Trading Without Emotions
Have you ever made a trade when price fell right after the execution of your order and you felt like an idiot? Have you then sold it right away because of the fear of losing more money but only to see it move up big right after your sell? If your answer is "yes", you're not alone. Most traders have gone thru with the experiences like this. You may even wonder what happens with your trades and why you lose money or if you'll ever make money trading stocks. Remember, making and losing money in the blink of an eye while trading evokes all sorts of emotions. It’s so easy to get excited when a trade develops exactly like your plan. It’s equally easy to get frustrated and mad when a stock goes the wrong way and you know that someone else is collecting on your mistake.
Most "so called" expert would tell you that making money by trading stocks is the easiest job in the world. You get exited by watching those infomercials on TV when someone tell you that they make $5,000 or even $10,000 a week trading stocks. You believe all the fuss and jump in with your hard earn cash. However, most people find out hard way that truth is far from reality. Majority of individual traders lose money trading stocks. One of the reasons why most people can't make money is not because they are not smart or educated, but because they can't control their emotions. Your emotions can make or break your trading career. Believe it or not, your emotions are the most important pieces of your trading success or failure. Let's consider some examples to understand this argument.
 |
Cconsider a situation where you have a long position and it immediately goes into profit. The normal human response is to want to take the profit quickly. This gives immediate gratification and removes any fear you may have had of losing the profit while the trade was on. End result - you have closed your position too quickly leaving most of the profit on the table. Some people would argue that you never go broke taking profits. But you have to consider trading costs and possible losing trades in future and what you're left with is almost no profit.
|
 |
 |
On the other hand, let's take up a case when you purchase a stock and it goes down. Your natural human response tells you to hang in there, or even add to your position so that your break even point gets lower. All your actions at this point at based on one human tendency and that is being positive and hopeful in most negative situations. However, your stock keeps going down and you stay with your trade because you want it to come back or at least break even. Everyone knows that losing money is emotionally painful and we don't want to admit being wrong, but in the end this emotional response would cost you lot more. |
As you can see from these two examples, most people tend to cut their profit short and allow their losses to run because their emotions control their trading behavior. For example, can you remember a time or instance when your emotions helped you in a trade? The reason you can't remember is because it probably never happened. Emotions would either force you to either book profits too early or stay in too long. Also, once you have suffered a big loss, your emotions usually take over and you next trade is usually a trade in anger with a hope to “make back” your money quickly after a loss? This usually causes more pain and fiscal losses because your judgment is clouded due to anger and being emotionally charged.
As you have figured out by now that your emotional response is your worst enemy in investing yourself and you have to have a plan to be able to make money consistently. Trading with a systematic approach can have a very positive effects on your profitability. The most difficult part of investing yourself is developing and following this "approach" or "plan". Remember, all online trading seminars and books would suggest a "plan" but these methods can never force you to execute this plan. These methods are too generic to address individual aspect of emotional response. To be able to make money and be successful in stock market, it is your sole responsibility to develop and execute this plan. There is no one better than you who can judge your emotions and capabilities.
How to get emotions out of your trades?
There are numerous steps that you can take to control your emotions when trading. Remember, you have to be realistic and realize that it is impossible to totally eliminate your emotions from anything that you do whether it is trading or anything else. The most important lesson to learn here is to instantly recognize the situations where your emotions start to take over your actions and correct them. Here are some of the important things that you should know if you ever want to trade with logic and not emotions.
Greed: It is in human nature and there is nothing wrong with it but it should not drive your trading habits. To understand the adverse effect of greed on your trading, here is a good example. Let's say you bought a stock at $15 and next morning it moves up to $20. As you can see, you have made decent profit. At this point, let's say, you close your position (another emotion - fear) but stock continue to go higher and in next two days it reaches $25. If you were keeping an eye on this stock, your greed would now kick in. You realized that you could have made lot of money if you would have continued to hold your position. So what you do next? You jump right in. Well, as you can see, this second trade has nothing to do with logic or research, it is just plain greed because you believe this stock would be $30 next week. Next week comes around and some people who were holding since $15 start to take profit and stock falls to $20 again. Now two things can happen. Either you would close out your position because you fear you would lose more or you would stay in or even add to your position hoping to break even soon. In either case, chances are that you would lose money. This is what greed can do to your trading. It not only wipes out original profit but also causes more loss. So first lesson in trading - Keep your greed out of it.
Fear: Fear causes many losses. People sell out because they fear that their stocks are going lower, but they often wait until the decline has run its course and they sell near the bottom. Often when they have been out of the market for some time, they get in because they fear it is going higher. Never make a trade on fear. You should always have a good reason to trade a stock and not hope or fear to dictate your position. If you follow rules, you will make profits. Fear is one of the reasons why institutional investors have developed sophisticated trading programs. You competition is not trading in fear or greed so why should you? And if you do, be assured that you will always lose since trading programs have decades of logic build in with no place for emotions.
Hope: You will never succeed buying or selling when you hope the market is going up or down. You will never succeed by making a trade because you fear the market is going up or down. Hope will ruin you because it is nothing more than wishful thinking and provides no basis for action. You need to evaluate the market based on the facts and not on your hopes. If you find a well defined trend(Bull or Bear) in the market, go with it regardless of what you think, hope or fear and you will make a success. You also need to remember that there is no such thing as permanent opinion. Sometime people short stocks and lose money but they never change their opinions on these stocks. One of the reasons may be the painful memory of loss, but don't let your old memories influence your decisions and continue to short a stock that is in up trend. You would lose lot more if you continue to do that.
Rules to manage your emotions: Here are some helpful tips to take charge of your trading habits.
 If you trade breakouts, make sure you open a position only after you clearly see a breakout. Don't make a trade because you believe that a stock is about to breakout. On the other hand, don't buy a stock in its downtrend just because you believe you have found the bottom. Let it bounce from the bottom and rise 5% to 10% from there before opening a position.
There is nothing wrong with emotions in general but they have no place in trading. If you can't get rid of your emotions, try using them differently to benefit. For example if you have too much fear and/or hope, you should fear that the loss will become bigger and hope that the profit will increase.
If you lose money on a trade, sit down with a calm head and write down one thing that you learned from it. Keep a log and make sure you don't have the same reason for a loss in your future trades.
Focus on current market conditions. Take action based on what is likely to happen rather than what has happened before.
If your stock is falling and you need to get out, don't use "LIMIT SELL" orders on a stock you need to get out. If you need to be out, get out right away and don't bother to get your limit price. Same is true on a stock that is rising. there is no reason to put "LIMIT SELL" order on a stock that is clearly moving up. Chances are that price will continue to go higher after your limit order. Use market orders to close such positions.
If you use STOP orders to trade, make sure you never put STOP order too close to the current market price. Market noise or daily fluctuations would take out your order causing you lot of grief. You STOP order should ideally be at least 3 to 5% higher or below current price.
Avoid the rush. It is never too late to enter a trade. Spending time will eliminate emotional factors and facts will take precedence. This is even more important if you daytrade.
Buy sector leaders and strong stocks. If they fall with general market, use that as an opportunity to get in. Do not buy them when they have some negative news or the sector has some problem.
Never ever buy a stock when it falls 6 to 10% in a single day due to bad news, analyst downgrade or bad earnings/guidance. chances are that it will fall more when people start to respond to margin calls and close their positions in coming weeks. On the other hand, this might present a good opportunity to short a stock.
If day trading, close the trade same day unless it is strongly on plus side. Remember, it is called day trade for a reason. Best thing is not to day trade and save time for better things.
Don't sell a stock to buy it later at a lower price. Remember, you closed your position for a reason and unless that reason has changes don't jump back in.
Always, always avoid buying cheap stocks. Avoid stocks under $5 and definitely penny stocks. |
