Controlling Fear and Greed
In my last post on trading psychology we started looking at some of the indvidual fears that traders can have, and also some of the effects greed can have as well. But if you missed reading it, click Understanding Fear and Greed and read that post first before reading on.
In this post, we’re going to start looking at how you may control fear and greed, so I hope you have your list of fears handy as we might be able to cross some of them off.
Managing Fear and Greed
Let’s start with a hypothetical scenario; a trader has a trading plan, trading system and money management strategy in place. They’ve backtested their system with good results (perhaps better than expected), but when it comes to putting on real trades they find following their plan’s entries and exits much harder than they expected. Does this sound like you?
Here’s a question that my mentor asked me when I was having some trouble with my own trading.
“Suppose you had a million dollars, and you were to trade only $5,000 of that on the market. Do you think you would be able to follow your trading system without your emotions getting in the way?”
My answer was an emphatic “yes”, and I understood my problem.
My emotions were coming in to play because I was too attached to the money I was risking. The result being that my decision making was affected as well.
That attachment is one of the main reasons why people can backtest a system so successfully, yet when it comes time to put money on the markets they start failing, and they may not even know why.
So, obviously the answer to taking fear and greed out of the equation is to get a million dollars and only trade $5,000 of it. That way you won’t become attached to such ’small change’ and won’t worry about losing it if the worst happens.
For those of you that aren’t millionaires trading small change, we need to look at some other ways to manage our fears.
Before I do that though, let me just make the point that not everyone can learn how to trade profitably. For some, managing the emotional roller coaster as the market moves their trades into profits and losses can be too difficult. But that’s ok if they can learn that before losing money they can’t afford to lose. If someone finds out that they aren’t going to be a trader it doesn’t mean they’ve somehow ‘failed’ in any way. Maybe later on they’ll come back to it again with a new mindset and try again.
Alright, let’s see if we can address some of those fears listed in the earlier post!
Fear: We fear that the market is going to move against us as soon as we place the trade.
Response: Why is this a problem? Surely we don’t expect our trading strategy to deliver a 100% success rate? That means we are going to experience losing trades. What we need to ensure is that those losses are capped and managed at levels that are not going to seriously affect our trading capital.
That’s why we have a money management strategy, and why we have stop losses - to limit the amount of money we lose from those “non-progressive” (losing) trades that we expect to have.
Fear: We fear that even if the trade does start to move the right way, that it’ll turn around any minute now.
Response: This is really the same fear as above, and the same response applies. This fear does have a different context though. The first fear was about losing money, while this one is more a fear of losing profits.
In his book “The Art of Trading“, Chris Tate noted that one of the top 10 blunders traders made was to cut their profits too soon, eg; “I never met a big profit that was not once a small profit.”
If you can cut your losses short and let your profits run, then you can trade a system that has a 50% success rate (or lower) and still trade profitably because the amount you win outstrips the amount you lose.
For example, suppose you could go to a casino and bet on the toss of a single coin that has a 50:50 chance of being right. and for every toss you get $2 (plus your bet back) for a win, but had to forfeit your $1 bet for every loss. Welcome to Fantasy Island!
You’d play that casino day and night until it went bust, right? But suppose you only won $1 instead of $2 though, making the amount you won the same as the amount you lost each time. Would there be any point in playing unless you had a way of winning more than 50% of the time? They say “You can’t go broke taking a profit”, but I don’t agree. I believe you can go broke taking a profit if your trading system needs bigger profits (by letting them run) to offset the losses.
In my next post I’ll continue working through the rest of the example fears I posted earlier. We’ll also start looking at strategies to manage greed.
…Stay tuned for Part 3
Happy Trading
Brian Dibbins
Trade Profitably © 2006 - 2007
3rd July 2007
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