY violation of the trading rules. Record every time you skip a valid trade, and record the result, whether it ended up a win or loss.
For the above trade, if the trade ended up getting stopped out, the violation was a difference of 6R to the good (you made more than the strategy would have). If the trade ultimately hit the 15R target, that is 10R to the bad (you didn't capture as much as the strategy would have).
Sometimes a mistake will produce a bigger profit than originally planned. Write it down. Other times the mistake will cause you to miss a big profit. Write it down. At the end of each month tally up how many R you made or lost relative to what following the strategy would have produced. If you had 15R in errors for the month, and you risk 1% per trade, you missed out on an extra 15% return. If you risk 2% per trade, you missed out on 30%! Correcting a few errors each month could mean you are putting more of that potential return back in your pocket!
Track the following errors. These are ones I could think of. You may have others. Not all of these necessarily will have a dollar or R-value you can attach to them, but you can still write them down. Poor habits may indirectly result in mistakes that do have a direct and measurable impact, so it's good to note them.
- Skipped a valid trade (usually because of fear of losing).
- Took a trade that wasn't valid based on the trading plan.
- Don't have a trading plan (every trade is a mistake).
- Wrong position size or don't have a position sizing method.
- Taking too many correlated positions (increases risk...as the correlated trades are essentially the same).
- Got out of a position before you were supposed to.
Got out of a position late.
- Still aren't out of a position you aren't supposed to be in! (This is "hoping" not trading)
The points below are not as measurable but are still mistakes. These could lead to the errors above.
- Wanting to make a trade, instead of letting a trade come to you.
- Too many positions at one time which means attention is too divided, resulting in one or more of the other errors.
- Blaming others for a mistake. Each of us is responsible for our own results.
- Didn't go through a pre-trade checklist prior to trade, or didn't perform a reward:risk analysis (just jumped in!).
- Viewing a mistake that was profitable as a positive thing...it isn't! It may work on one trade, but such mistakes will result in poor and random performance over the long-run.
- Trading while sick, angry, depressed, or super excited. Any extreme state of mind isn't good for trading, it will bias behavior making the plan less likely to be followed.
Why A Trading Error Journal Works
For some people, recording errors may mean writing in the journal on every trade! Not only does seeing the tallied amount of how much errors cost help fuel change, but having to write and calculate an error log is a pain in the ass. If someone commits to doing it, having to record all the errors can itself be a deterrent from messing with trades.
My errors result in tens of thousands of dollars not being captured each month! Even eliminating a couple of errors each month has a massive impact on my trading results. Since I trade with high reward:risk multiples, if I skip a trade that turns out to be profitable, that alone could cost 15R in profit not recognized (that should have been). Risking 2% per trade, I missed out on making another 30% on my account for the month! One mistake! That profit should have been mine based on my strategies, but due to errors, that profit is gone forever. By reducing errors, I reduce the possibility of this happening in the future.
Don't violate your trading rules and you don't need an error log. That is a reward in and of itself!
Sometimes improving isn't so much about learning something new, improving is simply better executing what we already know.
By Cory Mitchell, CMT @corymitc
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.