For the subject of this week’s article, I thought that I would take the time to explore the thought process behind most trading decisions we make during our FX speculating. As you may already know if you have read previous articles written by myself or my colleagues, we all drive home the importance of formulating and then following a detailed and actionable written trade plan, so as to remove any underlying emotions from the decision making process and thus enforce ongoing discipline in our trading activities. The less the trade becomes about us and more about our rules and plan, the more we have steered ourselves towards achieving success in the markets on a consistent basis. The plan tells us what to do, as opposed to us looking at a chart and guessing what we should do.
Controlling our emotions during our trading is perhaps the toughest obstacle we face in making our goals a reality. Every single time a candle on the charts moves up or down, we can be easily tempted to click the buy or sell button on a whim, without any real reason to be entering at all! In the early stages of my trading education, I remember reading that candlesticks and trend on a price chart are nothing more than simply a representation of people’s emotions when they buy and sell. Rising prices are an illustration of greed in the markets and when prices are falling, we are seeing the picture of fear taking over. Greed causes prices to rally and fear causes them to fall…or so they say. After teaching students worldwide with Online Trading Academy both in the classroom and during the ongoing virtual environment of our online graduate Extended Learning Track program and obviously through my own experiences as a trader for pushing eight years, I have started to look at the emotions of fear and greed in a slightly different light. Let me explain.
One of the most powerful aspects of Online Trading Academy’s Core Strategy, is that helps our students to change their mindset of the how markets work and gets them thinking like the groups who know how make the most money in the markets, mainly the Institutions. The difference between the way most retail traders think and act when they place trades and how some of the biggest banks and funds act when they trade, is hugely different. Think about this for a second: when a fund manager places an order to enter the market to take a position, do you think that they are worried about losing the trade and how it will make them feel? Or do you think that they find it easy to pull the trigger because firstly their superior has already given them their risk parameters and secondly because the money at risk is not actually theirs? To the fund manager, taking the trade is nothing more than their job and like any other job, they need to get on with it on a daily basis.
On the other hand, let’s think about the retail trader sitting at home and taking the same trade but with a much smaller size. Even if they were taking the trade at the same time and in the same direction as the fund manager, do you think that there is a possibility that their thoughts may be a little different than the fund manager’s? For most retail traders I would say absolutely, and why might you ask? Well for a start the retail trader is trading with their own money, not somebody else’s money, which will automatically have a different dynamic in itself, meaning that whatever the outcome of the trade, it will directly impact the retail trader. Secondly, the retail trader is doing a job also but they have no guarantee of an income at the end of the month, unlike the fund manager or trader who works for an institution. This person will no doubt still earn at the end of the month as long as they follow their instructions and trade plan as outlined to them by their superiors.
I have come to understand that the completely different environments in which retail and institutional traders work in, dictate clearly the challenges that can be faced for most retail speculators out there. I do not believe that the emotions of fear and greed work the same way for the small trader, as they do with the larger trader. In fact, I would go as far as to suggest that greed does not even become a factor in the potential success of the retail trader because if you ask most people who want to trade for themselves what they want more than anything else in their trading, they will normally say, consistency. They just want to be able achieve their goals with low risk trades and slowly build upon this. It does not become about greed at all. It is the fear which tends to be the biggest challenge of all.
It is fear which stops us from taking a solid setup in the markets because we have been on a losing streak, only to see it work out well and the opportunity missed. It is fear which causes us to not follow the trading plan to the hilt and make irrational changes all the time because the odd trade fails to work. It is fear which causes us to get out of a trade far too early with a small profit because we are scared to hold on in case it becomes another loser and it is fear which makes us search over and over again for the perfect strategy which does not exist, simply because we think there is always something out there we are missing out on or don’t know about. Fear my friends, is the biggest hurdle any retail trader has to face and will hold you back more than anything else ever will. Recognize that fear needs to be controlled with a plan and discipline. Once the consistency comes, then the fears will subside over time. Oh, and for those of you who were wondering what I feel about greed’s place in the market, well that is an easy one. Just ask yourself a quick question: Why do people become greedy? Because they are fearful there will never be enough…
See you in two weeks,
There are two demons constantly nipping at the heels of every potentially successful trader: fear and greed. The goal of every trader should be to cut a path between these demons and to help them gain control over their trading. This is what can bring a sense of security to speculative investing.
This is a motto that all types of traders can live by. Every trader understands that no one person can control the markets, but what can be controlled is how one react to the markets. This begins with the submission of the emotions of fear and greed. These two emotions can have a stranglehold over the unprepared trader, causing fatal mistakes that can and will blow out accounts.
Fear and greed can express themselves in a myriad of different ways. There are three common reactions that traders have when faced with unexpected market activity.
Holding Losing Trades
When you hold on to a “losing trade,” you are doing yourself and the trade a disservice. If the market is going against you, you should be out of the trade. There are no ifs, ands, or buts. Let’s look at some of the logic of why you would hold on to a losing trade.
If fear is ruling your emotions, then you will hold on to a losing trade because you are afraid of missing a market rebound. As we all know, the markets are constantly moving up and down. So the theory is sound-if you can hold on just long enough, you may catch the market back on an upswing. The faultiness of this logic is that you are dealing with a finite amount of capital. So can you truly afford to wait it out?
Will you allow your fear of missing out on a rebound to dictate your losing all of the money in your account?
If greed is ruling your emotions, then you will hold on to a losing trade because you want to get back to where you were. Giving back profits to the market can make you furious, so a little revenge trading sets in. Somehow, you believe the market owes you the profits you lost and then some. So when you have the opportunity to get out of a trade at a breakeven price, you still hold on, hoping the rebound will occur and give you back your profits. This greed will lead you to exiting the market only once all of your profits are gone and your principal has been tapped.
It’s easy to get caught “chasing the markets.” This can occur when you see an opportunity but you are too timid to take it the first time around, so you jump in once it gets moving. Then, immediately, the market doubles back on you and you start losing; you get out only to see the market start moving in your direction. So you go after it again, only to lose again. This is what is going on.
The fear of missing out can be overwhelming. It will drive you to operate irrationally. The setup that gave you the position in the first place no longer exists. So you are operating on old information. The logical thing to do is to go ahead and reassess the market, see if the trade is still valid, put a risk management tool in place, then execute a trade. This doesn’t happen; the fear gives you a false sense of urgency. If you don’t get in now, you will never find another good trade.
Chasing the markets when you are affected by greed is the worst ever. You have made money on the trade, the market stalls out, and you are patting yourself on the back. Then the market ramps up again and takes off. You got off the boat, it left the harbor, but you want back on. Don’t do it!
This is a fatal mistake.
Greed is talking to you. The problem of trading is that we take our best educated guess on the information presented to us at the time. If the market says get out, you get out. Don’t attempt to just jump on the bandwagon of the market without taking time to reassess. This is exactly how you end up buying the top or selling the bottom of a market only to give back all of your profits in a retracement.
Overleveraging Your Account
Overleveraging your account is simply putting on too many contracts for your account size. This is easy to do when you don’t understand how leverage works in futures and forex, but it can also be a fatal mistake when a trader is “taking a chance.” This is the equivalent of the “all in” in no-limit poker. If it works, you win big; if it doesn’t work, you are out for the count.
Those who overleverage because of fear are simply trying to get their accounts back to even money. Instead of being patient when they lose, they take an aggressive stance against the market to force it to cover their losses. The problem with this approach is that if you lose, you are losing twice or three times as fast as before. The fear of blowing out your account will come two or three times faster. The trick is to simply grind it out to recoup losses. Unfortunately, fear doesn’t allow for a systematic recovery.
Just because you made money with one contract doesn’t mean you will make money with two contracts or three contracts. It’s easy to look at your profits and calculate how much more you would have made with more contracts. This is the failure of 20/20 hindsight. You forget the agonizing when the market was moving against you, and you focus on the end result. Trading is a process. Have a plan and stick to it. Hold back your greed until you rewrite your trading plan based on your new capital amounts.
Written by Noble DraKoln, he is founder of Speculator Academy, http://www.speculatoracademy.com. After becoming a licensed broker at the age of nineteen, he has gone on to author seven trading books. He is a former editor of Futures Magazine, regular contributor to Forbes, has been a featured guest on numerous financial channels, and is a sought after consultant speaker in the futures, forex, and options world. Needless to say his twenty-one years in the industry have been well spent.
He is also the author of the books Trade Like a Pro, Winning the Trading Game, published by Wiley and Sons, and the author of four book “Small Speculators Series”.
His books have been translated into German, Romanian, and is currently being translated into Chinese, Korean, and Spanish.