Trading: Master Your Emotions or They Will Master You
These day in financial markets dominated by huge data, sophisticated analytical programs and quantitative strategies, concerns about the psychological aspect of trading may seem very strange.
But, in reality a clear understanding of trading psychology very important. As it is when people forget to question motivations and emotional states that they become vulnerable to weak decision-making.
The digitization of financial instruments trading has transformed many aspects of the game and its participants. But, little has changed in trading psychology. The lessons learned the hard way over years of experience are as applicable today as they were when 1st learned.
In this guide examines the 4 strongest emotions in trading psychology, and then looks at what traders can do to master emotions and ensure they are making informed, clear decisions each and every time they execute.
The Fear of Missing Out (FOMO) Can Ruin Judgement
The FOMO usually occurs when a stock is a making a big move and you missed it. This can lead to chasing an entry which is never a good trading decision because you will end up with a poor entry price and as you are caught up in the though of missing out you forget to manage the trade with the risk.
The fear of missing out is driven by a desire to be a part of a good thing, even when all signs suggest that it is not a wise investment.
FOMO is so pernicious because people see other people succeeding, even if they are taking unjustifiable risks at is, and people have a natural urge to join in. The more wildly successful other people are, which is usually directly correlated with the amount of risk they are taking on, the stronger the urge to join.
FOMO is usually harder for new traders to grasp because they have not been burned as many times as someone who has been trading the markets for a while. The best way to deal with FOMO is to have rules in place and if you break them then you need to have some kind of punishment, like shock treatment!
One cannot make trading decisions based on emotions no matter how much money other traders making on a hot run.
So, stick to your rules, there will always be a trade.
Fear is a sense of unjustified panic that occurs when market participants as a whole take a generally pessimistic view toward the financial, economic and political future.
When there is fear in the air traders focus on and ratchet up bad news, and are quick to close out Longs or open new Shorts.
A climate of fear in the markets is self-reinforcing, as more people become afraid and sell, the greater the overall sense of fear becomes. Under a cloud of fear it is very difficult for an individual participant to make rational trading decisions based on reasonable expectations of the behavior of the overall market.
Fear is common in traders because most do not know what’s going to happen after a trade is entered. They have an idea of what will happen but do not know with 100% certainty and when you have a lot of money up and do not know what is going to happen, it can cause fear, anxiety, worry and concern.
To counterbalance fear always trade within your means, setting an acceptable loss amount. This way you know, before you even enter the trade, that you are only risking a certain amount.
This takes some of the uncertainty out of the trading process because now we know what is on the line.
Also, trading too much size makes people uncomfortable and fearful of losing too much money or even blowing out the account.
Sizing is very important.
It is smart to small and work up. A good month does not mean 10X your size.
What about Greed: Good or Not
Greed is the other side of fear. It is also similar to the FOMO, but focused on the broad outlook instead of a narrow market target.
Under greed, economic, political and financial news is viewed extremely optimistic, and bad news is ignored of waved-away as unimportant.
Greed creates a self-reinforcing cycle of rising asset prices and positive outlooks.
When traders become accustomed to rising asset prices, like we have seen since this Bull Market began on 9 March 2009 they begin to ignore Key signs of risk or negative outcomes.
Trying to squeeze every cent out of a move is a sure way to give up profits and even lose money.
So, the best way to manage greed is just like how managing fear: Discipline
That means setting predetermined profit targets and when they hit, bank them. One has to have disciplined to follow rules.
Hope in trading psychology is the unrealistic expectation of something good happening.
Traders can be hopeful at the height of a gainer or the lows of a looser, but in all cases their desire for something to happen beats the ability to rationally foresee outcomes.
Hope is a natural human emotion, particularly in matters involving chance, risk and odds. Just the desire to want to believe in something is often enough to cloud judgment and lead to making poor decisions based on the hope that things will turn our way.
I say, leave Hope for church.
Mastering emotions in trading is a never-ending challenge, the basic framework for tackling the problem is simple.
When emotions run wild they are given the space to dominate one’s thinking, which is why professional traders always use a strict trading system that helps to contextualize their decisions and keep their emotions in check.
Traders can rely on a tried and tested trading strategy to help them gauge and control their emotional state.
A regimented trading system offers an anchor of proven reason that traders can rely upon when attempting to interpret market information and their emotions.
Any effective trading strategy is composed of various rules that help to frame all investment decisions.
The rules for identifying trades are useful for keeping traders on track and focused on those areas where their knowledge and experience gives them an advantage.
These rules are very useful when it comes to controlling greed and FOMO, as it keeps traders in a safe area that they understand instead of chasing profits in unfamiliar asset classes.
One needs to be like a robot when trading, that means being systematic and rely on trading process and rules as guidelines for success.
On Executing Trades
The opening and closing of positions is always the most difficult and stressful aspect of trading. Even the most well-researched trades can go poorly if the trader is overly emotional when executing trades.
Having a set of strict rules for how and when to execute trades is essential to maximizing the profits from good ideas and minimizing the losses from trades gone wrong.
An extensive use of advanced orders, such as profit-takers and stop orders, is an important element of a strong trade execution system, but they are not fool proof.
Experience and know how to correct mistakes come with time, you know when is happens, fix it and get back on track.
After the Trade
In this game it is always wise to have a system for cooling down after one trade before moving on to the next whether it is good or bad.
Every trade color emotion, so the best traders know how to cleanse themselves of the lingering emotions of the last trade before moving on to the next.
Many traders are technically skilled, but the super traders are masters of personal discipline 1st and trading knowledge 2nd.
A knowledge of the common potholes in trading psychology and a strict set of rules for trading are both essential to achieving lasting success in trading.
Once these are in place, it is a matter of putting in the time and effort to become the master of your emotions and a master at trading.
Remember, it is your money, so it is your responsibility.
Latest posts by Paul Ebeling (see all)
- The Street’s Key Stock Analysts Research Report - December 5, 2019
- Outlook for Gold and Silver in 2020 - December 5, 2019
- F1: Ferrari’s (NYSE:RACE) Vettel and Leclerc to Start 2020 Season as Equals - December 4, 2019