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The experience upgrade system isn't illogical, you just don't understand it. Increasing your life levels improves your defense, so you take less damage. It is like getting the blue and red rings in the original Zelda. Getting the heart containers gives you more health, but doesn't improve your...

There are only a couple of enemies that take away experience points, most take away health. If all of your stats are 5 or 6, you should have no problem beating the second Dungeon. Keep practicing, and you don't have to kill every enemy. There is no shame in running.