Taking Heat on Your Trades

The odds of selling or buying a market at the precise top or bottom are pretty slim. What that means is that even the best trades will take some heat, i.e., some adverse price movement. Indeed, distinguishing between normal heat--random price movement around an entry--and just plain being wrong on the trade is an important component of trading expertise.

The recent post on emotionally intelligent trading is highly relevant to the issue of taking heat on trades. The emotionally intelligent trader uses the feelings generated by adverse movement to become more market focused, absorbed in the details of how and why the market is moving. If the heat on an S&P trade occurs on a modest TICK reading, for example, and is not confirmed by similar moves among small cap stocks and leading sectors, the trader may well conclude that it is merely noise. Conversely, if a leading sector moves opposite one's trade and the broad market follows, the heat may represent an important shift in short-term sentiment and warrant a quick exit. The emotionally intelligent trader neither ignores the heat nor overreacts to it. Instead, it becomes a prod to revisit one's trade and trade assumptions.

One of the common reactions I observe among traders is that they react to heat with frustration and a venting of emotion. This creates distraction and a lapse in concentration. Lacking emotional intelligence, the trader takes the heat personally rather than as fresh market information. When reactions are personalized in this manner, it is difficult to make decisions that are not impulsive.

A great way to deal with heat is to anticipate it. When traders react personally to adverse movement, it's often because they didn't expect to take heat. If you check out the posts on hot and cold emotional states and using imagery to accelerate behavior change, you'll see that mentally rehearsing expectable heat (and one's desired reactions to the heat) can very much instill sound trading behaviors. When we vividly imagine adverse movement and what we would do under various scenarios, the heat becomes familiar to us; it loses its threat value. Heat on a trade doesn't have to make us hot-headed. Once we expect adverse movement and have rehearsed how to handle it, we can channel our discomfort toward greater focus, awareness, and planning.
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