The Risks of Trading with Emotions
In this post:
- What do traders and salespeople have in common?
- What is one of the fatal mistakes beginner traders make?
- Why you shouldn’t rely on your judgment while in a trade?
- What can lead to success in many aspects of life, but not in trading?
Traders are the best salespeople in the world. Although used car sales associates are saddled with reputations as being pushy and dishonest, they don’t hold a candle when compared to the average trader.
Why is this? Once the trader is in a position to buy or sell, a trader can deceive themselves into believing half-truths faster than a house cat pouncing on a freshly escaped hamster. When faced with a loss, the trader will look at a chart and tell themselves: a reversal will happen soon. The result is that they don’t exit their position and keep hopes alive, which usually results in more losses.
When faced with a profit, the trader hesitates to pull the trigger; they make themselves believe: that the market is acting great and selling would be premature at these levels. The trader doesn’t exit the trade and usually loses everything they have gained.
Trading with Emotions
The mistake these traders make is a common yet fatal affliction in most beginning traders. The net result is a trader who “eats like a sparrow, and defecates like an elephant.” This is a situation, of course, that no account can withstand. Worse, this cycle of trading with emotions will never end until it’s met head-on.
By stepping back and examining this process in more detail, the trader can learn to use their emotional reactions as indicators. Properly tuned, these dynamic indicators can create great triggers to enter and exit a market instead of leading to mistakes.
The problem is many traders feel they can rely on their judgment while in a trade. On paper, this makes a lot of sense. After all, a trader is at his most objective before a trade is placed. However, once the trade is on, the objectivity diminishes immediately and is directly proportional to the number of shares or contracts being traded relative to the account size.
Think of it this way: If one trader is long 10 Emini S&Ps in a $10,000 account, and another trader is long 1 Emini S&P in the same sized account, who will be sweating bullets over each tick? A trader relying on their judgment while their brain churns with extreme trading emotions is like someone trying to row a boat upstream with a piece of Swiss cheese—it simply does not work.
Video Guide to Trading with Emotions
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The Cycle of an Emotional Stock Trader
Trading with emotions perpetuates a vicious cycle, resulting in a trader who, like a bad used car sales associate, consistently sells a faulty collection of beliefs that sets themselves up for slaughter. Instead of following a game plan about when to exit a position, the trader in this situation will close a position for one of two reasons:
- First, the pain of holding becomes so great he cannot “take it” any longer. Once they reach this “uncle” point, they start frantically banging their keyboard to sell (or cover) “at the market” to relieve the pain.
- Second, a broker exits the position for the trader. Not because they are nice, but because the account has run out of margin. This trade is also placed “at the market.” In these situations, there is no plan, thought, or objectivity. There is just a batch of forced sell orders or, in the case of someone short, a collection of forced covering.
Act of capitulation
Traders exiting a position because they have to, not because they want to – is emotion-based trading at its finest. Whether it is a sustained multi-month move to the downside due to continuous capitulation selling, or a quick 10-minute rally due to shorts being forced to cover, these acts are responsible for the significant moves in all markets, on all time frames. In the end, markets don’t move because they want to. They move because they have to.
This imbalance of market orders causes rip-like movements that result in even worse fills. Disgusted with themselves and red in the face, the victims of these trades stalk off to contemplate the insanity of the universe. Meanwhile, another group of traders took the opposite side of this “capitulation trade” and made significant profits. How does a trader get on the winning side of these trades? The key is for the trader to use their emotions as triggers to take advantage of these “get me the hell out of this position” panic runs. To fully understand how to do this, we must first step back and understand why traders continually and instinctively sabotage themselves in the first place.
Trading with the Wrong Mentality
The problem is that the tactics an individual uses to achieve their goals in everyday life do not work in trading and are one of the main reasons for failure. While “good judgment” is critical to an individual who wants to climb the corporate ladder or start a business, we have already seen why it doesn’t work in the middle of a trade. In addition, stubbornness and determination are prerequisites for success in many aspects of life, yet trading with these qualities will kill your portfolio in the market. To say that the trader is unaware of this phenomenon and is set up for failure is like saying that Donald Trump “dabbles in Real Estate.”
In addition, traders who “play the markets” with a mental framework oriented towards how external society rewards and punishes “good” and “bad” behavior are set up to lose from day one. For example, “cutting losses short” is difficult when the market is possibly returning to the breakeven point. At breakeven, the trader is not a “loser.” Thus, according to society’s benchmarks, if the trader can exit a position with a gain, they are “successful.” This leads to the removal of stops in the hopes of breaking even, just to be a winner in the eyes of society (sigh).
This can work ten times in a row, but it is the one time it doesn’t work that knocks a trader flat on his back. On this particular day, this trader will be one of many who cause a “rip-like movement” in the markets. This habit of removing stops is reinforced by the societal belief of what defines a winner versus a loser. This is a habit that will destroy an account faster than The Donald can mutter the words, “You’re fired.”
Trade with Discipline
Controlling your emotions, following your trading plan, and trading with the right indicator are the most critical aspects of trading. However, none of that will matter if we are not disciplined. Every trader will experience the good, the bad, and the ugly of stock trading. It’s part of being a trader, but it’s up to us to keep focused and not let our successes and failures get to our heads.
No matter the experience level, trading with emotions can be a dreadful experience. If you are constantly struggling with that roller coaster of emotions in the market, we urge you to seek guidance and mentorship with us at Simpler Trading. If you don’t know where to start, join us in the Simpler Free Trading Room. We have many traders with all types of trading backgrounds, so you can find which one best aligns with your trading needs. Why trade alone when you can trade with us for FREE!
FAQs on Trading with Emotions
A: Trading psychology is a key to being a successful trader. Traders who let greed and fear influence their trading can experience more losses than traders who stick to their trading plan.
A: Devising a trading plan, relying on your technical and analytical research, and staying consistent is key to staying disciplined when trading in the stock market.
A: Staying focused, disciplined, and keeping your confidence intact.
A: Yes, taking losses is a normal part of trading. The key is to keep your losses small so that a large loss doesn’t wipe out all your gains. To do this, traders need to keep stay disciplined with their trading plan so they don’t make emotional decisions.
A: Revenge trading is another form of trading with emotions, it’s when a trader experiences a loss and tries to recoup that loss by entering into another trade without any strategy or plan. Revenge trading is a dangerous form of trading and should be recognized if a trader is trading with those bad habits.
Originally Published: August 24, 2016
Updated: June 23, 2022