As a trader at any skill level, I know how important it is to do our homework and understand the fundamentals and inner workings of a company that we are investing in. It’s also important to recognize the technical direction of the market’s trends and maintain a high level of discipline over our emotions. This I work on a lot…
Trading psychology
I also know that I’m often required to make quick decisions because we maybe rapidly moving in and out of stocks. This is where the psychology and discipline of trading is important because we need to be in a certain state of mind to remain on top of our investment endeavors. A big part of this discipline is to control the emotions and fully adhere to the trading plan and understand when to book profits and losses.
Understanding our fears
When we are involved in trading and stocks are down, it’s understandable that we will be a little scared. Unfortunately, this fear might cause us to overreact and liquidate our holdings, go to cash, and refrain from taking any more risks of losing money. This action might prevent us from some losses, but we also risk missing out on potential gains. I also struggled with this early on in my career as a newbie trader and had to really overcome this before my trading results saw any improvement.
One way to help deal with fear is to understand what fear is. By definition, fear is a natural reaction to what is perceived as a threat. In trading, that fear could be a reaction to a posed threat to your profit or potential to make money. You can deal with fear better if we consider what exactly we are afraid of and why we are afraid of it.
If we ponder the issues of our fear at a time when we are not emotionally charged, we are better able to determine how we might react in a given situation. For example, if we think things out ahead of time, we could identify our feelings of fear during a trading session. By acknowledging fear, we can focus our efforts on moving past the emotions that distract us from completing a successful trade. This exercise takes practice, but it is necessary to preserve the health of our portfolio.
Greed is our worst enemy
A common statement cited on Wall Street is pigs get slaughtered. When investors are winning, many of them hang on to their winning positions much longer than they should in the hopes of getting every possible tick. This is risky and can result in a devastating blow to their position.
Despite being aware of the greed factor in trading, it is a difficult emotion to overcome. Many traders have an inherent desire to keep doing better so they push the boundaries of their trades. It is important that we recognize this emotional trait and develop our trade plan on rational business decisions, not emotions. As I’m writing this, memories of a brash newbie trader of myself immediately come to mind. I learned the hard way…
The importance of following trading rules
To avoid the risk of emotions undermining our trading efforts, it’s a good idea to establish guidelines based on our risk-to-reward relationship before we enter a trade. These trading rules can function as a safety net that can prevent us from a catastrophic loss.
Our rules might not apply to only price targets. We may consider certain macroeconomic reports or specific positive or negative earnings as a guideline that will affect our trading decisions. For example, a signal to get out of a trade might be if a large buyer or seller enters the market.
Another guideline might be a limit on the amount you win or lose in a day. For example, if you win a certain profit amount, according to your rule on wins you would be done for the day. In contrast, if you lose a certain amount, it might be a signal for you to get out and go home for the day. Sometimes it’s best to just take what we can get and go home, even if the market has the potential for higher gains.
Creating your trading plan
A good rule to follow in trading is to learn as much about our area of interest. If our primary interest is in a certain area of technology, we can learn as much as we can about that industry. I myself am quite broad minded and have a broad view of most industries as I’m more of a big picture kind of person. Everyone is different in this regard but what’s important is that we must do our homework on every trade we are about to put on.
Educating ourselves is also an important part of an overall trading plan. There are plenty of trade publications and other resources where we can learn about an area of interest. Find out about industry seminars, conferences, and forums where we can interact with industry experts. Arming ourselves with knowledge of particular industries can help alleviate some of our fears with trading.
While it’s a good idea to develop a level of expertise in a chosen industry, it’s also important to experiment with new processes. For example, what other options are there for mitigating risk? How will moving our stop losses affect our trading strategy? Experimentation is a good way to learn about trading and help us contain our emotions during a trade.
Our trading plan could include intervals where we review and evaluate our performance. Some of the components we could review include:
- How up-to-date are we on the markets?
- How prepared are we for a trading session?
- How are we progressing with our education?
Periodically assessing our performance helps us correct past mistakes and prevent similar ones in the future. It also helps keep our mind clear, be in the proper zone, and be psychologically prepared to trade.
Bottom line
As a trader, we must be able to properly understand a company’s fundamentals (fundamental analysis), understand its price patterns (technical analysis) and have access to the right technology to successfully execute our orders. This is the mechanics of trading. Consider also the psychological components of trading. This entails creating a solid trading plan, setting trading rules, and researching our areas of interest. Understanding all these areas will help us overcome many of our fears in trading and lead a much easier path to trading success.
