There are only two factors you need to guard against.
GREED – the need to possess increasingly more of something.
Greed emotions include hope. Greed leads to trading losses
FEAR – a stressful state created by an awareness of impending hazard.
Fear emotions include
- fear of losing out (FOMO),
- fear of making a mistake,
- fear of losing money,
- fear of being wrong (not being right),
- fear of the opposite party in your trade.
Most investors believe they know what is going to happen next. This causes traders to put too much weight on the outcome of the current trade, while not assessing their performance as a probability game that they are playing over time. This manifests itself in investors getting in too high and too low and causing them to react emotionally, with excessive fear or greed after a series of losses or wins.
These are the two drivers of all human trading behaviour, and you need to understand which one is at play with every decision you make and every action you take.
Research shows that traders who experienced intense emotional reactions in winning and losing, showed a worse trading performance. The same research shows that there is no “trader personality profile”, which led the researchers to conclude that different personality profiles could do equally well after instruction and practice.
Why are the two trading emotions se negative? What do they do? Both greed and fear destroy the discipline of a trader.
How do I overcome fear and greed emotions?
Both emotions are not necessarily bad.
It becomes negative when it paralyses the trader or makes him incapable of functioning rationally. But that can be overcome by using certain techniques.
Irresponsible and uninformed trading lead to despair
- Plan to win but prepare to lose.
- Trade small – smaller than you can afford.
- Use a stop-loss – it ensures that your potential loss is below your emotional tolerance levels.
- Trade only with money you can afford to lose. Which implies that you should not trade to make grocery money.
- Follow your trading plan to the letter – do not deviate.
- Watch your language – words have emotional content and your words trigger your brain to react in a specific way.
- Embed it in your belief system that there is always another trade.
- Your broker should have a smart stop or maximum draw-down facility which will close all your positions automatically when you lose a pre-arranged percentage of your portfolio. I put mine at 50% of portfolio for that improbable event that I suffer a heart attack or am involved in an accident and cannot attend to my open positions. My stop-loss should take care of it. This is just to provide for any unforeseen events – and to protect you against your own emotions getting the better of you.
- Act in the moment (mindfulness). Be aware of your surroundings and what you are busy with. One way of ensuring you act in the moment is to question everything you do. Why do I pick this SL, why this TP, why enter here, why trade this pair? Answering questions helps you focus. If you question yourself, you make sure that your mind does not wander and that you think about something unrelated to what you are busy with. Concentrate!
Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.