Causes of Emotional Trading
Before we get to the process that will solve this problem of losing trades, let’s first talk about the underlying causes. There are generally only three things that lead someone to lose money in the market:
Lack of Education (You don’t know what you’re doing.)
Lack of Preparation (You know what you’re doing but have not practiced enough to be good at what you’re doing.)
Lack of Emotional Control (You know what you’re doing and you’re good at it, but your emotions get in the way of placing your trades well.)
Lack of Education. The first one is easy to fix. Go to some seminars like the ones I teach, read some books, or study on the Internet. There are many ways to educate yourself. Just make sure the education is complete and that it teaches you how to make money in any market condition.
Lack of Preparation. The second one is also easy to fix. Preparing yourself to be a good trader is really nothing more than discipline. Trading is a skill, just like riding a bike or speaking a foreign language. The more you do it the better you get. To develop this skill you need to have a virtual trading platform where you can trade without risking real money. Then as you are successful you can move into real, or funded, trades.
Lack of Emotional Control. The third area, however, is the one I want to take a look at in this article. Emotions are the great demon of traders. One can know exactly which strategy to use, know the exact timing, see the perfect trade set up, place it, and still lose money! How? Because emotions often get in the way of the trade. To be a successful trader you must learn to get your emotions under control and keep them out of the way of your trade. Otherwise you’re trading on emotion, not rational analysis, and this is a plan for failure ten times out of ten.
A Lot to Lose, A Lot to Gain
Let’s talk about why emotions so easily creep into your trades. Why do we trade? For some people it is the adrenaline rush. (If you’re one of these people, I suggest something way cheaper like sky diving or bungee jumping!) However, for most people (myself included), trading offers a promise of something better—financial freedom. Financial freedom brings with it a litany of other dreams and emotions because of what the freedom will allow us to do. Your goal may be to play more golf in the afternoons, take more frequent vacations to travel the world, or spend more time coaching your son’s little league team. It doesn’t matter what financial freedom looks like to you, because no matter what you’re envisioning, the bottom line is that it is an emotional motivation.
Now, understanding the promise of financial freedom, you can understand why it is an emotional thing to trade. When you trade, you’re “trading for something.” Usually it’s not money—it’s what that money will buy you. To top it off there is an extra emotion in the mix here. That is because it takes money to make money! Generally when people start trading their initial capital is their most prized possession. After all, preserving capital is one of the keys to being a successful trader. And that preservation is emotional because if you lose your starting capital—well, that could be it. You would have no starting capital OR the dreams that financial freedom will bring you. And this double whammy is the underlying reason so many new traders (and many seasoned traders, too) are so easily affected by emotion and unable to move forward in their trades.
So how do we fix this problem? I’m going to share with you a step-by-step system that I use if and when I start a losing streak and need to reign in my emotions to trade more efficiently. I teach this same system to my advanced trading students every month. I’m assuming a few things here. I’m assuming:
You already know how to trade. (You’re educated.)
You are already prepared to trade. (You’ve practiced your skills.)
You have been trading real money and you’re trying to get out of a rut.
If you do not meet these criteria, then the prescription below may only be marginally useful to you. Make sure you have already educated yourself and prepared yourself before you ever trade real money.
Your Personal Recovery Rx
For the rest of you, here is your prescription:
Stop trading real money immediately—no exceptions.
Take at least a two-week break from worrying about trading. Do not look at the market, do not look at your account, do not watch the news. Let all things trading detox from your mind. Failure to do this will create mental toxins that can poison your thinking. (After my worst series of losses it took me four months to clear my head and be able to focus again—and I’m supposed to be a pro!)
After the burn of your bad trades wears off a bit, consider reading a book on trading psychology like Trading in the Zone by Mark Douglas.
After this information has set in, review the “anatomy of a trade.” (This is a trade analysis system I teach in my classes.)
Pick a stock and do six months of back testing on it, walking through the anatomy of a trade. (Back testing is like using a trading simulator. It allows you to trade a stock’s history as though it is real time.)
Pick another stock and do the same thing.
Pick another stock and do the same thing, but JOURNAL every trade—even if it takes hours. (Journaling your trades can help you pinpoint where you’re breaking down.)
Do it again.
And again.
After finding success with back trading, resume virtual trading (real-time trading with fake money). Walk through the anatomy of the trade before every trade. Also ask the question, “Why would I do the opposite?” (If I’m thinking bullish, why might I think bearish?)
After virtually trading for a month, analyze the trades and determine your win/loss ratio. If you’re trading at least 70-80 percent profitably, then move into one (and only one) real trade with one (and only one) option contract. See how that goes.
If your real money trade is profitable, then do it again, but try two to three real trades with only one contract.
If your confidence is building, increase your contract sizes to two to three contracts/trades.
Continue in like manner until you are trading fluidly.
NEVER STOP VIRTUALLY TRADING. Always continue placing your virtual trades. Then as your confidence grows, move more and more of your virtual trades into real trades.
If you begin losing money in real trades, return to virtual trading complete this process again. Continue in like manner until your emotions are under control.
I have used this system myself for several years now. I have taught it to countless students, and when it is followed it always yields results. If you would like to learn how to apply these techniques and more to your own trading, please visit our website and http://www.TradeSmartU.com/TSU.asp?LPID=12
