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Emotions and Trading

Emotions when Trading
Written by Andy
  1. For a stock market trader, understanding mass psychology is probably more important than understanding economics. Psychology and the human nature of the modern man has many embedded TRAPS. For the importance of what I present, just look at all the supposed ‘smarties’ who suffered incalculable losses in the midst of the financial crisis. Trillions were just blown out these past years from the improper psychological relationship with known reality.
  2. One of the biggest mistakes that you can make as a trader is to allow human nature to take over your decision making process. It is human nature to not want to admit you are wrong, so instead of cutting your losses and running your profits, if you are not careful you will end up cutting your profits early and running your losses praying for them to come back.
  3. Beware of your primary enemy, yourself! If you’re not careful, you can be your own worst enemy. If you start getting too excited, beware! As excitement clouds your judgment, it starts influencing your decisions; increasing trading risks dramatically in the process. Be optimistic when your gut is pessimistic and pessimistic when your gut is over-excited. It all goes back to ‘saving you from yourself’, and the ability to honestly understand your own ability through improper psychology to at some point completely destroy everything you have worked very hard to build…never forget that unfortunate power that is always within you!
  4. In my opinion, most stock market traders fail because they are too emotional and irrational. Feel the emotions that swim through your head especially after a losing run. You feel like cursing everybody except yourself. Try this and I promise you, all those who have not experienced this first hand, that you will hate the feeling of helplessness as fear, greed and hope paralyzes you. Hope is what you want to happen, but is often different from what is likely to happen.
  5. Quoting a trader friend: ‘What looks cheap can get cheaper, which is why I try to avoid having profitable trades turning into losses. However, if I don’t sell early I tend to hold because there is always the danger one will be selling at the bottom. That’s my strategy currently but feel quite sick when looking at the figures! It is like when you have a sore and you rub it harder just to make it worse.’ That’s emotional thinking.
  6. It is indeed very hard to act upon patience and discipline when battling emotions relating to your own hard-earned cash rather than other people’s or ‘demo simulators’. I think it is generally unnatural to have this abiliy to remove your emotions from your own finances, and this is the biggest hurdle most traders face, particularly when chasing a loss. But you really need to leave your fears and emotions at the door, use that cold hard logic, and you’ll be way ahead of your competition. Case in point: yours truly. The same can be said for gambling, and its now noticeable in the housing market where for many a loss is too big a pill to swallow so people in some cases ending making foolish decisions as a consequence.
  7. Greed and fear often cause a trader to make the wrong decisions. So don’t be a fear based CFD trader or a greed based day trader. Fear based stock market traders are afraid of taking losses that they miss out on great trades. Greed based stock market traders are essentially gamblers and are likely to ignore money management rules. In other words, bull and bears make money, pigs and chickens rarely do. Be somewhere in between, respectful of the markets but ready to pull the trigger without hesitation when necessary.
  8. Don’t think that you have to get each trade right! In fact, starting to trade with the mindset that you need to get all trades right won’t work in stock market trading and can often end up being a costly mistake. You start finding it hard to close out losing positions as subconsciously you will continue disregarding evidence that suggests you are wrong. Simply recognise from the beginning that you won’t and don’t need to get all trades right. Unfortunately, we are hardwired to feel bad when we are wrong while feeling good when we are right but this mindset doesn’t work for trading.
  9. There are a few things you can do to avoid getting gripped by emotions. Those are having a concise simple strategy, trading in low trading sizes, print daily charts with a record of what you did right and wrong, sticking to one instrument/timeframe and mastering it, sticking to fixed trading times and keeping statistics of your performance.
  10. Market anchoring is another psychological trap that many beginner traders (and sometimes, even experienced ones) commonly fall into and one that can cost them dearly. This describes the tendency to be stuck on a particular reference point for making future judgements and stock decisions. For instance, a trader may anchor a trade to a particular entry level of a share since the price looked good value at the time; an example of this would be a trader who after buying a share which has gone down sticks to his entry point as a reference point to exit. The trader refuses to take the loss and insists on breaking-even; the risk is of course that you might be looking at a stock that never turns round and the trader ends up increasing his loss exponentially. If this is coupled with aggressive margin trading, it could potentially lead to disaster.
  11. Trading can be exciting and very profitable and sitting waiting for trading setups and opportunities can be pretty boring. This leaves traders prone to the dangers of impulse trading; you start feeling that you have to be in the market at all times and start to open and close CFD trades on a continual basis. This is even more dangerous if you start opening the positions for random reasons as opposed to following any trading plan.
  12. Winning trades can create feelings of elation and invincibility. If you make the mistake of allowing these emotions to take over, odds are you’ll end up taking too much risk or making stupid errors through carelessness. In fact the feeling to be in the market at all times can become very strong especially after a streak of successful trades (overconfidence takes over and you start feeling a bit like Nostradamus and try and anticipate market moves as opposed to following existing ones).
  13. Impulse trading can also be a problem after several losing trades in a row as you feel you have to make back the money you’ve lost and prove to yourself that you are a good trader. This is a danger which might lead you to overtrade as you try to make back the losses or to ‘get even’ with the market. I remember that when I started overtrading because I had loser after loser so I wanted to recoup my losses asap. This is a trap. I fell into it with the consequence that it ended eating most of my past profits and ended up lower than my initial capital. Needless to say, entering trades with this kind of mindset is a certain way of losing money in the long run. To help you avoid impulse trading you should have a good trading plan with clear entry and exit criteria and possibly a backtested method.
  14. A way to avoid falling victim of emotionally selling your intended long term trades is by introducing some shorts as a way of hedging any retracements. For instance, I’ve found that ideally I need to be comfortable with a drawdown of 20% on my account but emotionally I can’t handle that much. I usually end up selling some stocks that fundamentally and technically I should be holding onto. In order to prevent such a 20% drawdown and contain it to 15% (which I’m just about comfortable with) I am trying to: 1) Always hold some shorts 2) Hold a mix of forex pairs 3) Hold a mix of commodities including soft commodities (soft commodities seldom take notice of stock market moves whereas metals and energies usually follow stocks).
  15. You tend to make better decisions (more money) if there is little pressure to actually make money i.e. if you ignore the profits and losses and simply concentrate on the trading/investing game you are likely to do better than if you are more concerned with making money e.g. to live off. This holds because the nervous energy lost to worry is detrimental to decision making and this is why systems that take the emotions out of trading perform better. Of course when you have to make a living from your trading it isn’t possible to divorce yourself from the reality of having to make money; particularly when there isn’t a viable plan B. Compounding and money management have to help here.
  16. Many investors/traders like to talk and brag about their good trades but it is when we talk about our bad trades that we actually learn how much psychology plays a role in trading. I have had (and at times still have) my fair share of stinkers but now force myself to stick to stop losses which are fairly tight in the current market and most of my trade sizes tend to be relatively small (5k or less).
  17. It is worth noting that professional traders are able to suppress their emotions to a large degree. They don’t get ‘too high’ when they win or ‘too down’ when they lose. In this way you can achieve the necessary calm and analytical state of mind to assess each trade objectively, rather than emotionally…so it’s actually a good thing to keep your emotions in check.
  18. Whatever you do stick to your rules, and if you feel like breaking them, you should get away from the screen as quick as possible (easier said than done!). Don’t let emotions get in the way and stick to your stop loss! Trade the facts in front of you, not what you think is going to happen. The future is always uncertain. Always remember, anything can happen and you don’t need to know what’s going to happen in the future to make money trading. Good traders will focus on the downside risk potential of each CFD trade and will ensure that this is within their preset parameters as described in their trading plan.
  19. While you should try your best to suppress your emotions you need to understand that you are actually buying and trading on the emotions of other stock market traders, not the actual securities. Traders are people and you need to be aware of the human psychology and emotions that make up trading.
  20. Trading is supposed to be a business. Good trading should be boring, like repeating the same thing over and over again; if there’s a surething I can assure you is that thrill seekers and adrenaline junkies will get their accounts grounded sooner or later.
  21. Stock market trading is a challenging occupation as discipline means controlling impulses and keeping emotions at bay. This is easier said than done when it comes to your hard-earned money. Few can just open a trading account and trade profitably and consistently. It takes practice, hard work, and determination… Using a tested and proven trading strategy can help you minimise mistakes associated with emotion.
  22. Don’t Trade Symptoms: Trading with ‘scared’ money. Trading from a state of desperation and fear. Ruled by emotions and unable to take a loss. Changing your trading plan often. Trying to be perfect. Looking for medication to deal with emotional issues over trading. Adopting a trading technique (scalping one futures contract) that is beyond your level of trading competence. Attached to the outcome of each trade. Not committed to the process of learning to trade-using trading as a temporary ‘stop-gap’ source of income until something else becomes available. Acting out personal dramas in the financial markets.
  23. At the end of the day trading all to do with mindset. You can end up in emotionally in the gutter when trading unless you are able to control emotions. If you have a persistent losing run which wipes a big chunk of your trading account and end up feeling devastated, then you should really consider taking a break from trading – not because you don’t have the ability to, but because after losing so much, deep down you start feeling that you don’t have the ability to… You might come back in a few years time with a totally different mindset and be a really profitable trader. It isn’t intelligence that limits a lot of people, it’s the emotions. Greed and fear is what the markets operate on. Good traders can recognise those emotions, but still have the discipline to keep them out of the equation.

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