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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