One of the most difficult aspects of trading in today’s market is handling your emotions. For many months, we have struggled through a market and an economy that seems intent on bringing us up and down like a yo-yo. To say “don’t get emotional” is pointless. Everyone is emotional about money.
So what can you do about your emotions as they apply to trading? There is one aspect that stands out most clearly to me: the challenge of living in the past. I believe that this is one of the most significant obstacles for traders.
Why? Because the brain remembers, and fear is a powerful motivator. The fight-or-flight fear response is deeply ingrained, and although fear of financial loss isn’t the same as our ancestors’ fear of losing an arm or a leg to a saber-toothed tiger, it registers in our minds the same way. The saying “the market takes the stairs up and the elevator down” is true because of how strong our reaction to fear is. That fear might save your life in situations of physical danger, but in trading, it can be deadly.
The real culprit is long term memory. And again—it’s our physiology. Fear doesn’t form in a vacuum. It is a learned response to a particular event or probability. In the case of trading, when you have a trade that goes bad, the regret and frustration can carry over into the next trade. Or worse, the fear is so consuming, that you don’t enter your next trade. Of course, Murphy’s Law dictates that the trade you don’t enter is the one you should have entered.
Greed creates the opposite problem. With a couple of consecutive winning trades, the ego can enlarge and feeling invincible overcomes being logical. This will ultimately lead you to trades that you normally would not have entered. Finding good trades is hard enough, while finding poor trades seems to get much easier after a couple of winners. Never mistake genius for a little luck.
Emotions cause ‘perceptual distortion’ where we only see the part of the picture that our beliefs allow us to see. Traders need to learn which perceptions are emotional and which are based on hard facts. Feeling invincible after a string of winners or feeling like you just need to get out of trading altogether after a loss will only prevent yourself from moving forward.
The best traders forget about a loss the minute they take it and move on. They are confident in their system and their ability to execute it. It is not about the money for these people. It is about finding a system that will bring them more profits than losses. The best traders know how to take losses and not become depressed, angry, jealous, disgusted or defeated. They know how to take gains without gloating, boasting, cha-chinging or becoming outrageously happy. They only see the trade they are about to enter–not the trade that just ended. All past trades are out of sight and out of mind.
If you cannot do this, you will fail because fear and greed will lead you down the wrong path.
So what do fear and greed have to do with forgetting about the past?
This particular problem is fueled by the expectation that every trade you enter should be profitable. If you truly believe that, then here is an important piece of information for you—not every trade will be profitable!
It’s important to recognize your emotions, and more importantly, how they affect your day trading approach. In general, we all want to be bullish, and are eager to see any upward market movement as a rally, even when it’s not. Simultaneously, after a volatile beginning for the year we are all somewhat gun-shy right now, especially in the face of mixed messages. Are fear and greed driving your trading decisions right now, or are you in control of your emotions?
If you’re not sure, I’d recommend taking a step back and looking at the market from a different angle … an unemotional one.
