Friday, February 02, 2018

How to Prevent Emotional Trading

Trader Stewie recently pointed out something I've found in my own trading:  trades taken primarily for emotional reasons rarely prove profitable.  A number of the traders I work with email me their trading journals daily.  It's amazing how often the profitable days are relatively simple and easy: the trader has certain ideas that they trade, certain ways of entering those trades with good risk/reward, and certain ways of sizing those trades and managing those positions.  When they are patient and selective and focused, they trade the right ways without a lot of drama and they do well.

Conversely, when markets are moving quickly and others around them are making money and they lose money on their first trades, trading becomes frenzied and frustrated.  Patience and focus go out the window and the trader becomes reactive, chasing moves, trading marginal opportunities.  That generally means entering positions at poor levels and getting stopped out.

Now, yes, there are psychological techniques for becoming aware of our emotional responses, stepping back from them, and refocusing ourselves.  But why do such disruptions occur so frequently for otherwise sane, level-headed people and what can we do to prevent them?

A key to unraveling this challenge is examining the opposite of the trading frenzy:  periods when nothing is occurring in markets.  Action is slow, volatility is low, and things are chopping around.  Is this a nice rest period for traders?  Hell, no!  Boredom ends up becoming as much as a trigger as frustration.  The trader, feeling a press to make money and do something, tries to manufacture opportunity.  Every move to an X minute, X hour, or X day new high or low is seized upon as the start of a trend and the mean reversion stops them out.

The reason the boredom is so difficult to weather is that traders are *needing* some degree of excitement, challenge, and action from their work.  They are trading to meet a set of emotional needs, not just to maximize their reward relative to risk.  Similarly, they may be trading to outperform others out of a competitive need, or they may be trading to fill a missing need for self esteem.  It is those unmet needs that impel the emotional responses and poor trading.

Trading is a great endeavor, but it cannot be burdened with the expectation that it fill our personal emptiness.  Imagine the surgeon who is bored in his life and looks forward to the thrill of cutting when he gets to the operating room.  Is that really the physician who you want to heal you?  The speaker who cares so much about the approval of the audience is the same speaker that suddenly goes blank and freezes up.  Needing the outcome destroys the process of doing.

This is why I am wary of traders who insist that trading is their great passion and who spend so much of their time watching prices.  The successful traders I work with have complete lives that fulfill their passions.  They don't need market action or thrill because they have plenty of stimulation outside of market hours.  They don't need to prove themselves in markets because they experience their worth as spouses, parents, friends, family members, and as spiritual beings.

Prevention is always the best cure.  If emotions interfere with your trading, figure out the unmet needs that trigger those emotions and then figure out how you can begin meeting those needs *outside* of markets.  You will have a calm, focused mind--and you'll be best able to surf the expectable emotional waves--when you have a fulfilling, gratifying life.  

Further Reading: