For many traders emotional trading is a problem and it stops them from being consistent in the market. We see what causes emotional trading in this article and I share six steps to greatly help reduce it, or stop it entirely.
Emotions in trading have always been one of the main causes of losses, and at the same time − the main driving force for all types of money. Remember the classic idea: buyers push the price up because of greed, and sellers sell because of fear of losses?
It still works perfectly in any market.
Popular training materials on market trading almost do not pay attention to managing emotions. This is understandable: any broker is the first participant in the trading process, which is vitally interested in having you leave your deposit to the market.
That is why most newcomers, especially those who passed the super-fast and super effective training in various brokerage kitchens, remain psychologically unprepared for trading. And even good technical training will not help such players save their money.
Assessing and reacting to market risk is one of the most important things you’ll have to do as a trader. Sadly, human being as a whole are so mediocre at this task, investors and traders reliably make decisions that economists consider “irrational.”
So obviously these are commonly more referred to as emotional trading.
Six Steps to Help You Stop Emotional Trading
Financial markets are a by-product of modern era and, in the grand scheme of things, our brains have evolved over millions of years for survival out in the open. They haven’t had the time to get good at making sound and perfectly rational financial decisions.
We have brain processes; an emotional one and a logical one that are constantly competing against one another for our future expression in the market. And normally, for the trader that has little to no market experience, who trades money they can’t afford to lose, or who has a short fuse overall, the stage is set for an incident.
But also more seasoned traders tend to make emotional trading decisions that they consider stupid in hindsight. Perhaps less often than inexperienced traders do, and with minor consequences, but those errors do happen.
Many a times, although we know with the logical part of our brain that we will get better results if we follow our trading rules, so many of us do exactly the opposite, despite clear knowledge of what we should do.
We remove stops, we cut winners short, we go in with too big of a size… I mean, we’re clearly
not purely rational beings ― and we can’t be because that would make us robots, not humans.
In fact, our inability to be purely rational is the work of the emotional part of our brain, the
limbic system ―and it’s not tied to logic.
The limbic system is tasked only with identifying threats and rewards. It is evolutionarily primitive, it is strong, fast, and more importantly, it is very difficult to ignore.
Occasionally, to suppress that emotional part of your brain, may be a tempting thing for you. Above all, in trading, you hear this all the time: “Control your emotions!” So naturally, you think that if you could do that, you’d finally be consistently profitable in the market.
But, not only is it impossible to fully ignore our limbic system, it’s actually undesirable, and for a
very simple reason: if we can’t feel, we can’t decide.
And, at the same time, there’s a fine line. You don’t want to feel more than you think because
when you do, this results in compulsive, reckless behaviors that end up costing you a lot. So, what’s the solution then?
First, it’s important to remember that the emotional part of our brain is very powerful. It will
force a decision until the logical part of our brain intervenes.
But the emotional part of our brain easily overpowered the logical part of our brain because its weak..
For example, majority of the traders know how to trade – they know how to read charts and manage risk, but they can’t trade profitably because the emotional part of their brain is strong. When trading, it anticipates joy from profits and being right, and pain from losses and being wrong, and it seeks to go towards or away from those feelings at all costs.
And, that emotional part of your brain, the limbic system, likely doesn’t hear the protests from
your neocortex, the logical part of your brain that knows the better way forward.
So, in order to become a better decision-maker and a better trader overall, you need to remember that always.
And secondly, you need to find ways to create more harmony in your mind so that your two main brain processes are not in this constant tug of war.
Below are six steps to help you achieve all this and stop emotional trading.
Step 1 – Understand Your Trading System
Make sure you understand your trading system, its strengths and limitations, and what it will help you achieve in the market if you are the trade it consistently.
This will give you the confidence to follow it through good and bad. This has to be the first step, above anything else.
Step 2 – Trade with Money That You Can Afford to Lose
When you are taking risk, you’re actually doing so with the expectation of earning something in return. At the same time, you must also think of the money you’re risking as already lost.
So you should be happy while taking that risk knowing that the money is already gone because the trade idea is worth a try.
If you do that, then it’s a good risk.
If you’re worried about not being able to make ends meet because of that bet, then it’s a bad risk, and you should think twice about placing that trade. Because if you don’t, you will only conserve emotional trading.
Definitely, needing money and trading is possible, but it would take some serious strong mental discipline. Most people don’t have that.
Step 3 – Bet Small
It’s very simple: By keeping your risk small, you’ll get to place a lot of small bets with big reward
And, because you’re risking less, it’ll be easier for you to make more rational decisions while
keeping emotions and ego out of the way.
But perhaps more importantly, by risking less, you’ll get stay in the game, and by staying in the game you’ll get to learn and develop an expertise.
Step 4 – Reduce Your Trading Volume When Things Are Going Poorly
This one is also pretty straight forward: you want to push the gas pedal when it’s easy for you to make money and release it when it’s hard for you to make money.
Reducing the volume of your trading when you’re not doing very well will help decrease the
possibility of emotional trading.
Step 5 – Be More Aware of The Ego Trap
The best way to become more aware of your ego and the traps it tends to set up for you is to meditate.
Often, people think meditation that is hard or mystical, but it’s fairly straight forward.
Practice this: Take a few minutes to sit still, and focus on your breathing – the air coming in and out at the level of your nostrils.
Notice when your mind wanders and kindly return to observing the breath.
Of course, there are lots of other ways to meditate, but this is easy and simple, and it shows you how to watch your thoughts, feelings, and urges that come up, and see that you don’t need to act on them.
At first, you might not be good at this, but that’s why you practice. And, while you get better and better, you will learn to handle yourself better as a trader, that means that emotional trading will be more under control.
But meditation is not the only way to develop self-awareness. In my opinion, it’s the most
effective way, but it’s definitely not the only way. Writing, for example, can also be a wonderful ally as you work on developing self-awareness.
Step 6 – Make Your Wellbeing Your Top Priority
The final technique for creating harmony in your mind is to make sure that you’re well-rested, well-fed, well-hydrated, at peace with yourself, and as much as possible under little to no financial pressure.
The logical, executive part of our brain is very sensitive to little things like that.
It doesn’t take much to impair our judgment.
If you’re about to make a difficult decision about risk, first eat a granola bar, drink some water, and check how you’re feeling.
If you’re tired, get some sleep. The market is not going nowhere, but your capital is, if you trade
with compromised mindset and carry on with emotional trading.