Philosophy (Emotion, Discipline & Risk)
Before you can even consider buying shares in a particular company, you need some background firstly about yourself. I trust that you will read this section before you go on to the actual particulars of company fundamentals, technical analysis and wider stock market forces. I also assume that after reading this section, many may be put off. You can come across many web sites giving you the magic, all inclusive, no loss strategy that will mean you never have to work again, but life in general is never that easy and neither, should you assume, are the markets. Brokers will chew you up and spit you out if you give them the chance and as such, I feel it best that we study ourselves before we study the markets. A correct mentality, control on the emotions and a strict sense of discipline at all times will shorten your losses, make each trade a more rationally thought out decision and confidence to continue trading for a profit in the long term future. So onto emotion…
Almost all emotions you have ever experienced (and possibly avoided ever since) will come and haunt you at one time or another when investing in the stock market. Fear, greed, envy, revenge, disappointment, rejection, betrayal, hope, enthusiasm, etc. are part and parcel of the basic human emotional makeup. It is tantamount to firstly recognise that we have these emotions and then know when they may play a part in our decision making to buy or sell a share. And then, only if you can control theses emotions and stick to your method with discipline, will you initially have the ability to, at least theoretically, be able to gain a return from your investments.
So what scenarios will bring out your emotions?
Making a losing trade – Firstly and fore-mostly it produces fear. Fear is the main emotion that will eat away your investing and trading if not identified and controlled. Making a losing trade may result in a number of different reactions depending on the kind of person you are. However the initial emotion, when you see that negative figure in your account will be fear. You may run for the hills and never trade again. For the most part that is a good idea, at least you will not be losing any more money. It may produce revenge or an aggressive attitude to pay the market or the company back for the loss you have taken. Disappointment may come as the strategy you used did not work on this occasion and now you fear for the future results of any other investments you may have. With hard work, well thought out processes for making trades enacted through discipline, these fears need not be so debilitating as they may appear. It´s a natural emotion that we experience all through our lives when we lose something, we fear then enact someway to cope with that fear. Profiting in trading is based upon a lot of hard work, denying the voices that come from our emotions and sticking to what we know best (we will get to this later).
Making a winning trader – It seems unimaginable that this may be something to watch out for in trading and making a winning trade is really the whole point about why we buy and sell shares. But nonetheless emotions come from making a winning trade and these emotions can lead to bigger losses. If you have just profited from a company´s rise in share price you should feel a sense of satisfaction that your method worked and you have the courage to follow it. It can lead to laziness on the next trade or complacency. Profiting from your trades should never lessen the amount of study you need to do to keep your method consistent. The other emotion raised after a winning trade is greed, arguably the most dangerous and certainly the ruin-er of many a trader. Greed is to be avoided at all costs. Greed leads to stupidity, complacency and laziness in study and quickly results in losses. If you have the initial capital to make a living out of trading, that´s great but most of us do not and as such it is a pipe dream to think that a few more good trades, a bit more capital used on the next trade, a bit less discipline in risk could spell my way out of boredom at the office and buy that nice beach front house, eating tropical fruit for the rest of my life. Very few people have this experience and even those who do still continue to work hard at their trading methods and careful analysis of the markets. Warren Buffet was officially classed as the richest man in the world in 2008, according to the Forbes’ List of richest people in the world. He at the ripe old age of 83 (in 2013) stills plays a role in his investment company and does not seem to have stopped analysing the companies he invests in, just as he has done for years. If I were him, I would absolutely retire but then I’m not, nor indeed do I have his money. You could argue that greed has led people such as Mr Buffet to the pedestal he now sits on. Personally I think he has demonstrated ambition, for as greed so often ruins a trader’s success, Mr Buffet is not currently bankrupt nor is he applying for the best job he can get. Ambition helps to maintain discipline, keep studying hard, trust in the method you have found to work best. Greed will take your eye away from the basic data and help you lose your money with consummate ease.
Missing out on a winning trade – If you see a company’s share price rocket and you did not buy into the company you can be expected to feel disappointment, frustrated, angry, possibly fearful about other rocketing companies that you may miss in the future. This again leads to complacency and diverting your eye from what is really important. We would all like to benefit from every movement upward in every company that exists and thus take a profit from it. The reality is that it is not possible and the emotions that come from missing out should be avoided. Again the usual reaction is to get in too early on the next trade in the hope that it will move significantly higher, possibly without the bare data to back up the move. It may result in getting in too late on the big movement upward and then when the traders who were in on the big movement, sold shares and took profit. You therefore are left with a loss as the price starts to decline again. Following your method and implementing your strategy with discipline may enable you to see these movements before they happen but for the least part, you should continue to be profitable inspite of the major rockets that occur in the markets.
Seeing winners become losers – You should be able to work out from this scenario what would happen. This case is slightly different in that anger will be involved, essentially in the fact that the profit was not taken initially as well as fear and disappointment as now the trade has resulted in a loss. The question as to why the profit was not taken should be raised. As part and parcel of any good trading strategy, an exit point will be just as important as an entry point. Greed may have got in the way as the trader now assumes that in view of the profit he has, why not wait a while to see if more will come. Again all these emotions namely fear, anger, and especially greed have taken attention away from what was important and have resulted in the ultimate failure of a potentially good method. It should be noted that the market does not know you, it does not care about you and unless you are 100 times richer than Warren Buffet, you will never have the power to change its course. Emotions that destroy your trading and take away your initial hard earned cash are your worst enemy and to be avoided at all costs.
Much more could be said on this but for now I trust you have a basic idea of the general kind of scenarios you may experience as a share trader and know what to expect, all least from an emotional point of view.
Discipline – Is essentially following your method whenever every part of your body is telling you the contrary. Discipline takes practice, lots of hard work and hours of study and the bad point is that it will only continue to be hard work and hours of study for as long as you remain a trader. Investopedia has an interesting article on this. We will get to method later on and in that section we will see what we need to do in order to be successful. Discipline is purely about doing the work, following the plan. The method is more rational, more objective and more thorough than any emotion and as such it works a lot better than following your emotions.