An In-Depth Guide to Managing Your Trading Emotions

If you’re serious about your trading I’m sure you already treat it like a business. You have a trading plan, you keep meticulous records, you study the markets each evening and on weekends, but you still may not be making consistent money.

Stop and think for a moment…

What’s your most important activity in your trading business?

What pain do you have associated with that activity?

Let’s face it, the reason we trade is to make money. Yes, there are challenges and obstacles that help us better understand ourselves and grow as individuals, but the bottom line is to generate positive returns and make money.

Ok, so the goal is clearly defined. The most important activity then, is to execute a profitable trading strategy. (More on determining the profitability factor of your trading strategy in next week’s post)

The Road to Consistently Profitable Trading Starts Here…

You’ve probably heard that consistently profitable trading is more a function of mental strategy than it is trading strategy. And I know you’ve heard me stress the importance of keeping your strategy simple. So, it may surprise you when I tell you that most trading strategies have the ability to be profitable. It all comes down to execution.

Most traders spend their careers bouncing from strategy to strategy instead of honing their focus on one method. The reason this is important is because focusing on a method allows us to master not only the strategy, but the emotions and decision making skills that surround it.

Have you noticed the more you know about a system, the simpler it is, and the more you’ve made it your own, the better your trading results are? That’s because you’re able to better execute the strategy.

What pain then, is associated with or stopping you from executing your strategy effectively? Your emotions.

The emotion of fear is the #1 culprit that keeps most traders from reaching the level of consistency and profitability over the long term.

Does your heart beat faster as you’re about to enter a trade? Do your palms start to sweat when you hear the sound of your order being filled? Do you feel like your trading plan goes out the window as soon as you see the price ladder start to move and you impulsively exit, or break your rules? Let’s look at some ways to overcome your trading fears.

Getting Over the Fear

You absolutely must have conviction in your system; belief that over the long run, a positive outcome will result. There’s only one way to gain this conviction and that’s to test. Test, test, test.

You want to build a data set that you can go back and analyze. Observing results over a larger period of time then adds to your confidence and ability to execute effectively.

The more testing you do and the more data you gather (through both live and SIM trading) the more those feelings of fear, attachment, and uncertainty will diminish. What you are really doing is removing the human discretionary element from your trading and turning it into more of a mechanically structured framework.

Why Experienced Traders Lose

The biggest issue I see with more experienced traders after they learn a system and begin to make money is they feel unsatisfied at the end of the day because they’ve left money on the table. Their rules told them to exit so they did, but then the trade ran another 3 points. So what they do? They make changes to their execution so that instead of taking a medium arbitrary profit, the next trade they will trail their stop. But then the next trade doesn’t happen to be a runner so they switch back to taking a smaller profit and the next trade is a runner. Back and forth this persists. Instead of sticking to one set of rules and focusing on the outcome over the longer period the more experienced trader finds the need to keep making constant changes.

Developing Emotional (Un)-Attachment

Losses are unavoidable, but often the pain of losing is felt stronger than the joy of winning. A missed profit may hurt just as bad as taking a loss, thus traders hang on to losers in the hopes that they come back around and turn into winners.

If you resonate with these statements you’re not alone…

Knowing What You Know NOW

A great trader makes the best decision with the information they have in front of them at the time. They don’t dwell on the fact that the trade either worked or didn’t work. What’s most important is putting your money into the best opportunity at the time.

If you strategy shows a positive expectancy over the long-term (as many simple strategies such as my own do), then you must develop the conviction to take every trade and manage it according to your rules, regardless of the individual outcome.

In the firsthand account of the turtle traders experiment by Richard Dennis and William Eckhardt Way of the Turtle by Curtis Faith, Curtis talks about 4 emotions and 8 cognitive biases all traders bring with them into trading. Understand them, and you will have a leg up on your competition.

  • Hope: I sure hope this goes up right after I buy it.
  • Fear: I can’t take another loss; I’ll sit this one out.
  • Greed: I’m making so much money, I’m going to double my position.
  • Despair: This trading system doesn’t work I‘ll keep losing money.

I recommend you keep an “emotional journal” during the trading day and record when you feel these emotions and how you react to them. In time, you will begin to better control your first impulse after feeling one of these emotions.

Why You Might Be Sabotaging Your Own Trading?

The way most people view the world is not the way successful traders view it. You may come into trading with the following cognitive biases, but shifting away from these natural tendencies is necessary to make it as a trader.

Here are some of the cognitive biases that affect trading from Way of the Turtle.

  • Loss Aversion: The tendency for people to have a strong preference for avoiding losses over acquiring gains.
  • Sunk Costs Effect: The tendency to treat money that already has been committed or spent as more valuable than money that may be spent in the future
  • Disposition Effect: The tendency for people to lock in gains and ride losses.
  • Outcome Bias: The tendency to judge a decision by its outcome rather than by the quality of the decision at the time it was made.
  • Recency Bias: The tendency to weight recent data or experience more than earlier date or experience.
  • Anchoring: The tendency to rely too heavily, or anchor, on readily available information.
  • Bandwagon Effect: The tendency to believe things because many other people believe them.
  • Belief in the Law of Small Numbers: The tendency to draw unjustified conclusions from too little information.

These powerful misconceptions affect most traders in a dramatic way more so on a subconscious level. It’s up to you to observe these biases, understand their effect on your decision making, and learn to shift away from these initial tendencies.

If you feel emotional pain associated with trading on your journey to becoming consistently profitable I recommend you study these cognitive biases, test and master your trading method, and widen your view of the markets from this next trade, to the larger expected outcome of your trading system.

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About Tim Racette

Tim is a full-time trader in the futures and stock markets and founder of EminiMind.com. He is also a Chicago-land native, competitive mountain biker, adventurer, and ASU Sun Devil.

2 Responses to “An In-Depth Guide to Managing Your Trading Emotions”

  1. I’m definitely feeling there’s a gap between having and knowing your edge, versus being able to execute it in real time.

    For me reviewing a 5 hour trading session on paper the entries are all objectively right there, it’s being able to stay focused for the trading session and take the setups as they develop.

    Thanks for the post though, consistency seems to be the key.

    • Hi Andrew,

      You’re absolutely right about that and even more so, being able to identify your edge is one thing, being able to act effectively and repeatedly is an additional skill.

      For me, going through and calculating out my expectancy of each trading system was key. Getting to know what happens when you change different variables allows you to modify your outlining strategy.

      At the end of the day, a good trader has to be able to pull the trigger and get things done.

      You ever notice how some people talk about doing something for a long time, others are always taking steps and trying new things. Having a top down approach keeps you moving in the (generally) same direction.

      Tim

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