We are all human, thus we are not perfect. Our emotions are a quality which make us unique and allow amazing things to happen but those emotions can also get us into trouble now and then too. Emotion is a key component in our make and will often lead us to accomplish great things as well and some pretty bad things too. In trading, there is little use in allowing you emotions to control you, as this will lead you down a steady road to financial disaster if you are not careful. I think we all know this, yet most of us still don’t do anything about it when we trade. It is time to look at why this is and how we can overcome it.
Now, before we go any further, let’s get something straight: Without question every trader active in the markets is trading for emotional reasons. They want to make money which will affect their life in some way, which in turn will affect the lives of others in turn. I would question anyone who said that they were not trading because of emotional reasons. Making money, or not having enough money will have an impact on anyone, so it would be foolish to ignore that fact that there is an emotional reason behind any individual’s desire to make money from trading, because what they intend to do with the potential money they make, will have an emotional effect. However, during the decision-making process of placing or managing a trade, it is vital that those emotions have absolutely no say on the actions of the trader. Unfortunately for most traders, the potential result or outcome of their trading starts to impact their actions right from the very start. We need to leave these emotions at the door from the get-go and apply logic above all else when analyzing and trading the FX markets.
The biggest issue which we face is when things happen in the market which lead us to believe that a certain behavior is required, or that we are seeing something happen right before our very eyes and we get that feeling that we are “missing out” on something big. I am sure you can remember a few occasions when you witnessed a huge 100 pip surge in the market fire off without you or you have sat there watching a trend develop nicely over a period of time and couldn’t find a way in? Maybe you read a piece of news which made you want to short the market and the minute you entered it rallied and stopped you out, only to end up going your way after all? I hear this many times over and have experienced it myself, however if we let this get to us we are in danger of becoming emotionally compromised, which typically leads to costly mistakes in out trading.
The simplest way to overcome these common pitfalls is to build yourself a plan of action for your trading which follows a core strategy and rules. You have to learn how to avoid the two biggest mistakes in trading:
1 – To Buy after a Rally or Sell after a Drop in price
2 – To Buy in an objective area of Supply or Sell in an objective area of Demand
These two simple rules are the start of a comprehensive trade plan which the students develop in class and during the ongoing Extended Learning Track (XLT) program and allow our students to take the emotion out of their trading activities. Let’s look to a recent example from an FX class I was teaching in London a few weeks ago which shows how vital it is to leave the emotions at the door.
On Thursday 25th October a key piece of economic news was released to the general public at 9.30am UK time and is highlighted below:
As highlighted above, we can see that on this day the Key GDP figures for Great Britain showed a much larger improvement than predicted and this positive news on the UK economy was followed up later that day by Prime Minister David Cameron publically stating that the nation was officially out of recession. We were in class throughout this time and watched the price movement of the GBPUSD currency pair as it was happening. Let’s look at how the chart appeared:
Although the GBPUSD had kicked off a rally from 1.5940 the day before, upon the news release it then went on to rally higher for most of the day up to a price of around 1.6140. Before the news it was sitting around 1.6040 and made another 100 pip so after the announcement. As we watched this happen in class, one of the new students asked if we were going to buy the pair. Before I could even respond, one of our veteran students in the class who was joining us for a free refresher class said “no, we are going to look to sell”! The new student found the idea confusing and couldn’t understand why we would sell something which was going up because they were still thinking with their emotions and focusing on the fact that a move had happened, they had missed out and didn’t want to miss out on anymore. The veteran student on the other hand, was thinking objectively, as they were far more familiar with our rule-based strategy which told a very different story of what was happening. This is how things turned out:
As the rally was happening, we knew it was getting harder to buy as the buying had already happened, so all we needed to do was to look to where the objective area of supply was on the chart at around the 1.6140 area. This offered the class the lowest risk and highest potential reward trade, not buying emotionally but rather selling objectively. We wanted to sell not because of any other reason than that is what the chart was telling us to do. This was not based on an emotional impulse to buy good news but instead was based upon an objective rule based trade plan which states that when supply is greater than demand prices must fall.
Interestingly enough, prices did fall as we anticipated and then gave us a chance to buy back lower at demand around 1.6020. Why would we want to do this? Simply, because the chart offered this low risk trade and we follow our trade plan that tells us where to be objective buyers. I feel sorry for the people who did buy the good news because they would have bought far too late, watched the price go down and taken a loss, only to see it rally again to make new highs. Their idea to follow the news wasn’t necessarily a bad one but the market timing was completely wrong because they were trading emotionally without a rule-based objective trade plan and core strategy. I hope this was useful.
Be well and take care,
Source: Online Trading Academy