You can often tell if people are having a good day just by looking at them. Happy or sad, we can see it.
This shouldn’t be the case with traders because success in the market requires overcoming emotions. This post will consider some of the forces tugging at our hearts and minds so they can be controlled.
Hope Is a Dangerous Emotion
Hope can be the most dangerous emotion for traders because it blinds them to risks and gives a false sense of confidence. Investors acting on hope often add to losing positions, digging themselves deeper into holes they should have climbed out of quickly.
Another problem with hope is that it’s closely related to pride. People don’t like admitting they’re wrong, so they refuse to acknowledge the harm they’re going do their own wealth. Risk management becomes impossible.
Remember that what goes down doesn’t have to come back up. Countless investors tried to buy the dip in technology stocks in late 2000, only to see the Nasdaq-100 languish below those levels for almost two decades.
As the famous trader Jesse Livermore said: “A loss never bothers me after I take it. I forget it overnight. But being wrong — not taking the loss, that is what does damage to the pocketbook and the soul.”
Fear Must Be Controlled
The flip side of irrational hope is fear. This emotion often causes the same traders who hold losing positions to exit at the worst time. Excessive optimism morphs into senseless panic. It happens all the time.
In reality, fear can be useful. It reminds us of how bad it is to lose money. It can prevent us from deviating from our trading plan. Fear can also tell us when a position is too large or the market’s turning against us. We shouldn’t ignore these feelings.
But we should control them. Otherwise, we may pass up great opportunities that our system recommends. We might refuse to pull the trigger at the right time and then find ourselves succumbing to hope by chasing after a move has taken place.
Greed Isn’t Always Good
In the classic 1987 film Wall Street, Gordon Gekko declares: “Greed, for lack of a better word, is good.”
The statement was correct because investors and corporate managers have duties to their clients and shareholders. However it’s not always true for traders because, like hope, it can blind us to reality.
Greed can be good when we let winners run. It can also help us minimize losses, or give us an appetite for risk at the right time. But greed can hurt traders by making them hold winners too long.
How do we distinguish? The first way is by honoring our system.
Say your strategy has a 5-to-1 risk reward, and a stock runs to the intended level. You might be sitting on a nice profit, but then you want to hold it longer. “This is easy, I have nothing to worry about,” you think. “I have a right to make money.”
That’s the voice of bad greed. It must be resisted before it morphs into its own kind of irrational hope. Furthermore, staying in that position too long could make you miss better opportunities emerging in the present.
Hold Yourself Accountable
There’s another way to know the difference between good greed and bad greed. You can hold yourself accountable with a journal.
Successful traders record all their transactions so they can study winners and losers. Were gains the product of their strategy, or luck? Did losses result from following the plan, or did they flow from breaking the rules? This is important because there’s no replacement for adhering to a good system over the long run.
Journaling also helps you slow the game down and think more clearly. It can prevent unplanned and knee-jerk decision-making. Never be afraid to hold yourself accountable.