Trading Psychology – Controlling Emotions
Trading emotions play a vital role in the success or failure of traders. Emotions affect the outcome of our decision making process and will prove the difference between successful trading and unsuccessful trading. Before diving into the emotions and their affect on trading decisions it’s a good idea to grasp the idea of trading emotions so you know when they come into effect and how to avoid making mistakes.
Take the example of trading in a dummy account with virtual money. Paper trading or virtual money is not a very good way to test a trading strategy. Virtual money there is very little consequence tied to it and therefore personal emotions do not interfere. Unfortunately when a traders actions have an effect on the gain or loss of their own assets then the trader is less likely to behave in such a methodical way. It is these emotions that will then change the way you trade for the worse. This is why I always believe when testing trading or trading strategies the use of real money is vital just much smaller position sizes. This will enable the trader to make sure they are able to trade without the interference of trading emotions.
Below we discuss these specific emotions, such as fear and greed, and how they can be detrimental to trading and more importantly how we can conquer them.
Trading Psychology – Greed
It is a very hard step from paper trading/virtual money into trading real cash. With virtual money there is very little consequence tied to it and therefore personal emotions do not interfere. Unfortunately when a traders actions have an effect on the gain or loss of their own assets then the trader is less likely to behave in such a methodical way.
Feelings generate ‘mindtraps’ which are harmful to trading. Two of these mindtraps are Greed and Fear. These also happen to be the two most common amongst traders. Greed can lead a trader to hold a position too long in hopes of a higher price, even if the price is falling. This can work for both chewing profits as well as running bigger losses. When one of your positions experiences a large run you must ask yourself whether the reasons behind your initial investment still remain, if not, maybe it’s time to exit. Otherwise the biggest killer for a trader is greed when a position is simply gone against them and they then have the inability to exit the position before it wipes the account out because their greed overruns rational as a losing trade will not be tolerated. This unfortunately is where most traders will come unstuck.
Trading Psychology – Fear
Fear can prevent a trader from entering trades in the first place along with taking them out of positions far too early. By getting overly concerned with the risks or potential loss that comes with a trade the trader can easily be dissuaded from good opportunity. By this we look at three common scenarios.
Firstly the fear of losing the small profits made by a trade and cutting it short. By doing this a trader potential puts themselves in a position where they miss out on a really good trade and the profits that come with it. In this scenario trading costs will far outweigh the tiny profits being taken by the trader and make the experience unprofitable.
Secondly the fear of losing too much and setting stop losses too tight an hence being frequently stopped out of trade much too early, impeding on the stocks normal trading bands. Using an Average True Range or general market judgement will help judgement for suitable stops.
Acknowelding these emotions are vital in trading. All traders will experience at least one mind trap, yet it is very easy to recognise these traps. It’s the ability to understand and neutralise them and this can be effectively achieved through a trading plan and using automated trading strategies to limit human interventions and these emotions