Is stress an ultimately meaningless but inevitable part of trading or is your psyche trying to tell you something about your trading approach? Find out what your emotions can reveal about how you trade.
Ask yourself the following question: Have your ever, before placing a trade, thought of all the reasons the trade was a good idea, but once you pulled the trigger obsessed about all the things that could go wrong? Has this nervousness caused you to abandon your trading plan and, perhaps, exit a trade too early — resulting either in an unnecessary loss or unnecessarily small gain?
Before seeking the advice of a Freudian analyst to discover the traumatic events in your childhood that are causing you to abandon discipline, it may be worthwhile to consider more immediate explanations. Most likely, one of three things is going on here or, possibly, a blend of the three.
The first possibility is you simply have trouble putting money at risk. In the past,you’ve never really liked anything more unpredictable than a treasury-bond fund, and you immediately get knots in your stomach when a trade moves one tick against you. The “paranoid” feelings you experience in a trade are completely detached from the reality of the market situation and your trading strategy.
Some people are inherently riskaverse. Regardless of the causes of such feelings, some people can work through them. Others, though, are better off not trading. Because the first rule of trading is capital preservation, refraining from trading can be the best money-management decision some people can make.
The second possibility is you are not really working with a fully developed trading plan. If you can immediately think of 10 things that are wrong with your trade right after you click “buy” or “sell,” you must ask yourself why you didn’t think of them before. The rush of enthusiasm that can accompany an attractive trade setup can quickly disappear once you’ve executed the trade and realize you don’t really know how you’re going to get out or how much you’re risking.
Finally, it might simply be you’re not trading with enough money. No trader or trading strategy can survive undercapitalization. If even a small loss represents a significant percentage of your trading capital — say, 10, 15 or 20 percent — the stress will likely be so great that you will not be able to stick with the trade long enough to profit from it. Lack of capital is the No. 1 killer of most new businesses and almost all new traders.
Paper trades that do not risk real money tend to have less psychological baggage than those that do.
Are you paranoid or are you really being followed?
The problem comes in determining whether your negative feelings are really “risk paranoia” or whether they are tipping you off to flaws in either the design or execution of your trade. In the latter case, there are some simple techniques to consider to reduce or eliminate this problem.
The first solution is to only trade systematically. Removing emotions from trading is the very reason many traders adopt a systematic approach, even if they think they might have better performance trading with discretion.
Truly systematic or mechanical trading approaches leave no room for interpretation. Trades must be executed without hesitation or reflection on the current market circumstances or the possible outcome. Of course, to have the confidence to automatically follow a system requires a great deal of research, historical testing and trial trading — not to mention discipline when it comes time to execute. The upside of mechanical trading is that it can greatly reduce the emotional element of trading.
The second solution is to track your trades and jot down your fears at the time of execution. By comparing these notes to the actual results of the trade, you can see if your fears are unfounded or if your trading plan indeed is flawed. It would be nice to paper trade and make such notes, but trades that do not risk real money tend to have less psychological baggage than those that do.
One idea is to put on very small trades, even if winning trades merely squeak out a small profit (or small loss) after commissions. It’s amazing how even putting a little money at risk can up the psychological ante. It’s similar to being in a quarter/50-cent/dollar poker game: After you go around the table a few of times, that $40 pot seems like all the money in the world. Using this technique gives you the opportunity to analyze your strategy, execution process and mindset with some degree of realism while limiting risk exposure.
A dose of reality
Truth be told, even some veteran traders have difficulty completely removing the fear factor from their trades. This only makes sense, because experienced traders understand the inherent unpredictability of the markets.
Following any strategy — whether it includes discretion or is completely mechanical — requires a fully developed plan, with entry, exit (where you get out with a profit or loss) and moneymanagement (how much you risk) rules.
You also need to know why your system works and when it is likely to fail. Only then will you have enough confidence to survive the bad trades as well as enjoy the good ones.