There is no doubt that trading in any financial market can be emotionally daunting as we go through a lot of phases I like to refer to as ‘’emotional tests’’ in the market. This article is tailored to retail traders and the emotional roller coaster we encounter while trading markets.
Scientists suggest that as human beings, our brains are designed to seek out one of two things, good news and bad news, when one is triggered, the part of the brain that interprets feelings releases chemicals into our system and the effects of this chemicals are the emotions we experience.
In the case of positive news, our brain releases chemicals such as dopamine and oxytocin, these chemicals make us feel positive and keep us more inclined to stay on the current course or cause us to want to repeat whatever action or behavior that resulted in that feeling. On the other hand, these chemicals can sometimes be addictive and cause the feelings part of our brain to override the thinking part, resulting in an individual acting irrationally. In trading we experience this on a regular basis where you may be on a high from a few consecutive winning trades we begin to feel infallible, causing us to be too trusting of our analysis where we ignore our set plan and hold a position for too long or increase our position size to enormously exceed your set risk limits.
In the second case where negative news is triggered, scientists suggest that the feeling part of the brain releases stress hormones such as adrenaline into the body causing a heightened level of fear and the need for self-preservation. In trading, these bad news could present itself as a losing trade or a series of losing trades, which most of the time results in traders pulling their punches when it comes to taking positions or done by cutting winning trades too early and using less than the required position size.
The moral of the story is you are likely to act irrationally and in a manner that isn’t in your best interest many times in your journey as a retail trader, due to your high reliance on your emotions BUT it is not all doom and gloom here because we are about to discuss a few tested and proven techniques that would help you control and in some cases use your emotions in trading that is very much likely to enhance your performance.
1) Planning before execution
It is important to know that a strategic delivery of a well-defined strategy is the only method to trading with an edge in within retail trading. The first way to control your emotional interaction with a process is to clearly define the process, a well-developed trading plan should create a trading environment where the trade is separate from the individual. This way you see execution only as following set rules, where the rules are dictated completely by the strategy and the market and not you the individual trader. You have to see yourself as a passenger being driven by your strategies interaction with the market.
An efficient trading plan should cover the current market environment, the entry and exit processes, and multiple scenarios that could invalidate a setup or an existing trade. It should also be tailored to the individuals best-suited trading times, as you can only implement a plan if you make time for it. It is also vital that this plan be written down and placed next to you at all times, especially when you are a beginner trader and you have not inculcated your rules to become a habit yet.
Having a plan also reduces the anxiety you have as a trader, as already mentioned, this plan disconnects you from the process to some level because you can now blame it on the strategy rather than on yourself and by this means to protect your self-esteem from the feeling of failure that comes with taking a loss. The downside to this is you’re likely to dump your strategy prematurely especially for beginner traders who have not been guided properly on the true process of becoming profitable. The truth is most strategies work but our ability to make them work for us it what makes the difference between the losing and the profitable trader.
2) Self awareness
This is a process that one develops only after a long time spent paying close attention to yourself and how you react emotionally to both pain and excitement in your life. It also encompasses your patience level within uncomfortable situations. Self-awareness is the ability to sit on the outside looking in at one’s behavior over time.
This is evident in trading as well, only through self-observation can you really know the exact emotional issues you have as a trader. Some traders get so frustrated after a series of losses that they begin to revenge trade, as though increasing your frequency or increasing your position size would automatically translate to quality setups and profitability. At this point they let the feeling part of the brain override the logical part and you’re stuck in a spiral of self-sabotage.
A trader with consistent self-observation and awareness is able to catch themselves at this point of frustration and can decide to stay away from the market for a while or go back to the drawing board and review your plan. This would, in turn, curb the need to be driven solely by your emotions and is likely to keep you from further losing trades.
Self-awareness can also help a trader figure out the exact kind of strategy or method he can best approach the market with that would yield their best performance. You would know what your strength and weaknesses are and would only select strategies that play to your strengths. Let’s say you are not a really patient person and feel a high level of unrest waiting for anything for too long, you are likely to perform better with strategies that let you take profits early than strategies that have holding periods of days or weeks.
3) Life outside trading
A lot of traders approach trading with a certain kind of drive that can be overwhelming, you sometimes here traders brag about spending almost all their time in the markets and how much all their life is wired around the markets. Unfortunately, this approach can be detrimental to your performance in the long run, as having a life outside the markets that you are just as passionate about as you are about the markets can serve as a shield towards undue frustration. Losing in trading can feel like a failure and this can be demoralizing for a person, having other things in your life that you are winning at can help uplift your spirit when you might be facing a draw-down.
4) Focus on the process
I understand that the overall purpose of trading is to make money, this is an investment after all and we need an adequate return on our investment but you have to realize that this is a skill as well and to be profitable you have to develop your skill to a high-performance level. In other to do that you have to care about the process more than you do the rewards it brings. Think about it like learning to play a musical instrument professionally, you get excited when you make progress not by how much u can make from playing the instrument even when making money might be possible as well.
Fall in love with the process by measuring your knowledge and performance levels across barometers that don’t include cash returns. Examples of this would be win/loss ratios or accuracy of execution: this shows you how well you apply your strategy and your understanding of the market environment.
Keeping focus solely on the process of trading, you are able to gradually curb the feeling of greed and over-excitement that can be gotten from focusing on cash rewards. Profitability would be measured only by percentage change and success would be measured by trading well not by how much you make.
5) Turn your correct trading process into a habit
Another way to curb trading emotionally is making your trade process second nature. As humans, we are mostly consistent with things of habit, things that we have repeated so much that it becomes as ingrained as muscle memory. The objective here is to find yourself sticking to your trade rules regardless of your current emotional state, this is possible simply because you’re so used to trading in a set process that it seems like you know no other way.
6) Get comfortable losing
This might sound counter-intuitive for most people but it is the absolute truth, as the fear of losing is the most common driver for irrational emotional behavior in the markets. It really is all about accepting the possibility of the loss which is why you should never risk money you can’t afford to lose in trading. Do not use and interest paying loan for trading, do not mortgage your home for trading capital, do not use your family slush fund for trading, basically, anything that places added pressure on you besides the pressures directly from the market would increase your emotional burden in the market. This would protect you from being focused on returns and allow you the opportunity to focus on your trading process.
How to implement all this?
In the beginning I suggest you start with one technique and then start adding more. Pick one you think would help you the most and start with that one. After you feel you have made a solid progress, go for the next one and continue with the process until you have mastered all those techniques. Don’t rush it. It is quite natural that it takes some time.
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