Ask a person on the street the question “What makes a good trader?” and one of the most common answers you will receive will be “trading strategy”.
However, ask someone who has traded forex for any length of time the same question and the answer you will get will be far more complex.
No one doubts that strategy is key. In order to achieve a goal, you need a plan. Footballers have a game plan and soldiers have a battleplan. However, strategy on its own will not ensure success. What happens if a footballer gets angry? Will they follow the plan?
The answer is simple. In most cases, when a person is overcome with emotion the risk of failure increases.
Strategy tells you what to do and when to do it but, it does not ensure that the plan will be followed. To be successful in the long term you need to keep your emotions in check, which is why in this article we will be looking at the role of negative emotion in trading and how to limits their impact.
At this point you are probably asking yourself “What emotions can I expect to feel when trading?” and the answer is simple. You can expect to experience nearly all of them.
Luckily however, most sources within the realm of trading psychology accept that there are three key emotional states that a trader should avoid.
Unlike other emotions greed usually appears when you are riding high and contrary to the words of a certain Michael Douglas in the film Wall Street, Greed is not good.
It is one of the worst emotions out there in trading. Greed leads to Arrogance and arrogance clouds the objective judgement that a trader needs to be successful.
Examples of Greed include:
- Trading when your strategy tells you not to.
- Increasing the “size” of trades contrary to your money management rules
- Not adhering to stop losses/profit targets and holding trades longer than you should
Fear is the most common emotion a trader will experience. It appears during both good and bad times. Fear encompasses many aspects in trading, ranging from the fear of taking a loss to the fear of missing out on a trading opportunity.
Examples of fear include:
- Trading a smaller than normal size through fear of taking a loss.
- Refusing to enter a trade through fear of losing banked profit.
- Refusing to enter a trade through fear of taking a loss.
- Entering a trade after the opportunity has gone through fear of missing out on potential profit.
- Failing to exit a trade through fear of banking a loss.
When people are angry, they make rash decisions. It is human nature to get annoyed but, in trading being angry may lead to you hitting the self-destruct button.
Examples of anger include:
- Entering trades with little or no strategy.
- Trading larger size to make back losses.
- Increasing your position as a trade size moves against you.
- Refusing to enter or exit trades because you are angry at the markets.
- Shouting/banging your desk.
Dealing with negative emotions
Unfortunately, there is not a magic fix. However, although there is not a one size fits all solution to dealing with a negative mindset there are some simple rituals that a trader can use to help avoid the impacts of negative emotions.
Have and Follow a Trading Plan
A trading plan tells you how and when to trade, what money management rules to follow and how to deal with the good the bad and the ugly aspects of trading. Follow it.
Always enter a profit target and stop loss
The temptation will always be there to “see how things go” when the market hits a level but, by entering a Stop loss and Profit target at trade entry emotions wont be able to get the better of you when the time comes to exit.
Trade your strategy
If the strategy says no, don’t trade.
Plan your trades
Make sure you have planned for every scenario. Plan your entry, your exit points and Include what you will do if market moving news is released.
Only Trade what you can afford to lose
The reality is that trading can be tough. People fail. Trading with money you cannot afford to lose adds pressure and increases fear.
Take breaks frequently. Stepping away from the markets for 15 minutes and focusing on something not related to trading will help level out your emotional state
Log your emotional mindset in your trading journal
When filling in your journal have a section focusing on your emotional mindset at the time of entry and exit. Rank your mood between 1-5 with 1 being negative and 5 being “optimal”. You will be surprised at the patterns that emerge when you look back over your trading history.
Review your trades
In the heat of battle it is often hard to accept that you could have done things differently. Going back over your trade history at the end of the day or even week will allow you to objectively identify when you were affected by negative emotions and see the monetary effects.
Talk to others
In trading there will always be someone with more experience than you. They have been through the same emotional rollercoaster. Ask them how they deal with emotions in trading. You never know, you might find something you can use.
Accept that losing is part of the job
Any trader that tells you they are right 100% of the time is lying. Trading is not about being right all the time. Trading is about being right more than you are wrong and accepting this is critical to becoming a good trader.