Friday, May 07, 2010

Emotional Issues

Nearly everyone who has read anything about trading has been exposed to the notion that the markets operate on fear and greed. Consciously we know we can make money and we know we can lose money when we trade and we have an emotional attachment to the money. If we start losing money, some element of fear tends to creep in and we might feel different than we do when we are making money and greed then may have the upper hand.

It has been interesting to observe that many retail traders with whom I have become acquainted readily acknowledge and understand the danger of trading through emotion, but at the same time rarely do they appreciate that those emotions affect themselves personally. I confess that there was a time in my trading career where I was in that very boat. In other words, we understand how emotions can affect the other guy, but believe that we are somehow immune and able to overcome them without effort. As a matter of fact, it is the unusual person (I've yet to meet him or her) who has no emotion when it comes to their trading.

Social security is a joke and provides no security. Liberals are ruining the country. Conservatives only care about their money. The SEC should be regulating more. The SEC should be regulating less. We need to clean house in Congress and elect all new officials. I am paying way too much in taxes. The United States should have only one religion and it should be the same as mine. The government should be able to control political speech.

As you read those sentences did you feel any emotions? Did your blood boil over one or more of those statements? Did you feel like saying: "Right on!" to any of them? I'm guessing that with at least one of those statements you felt something, maybe even something powerful. In the past when I have included any statement related to politics the blog has been active and filled with both praise on one side and vitriol on the other. People feel passionate about many things, at times so passionate that they will sit down and write something to berate me for some view or praise me for some view. An emotional response has been triggered in them and it can be powerful. At times, emotions become so strong that they overcome things like manners and civility.

If we feel such strong emotions about things like politics, imagine now how strong our emotions are about our money. Money buys what we need, it symbolizes what material things we may desire, it can symbolize security, shelter, food, education, safety, pleasure. If we lose our money we lose so many things including, perhaps, our dreams so the idea that we are losing our money can be very powerful. Conversely, gaining money may add to our feelings of security, enable us to achieve dreams, perhaps enhance our prestige, and may give us comfort. These are powerful images and it is no wonder that they can affect our trading quite dramatically.

What can we do? It's unlikely that many of us can escape our emotions and even if we could would it be better? My suggestion is that we be aware of our emotions when trading; understand that they are present and can be powerful, allow ourselves to feel them, but at the same time act with a discipline that we have determined in advance. For example, suppose we are entering a trade and we have a pre-determined exit strategy. Let's say for that trade, a loss of 7% from our entry is our initial exit if the trade goes against us. Now, as the position begins to lose what are we feeling? Are we saying to ourselves: "It'll come back?" and if we do say that what might we do without a pre-determined exit plan? That's right, we may let it continue to drop hoping that it will come back. It might drop 8% or 15% or 90% and we're still holding on and waiting until maybe it just gets back to where we bought it, and so on. If we do have that pre-determined exit we may still feel the same emotions as the stock drops, but if we ignore the emotion, that "inner voice" saying it'll come back, and just follow the plan, we have accomplished what we really wanted to accomplish and that is to cut our losses. As has often been said: "The first loss is the best loss."

When we have a plan and we follow that plan, we may bring another emotion to the fore and find that we are satisfied because we have done our job well. We have planned our trade and traded our plan. We cut our loss or we let our profit run as the case may be and in both cases we have been successful in making the trade as planned. After all, doesn't that feel better than letting a loss run, holding on hoping and waiting for it to come back?

by Bill Kraft, Editor
Copyright 2010, Makin' Hay, Inc.
All Rights Reserved


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To comment on Bill's article click on the "comments" link below.

14 comments:

Anonymous said...

Bill,

Great comment and so true. Where does one get information on what are the components of a "Trading Plan"?

Frank

Anonymous said...

Bill,

One thing I do for losses is to go back after the trade has been exited and the emotion has passed, and analyze the trade. Did I really set my stop correctly? Did I follow my rules in initial analysis of the trade as to risk/reward, initial profit target, etc. Was there anything different about the setup that should have caused me to invoke different rules or modify my standard rules?

I find that if I rigorously analyze the trade after the emotion has passed, I can feel better about it later, especially if I actually followed all my rules. In that case it was just a trade that didn't work out. As long as the "just didn't work out" trades stay within my predetermined percentage, I can continue to feel confident in my trading setup rules.

-Dan

Nona said...

May I suggest to Anonymous #1 that you read Bill Kraft's book TRADE YOUR WAY TO WEALTH? You'll get lots of good information re: a "Trading Plan".

To Dan, Anonymous #2: Good advice to do a post-analysis of your trade.

I have found that if I follow my rules, even when they take me out of a trade that would have worked out later and/or in the long-run, I feel a certain satisfaction because I took myself out according to my rules.

USUALLY my rules protect me; sometimes they don't. I accept that. Indeed, that's part of trading. After all, nothing is 100% -- and certainly there is no 100% in trading in which all trades are percentage plays with (hopefully!) the larger percentage being in one's favor.

Anonymous said...

When I saw your comment about Social Security, my dander got up, but that is because I had not finished reading the paragraph. However, the very hardest thing for me to do is to admit my trade was wrong and sell at a loss. Because of you, I have done that recently, and I must admit, "The first loss is the best loss," is the truest statement I have heard. I wish I would have done that on all the losers that I held onto, 2 of which went down to .10 and even below.
Thank you Bill for all your thoughts and advice--I have been listening to you for years. John, in Laurel, MD, a retired SSA Senior Executive. I have commented once before here.

Nona said...

Also (and I wish Bill would comment on this) if 6 to 7 trades out of 10 trades are profitable, you will do well OVER TIME. The "over time" part is what matters.

This is why I don't mind (too much: I do mind a little!) closing a trade at a loss. I think of it as "...the best loss" but truth be told, even little losses irritate BUT are part of trading.

The other matter that I have truly internalized is the notion of preserving capital. It's a tad counter-intuitive, but if you think about it, taking small losses is one way to preserve capital provided your overall loss-win ratio is favorable.

Grant said...

On the other hand, we have to allow emotion to play some role in our decision making. I've decided I can't invest in BP or RIG because of the environmental risk they are taking. There are safer ways todrill in deep water but they tried to maximise profiits and look what happened. I've got grandchildren and they are more important than money. Grant Johnston,Chico, CA

Bill Kraft, MarketFN.com said...

Thanks for writing, Frank. I set out what I consider to be the components of a trading plan as well as what considerations might lead to the decisions as to what to include in my book, "Trade Your Way to Wealth." Thank you for your kind thoughts.
Bill Kraft

Bill Kraft, MarketFN.com said...

Great contribution, thanks, Dan. I agree that a review after the trade can really help each of us become better traders.
Bill Kraft

Bill Kraft, MarketFN.com said...

Thanks Nona. You are on the mark as usual.
Bill Kraft

Bill Kraft, MarketFN.com said...

Thanks for writing again John. I'm glad to hear you are cutting losses now. We've all let them run at times and that's not in our best interests. Even when we cut a loss and the position turns again we can always get back into a position. Sorry to get your dander up, but as you realized, that was my intent to demonstrate the point.
Bill Kraft

Bill Kraft, MarketFN.com said...

Nona mentions that a trader can make money if 6 or more trades out of 10 are profitable. Actually, if one uses a 2.5:1 reward to risk ratio the trader can lose 7 out of 10 trades and still be profitable. Using an example of one unit per trade, if there are 7 losses, the trader is down 7 units. If the other remaining 3 trades bring in 2.5 units each, the trader has a gain of 7.5 units so overall is up .5 units after 10 trades where 7 have lost.
Bill Kraft

Bill Kraft, MarketFN.com said...

Thanks for writing, Grant. Definitely we are going to have emotions about our trades, but those emotions need not control our trades. In fact, if we are to be successful, I am convinced that discipline must be the control. Certainly one may choose not to make specific investments because of some individual prejudices. You don't want to own BP, for example, while others may choose not to buy stocks associated with cigarettes.
Bill Kraft

Mike said...

You are a very brave man to come up with a Social analogy to stock trading. Our society is too polarized and it could reach critical mass if we continue down the same road.

Bill Kraft, MarketFN.com said...

Thanks for your comment, Mike. Trading is governed, quite often, by emotion and at times is much more emotional than logical. Perhaps the same can be said of our political climate.
Bill Kraft