Online Trading: How to Profit from Losses

Earning with Losses in Online Trading Is it possible to earn with losses in online trading? Obviously, the title is meant to be provocative but it hides a great truth. To succeed in online trading, regardless of the market, it is necessary to start not from profit but from losses. That is, to think first about not losing money and only then about earning it. A behavior that should be taken for granted but not everyone follows. On the contrary, beginners, confident as they are in a rapid growth of capital, lose sight of this important point. The result? Loss after loss, account at risk, high probability of throwing in the towel after a few negative experiences. In the following article, we address this topic, offering some ideas to base one's online trading activity not so much on profit (which is also important) but on loss control.

Changing Perspective with Money & Risk Management

Evidently, this is a very important change of perspective, capable of permanently modifying online trading activity, permeating all phases of the investment, from analysis to closing the position. A necessary change of perspective, as it is based on prudence. Let's be clear, not a type of prudence so excessive as to compromise profits, or to push towards immobility, but rather capable of acting where online trading is most dangerous. To implement this change of perspective, and make it capable of optimizing online trading activity, it is necessary to give a boost to one's money management, practice it not only regularly but also effectively and comprehensively. The same, obviously, applies to risk management, which is linked to "money". Risk management means, for example, setting a stop loss. It is not possible to practice risk management without practicing money management. The link is obvious: how can you control risk if you don't know exactly the amount you can afford to lose?

The Kelly Formula

Money management is a complex subject, a discipline that must be exercised with extreme rigor. Also because, if done well, it can truly represent life insurance for a trader. The techniques are numerous. However, it is good to start from the basics, if you are really unable to practice a more complex money management. An idea could be to start right from the Kelly formula. This suggests exactly how much to invest, at most, per single trade. It does so by expressing a value as a percentage of the entire capital. Now, the Kelly formula always gives a different result depending on the trader who calculates it. There is nothing to be surprised about: each trader has his own history, his own statistics, etc. However, from the Kelly formula, a percentage has emerged, which is simply the most recurrent value among traders: 2%. This means one precise thing: you should never invest more than 2% of your capital per single trade. In any case, if you intend to do a meticulous job and identify not an arbitrary value but the value that exactly suits your trading activity, you should perform the Kelly formula in full, which is as follows: W - ((1-W/R) where W stands for Probability of Winning, i.e., the percentage (normalized to 1) of traders who have made a profit in the last period R stands for the ratio between the average win and the average ratio As already mentioned, most traders derive a value of 0.02, which as a percentage becomes 2%.

The Question of Leverage

Leverage is at the center of a long-standing debate, to the point of requiring regulation by important supervisory bodies. The reason is simple: leverage is the classic double-edged sword, and moreover very sharp. It can cause good as well as bad. If used improperly, it can bankrupt and drain the account. For those who don't know, leverage is a tool that allows you to produce different effects from those generated by the invested amount. If, for example, you open a position by investing 1000 euros, but use a leverage with a 1:10 ratio, it's as if you were trading with a position equal to 10,000 euros. This means that in case of a 1% profit, this would not be equal to 10 euros, but to 100 euros. Leverage is an effective method to increase profits quickly, which is very useful if you start with low capital. The fundamental problem is precisely its quality as a double-edged sword. In fact, it multiplies wins, it's true, but it also multiplies losses. It could even completely drain the account. On the other hand, it's rare to go into the red (that would be the last straw), also because the vast majority of brokers take initiatives in this regard: such as automatic exit in case a certain loss is reached. In any case, from these simple events, it is clear how dangerous leverage can be. The advice is to employ an approach that is as prudent and wary as possible. Completely depriving oneself of leverage would be a waste, or a missed opportunity, but abuse is still to be avoided. A bit arbitrarily (but wisely), one could impose a leverage not exceeding the 1:10 ratio, with a maximum limit to be set around 1:50.

Some Useful Parameters for Money Management

Obviously, money management is not limited to the Kelly formula and a wise approach to leverage. It takes into consideration many other techniques and parameters. Here are some of them. Equity Line. Very simply, this term indicates a graph formed by a single line. In this line, each point indicates a trade. The x-axis is temporal, the y-axis indicates the outcome in a quantitative sense. It is a very simple but at the same time useful tool for analysis, even at a glance. The ideal would be to have an equity line as regular as possible. Position Sizing. It is the method by which the size of the position is calculated, i.e., the amount invested in the single trade. The Kelly formula is an excellent method for defining position size but obviously there are many other techniques. Win Ratio. This is also a very simple but useful indicator. It is simply calculated by putting the winning trades in relation to the total trades and multiplying everything by one hundred. Therefore, it is simply the percentage of trades that ended in profit. It is a parameter to keep in order to always have an overview of one's trading activity, especially in terms of effectiveness. Profit Factor. This parameter is calculated by relating the wins recorded in a period with the losses recorded in the same period. The result, obviously, is not the profit produced (for that, simple subtraction is enough) but an index that suggests the quality of one's trading system. If it is less than 1, obviously, something is wrong.