Home › Market News › The Myths, Realities, and Remedies of Emotional Trading
By: FairValueTrader
Management is a crucial element to successful living in all facets of life, and when it comes to trading, becoming a good manager is imperative. Traders will know that trade management is a critical difference-maker in a trading career’s productivity and longevity and is the critical focus area. With an entrepreneurial spirit, time management, and broader financial management, control of our life’s economic plan is also vital to success.
However, one of the more neglected managerial aspects we consider is that of managing our emotions. Each management area will be the difference in permanent success or failure in trading, and the emotional aspect is no less pertinent. A trader whose emotions are unruly may enjoy limited, short-term success but will never survive the long-term.
One trader that I know had learned to balance his emotions about 99% of the time, and during that period, he was the most consistent trader I had ever seen. To borrow baseball terminology, this trader was a contact hitter with a high on-base percentage. He never hit home runs but consistently brought home his day’s pay by getting to first base. I had seen him have 20+ profitable days in a row, having a winning streak of 50+ consecutive trades.
His weakness was on the occasions when his system misfired, maybe one day out of a quarter, but the problem was he would become emotional and strike out, giving up a month’s worth of gains. In other words, the 1% of the time when he became emotional, his results were detrimental.
Today’s article will address the theme of how to become better at managing emotions. I often remind our readers that every individual has different personalities; therefore, you can pick out what connects to you out of this data.
First, it is necessary to bust a couple of myths concerning emotions. Feelings are not wrong! We often treat emotions as though they are an enemy when, in reality, emotions should become our friends. What becomes problematic in life and trading is when any of us becomes imbalanced and fluctuates between emotional extremes.
I recently had the occasion to watch a couple of episodes from the original Star Trek series. You’ll recall Mr. Spock, a Vulcan who has learned to lean purely on logic while discarding emotions. The same can be said of “Data” from the Next Generation series. A recurrent theme of these characters is how their assessments of various challenges were incomplete because they only utilized logic while failing to understand emotional aspects.
Emotions are very much a part of life and very natural. Emotions help preserve us while also aiding in our interpretation of living. I noticed my three-year-old daughter had a natural fear of heights, even without understanding the concepts of life and death deeply. This fear is part of our natural disposition to keep us safe and alive.
Therefore emotions are not an enemy, but we are responsible for creating a friendship with our feelings, knowing how and when to utilize them properly. As long as emotions are a bad word in our vocabulary, we are unlikely to approach emotions healthily and beneficially.
The second myth to address is that emotions should be avoided by shutting feelings out and ignoring them. This is not only psychologically unhealthy but is also harmful. To own our emotions, we must first be aware of what our feelings are. I earned a degree in psychology, and part of my training was in observing how frequently people go into denial over their emotions. When it comes to trading, this kind of denial is what causes financial catastrophes.
A trader can take one positive step by keeping a trading journal that catalogs all kinds of information, including emotions. The more you take inventory of yourself, the better you are at detecting your emotional patterns.
A trader I know took this advice and realized there was a particular time of day when she became more apprehensive in her trading. After circling the reasons why we noted that her routine for a few years had been to take specific actions in caring for her young children at that time of day. Even though circumstances had changed, she naturally became more emotional in her trading during this part of the day, and it was reflected in her profit and loss statements.
Some people would choose to ignore trading during that time of day. Others, like her, once she recognized that she was susceptible to apprehension at that time of day, she owned her emotions and adapted.
One final example comes from a man who sold his business and began trading. On Fridays, his trading was horrible. It turns out that when he owned his business, Fridays were the most stressful day, and those emotions carried over to his trading. His solution was to become a trader Monday through Thursday.
We probably often reflect on the ramifications of fear when trading the markets, and rightfully so. Fear can cause us to miss out on good trades or take bad trades. Anger can cause us to revenge trade, becoming a Captain Ahab of Moby-Dick, searching for a whale. I think we all know these feelings, which also include disappointment and depression, are not only harmful to trading but also, when they become our predominant dispositions, seriously damper our life experiences.
What might be generally considered positive emotions can be just as troubling as the negative ones. The following story was a personal one when joy became ecstasy.
It was a Friday afternoon, and I swung for the fences on an options trade which was essentially a lotto ticket with thirty minutes remaining in the session and in the life of the options contracts. Not only did I hit a home run, but it turned out to be a grand slam. I made several month’s worth of salary in thirty minutes.
However, I realized that I was having difficulty allowing my joy to subside to median levels. In fact, I was in ecstasy for days, and I couldn’t settle myself down to a healthy place. Eventually, I needed more thrill, and I began to gamble over the weekend, trying to re-create my good feelings. A short while later, I suffered the most significant loss in my career.
The point is, any emotion, when it becomes undisciplined, takes control of us and can be destructive. At that moment in my life, I realized why many of my predecessors and counterparts where I worked in the financial industry had suffered from many addictions; from gambling to chemicals; because, in part, of the euphoria that we experience when trading and how we want that feeling to maintain.
This is why the momentum has moved to algorithmic trading. Not only are computers able to process information quicker than the human mind, but they are also unaffected by the previous win or loss. They carry no anger, resentment, or joy. We can never reach that level as humans, but we can recognize and own ourselves as emotional beings. We can plan according to our emotions by automating our trading exits and even walking away while trades are working if need be.
Remember, emotions should be experienced appropriately, and where our emotions present a problem, there is a solution to be found. I won’t say “trade without emotion;” instead, I will encourage you to trade with healthy emotions. Until next time.
Trade Well!
