Are You an Emotional Trader – The Answer is Likely YES

Overview:

There is no shortage of articles on the internet about allowing your emotions to influence your trades.   A quick Google search and you will find the typical characteristics of this type of trader.  We hear of Greed, Hope, Excitement and Frustration, which often fall along Cognitive Biases of being part of the herd.   We speak of these all the time, but there is another emotional state that is often overlooked, and it is the difference between professional traders and the emotional retail trader.

Emotional Swings

One of the most emotional games is soccer or hockey.  Yes, football has its moments, but in soccer and hockey the action never stops.  This encourages emotional swings and quickly.  However, have you ever noticed after a goal is scored, a team sometimes turns around and returns the favor?  Much of this has to do with how emotional swings affect our next decisions.

Go back to the 1982 playoffs, with the Edmonton Oilers up 5 goals against the underdog Kings, at home, going into the third quarter.  This should have been a foregone conclusion, but with 5 seconds left in the game, the Kings scored the game tying 5th goal.  Wayne Gretzky admitted afterwards in an interview, that they were laughing at the Kings during the second intermission.  This is the perfect example of how emotions can bring down your guard.

Coaching:

As a soccer coach for over many years, it wasn’t until I met a coach at IMG academies that taught me an important lesson that holds true today.  This is not only relevant in sports, but in trading and life itself.  I apply this to my business, trading, investing and personal life.  So what was this game changer?

I noticed as my son was playing, that whenever a goal was scored, there were no “high fives” or “slidding on their knees”, heck the coach simply would get up from the bench and clap his hands, often correcting them after a beautiful goal. I wondered wow, what a lack of enthusiasm.

This continued for a good part of the season and one day after practice I asked the coach, “I notice the kids do not have any emotions on the field is there a reason for this”?  His response? “On the field it is business, emotional highs are followed by emotional lows, and we are not on the field to be emotional we are there to get our business done and win the game.  In order to win consistently, you must remove ALL emotions from the game.  The time to celebrate is at the end of the season!”

Talk about some insight!

Highs and Lows:

These emotional swings are critical to control to be successful over the long term.  I too am subject to the emotional swings in the market, but in realization of this I quickly put my “back to business cap on” and suppress the desire of celebration or frustration.   Unfortunately it is burned into our DNA, and the only way to change this is by changing your habits.

When trading it is all about business and making rational decisions in the now, not what has already happened.  A couple winning trades can quickly leads to over confidence and oversizing on the next trade.  A few losing trades can quickly lead to frustration and trying to make it back on the next trade.

This is exactly why the Edmonton Oilers lost game 3 of the 1982 playoffs to the underdog Kings; or why the falcons gave up a 28-3 lead in the 3rd quarter of the Super Bowl.  These same emotions that we often overlook are why many traders also blow out their accounts.  They lacked the discipline over the emotional challenges that are subliminally driving our decision making.

Recent Example:

Our strategy with Forex is USD based.  We are either short or long the dollar and do not often trade other pairs.  You can read more on our Forex Strategy here, but in short we have a strategy we stick to.  Not that we do not adjust, but it is an adjustment made on rational not emotions.

GBPUSD

We issued a trade signal on the Pound and after hitting the first target at 1.2558 it pulled back up near to our entry level and was jerking around.  After the first target was hit, there was a setup for a Long USDCAD.  Great things are going my way I will jump on this one too!

USDCAD

Because we were still in the GBPUSD trade, and even though our first target was hit, adding another Long USD assumes additional capital risk.  As much as we liked this trade, and under normal circumstances we would have entered a full position, we can not let our emotions take control of the wheel.

So we texted the trade out to our subscribers, but only for a half position here.  There was a rational decision not to over expose our account to the dollar. This was made prior to entering the GBPUSD trade and part of our strategy.  Simply we have a strategy and as good as the chart looks, we must make rational decisions, not emotional ones based on the previous score.

The first target was hit, and we came within 2 pips of hitting the second and then something happened. The pound took out the second target, but suddenly the USD started to show some weakness among a few currencies one being the USDCAD.  This is where we should have seen a continuation.  In the end we decided to close out the second half of our position for a slight gain going into the weekend.

Clearly we could have easily become overconfident in the USD strength and started taking additional risks with a cocky attitude exposing ourselves to the emotions that subliminally drive our thoughts.  Though this time it may have worked out, we remove our emotions and stick with our strategy.  In the long run this keeps us out of too much exposure and large losses.

Emotions:

Often we do not realize how sub-consciously our emotions are affecting our trade and investing decisions.  One way we are exposed to our emotions is with a win.  Yes we get a score and that feeling rolls over into taking on too much risk, or taking a trade we would normally not.

Winning is not the only way are emotions are affected.  Taking a loss on a trade is equally as emotional.  Do you take additional risk, doubling down on the next trade, or simply throw in the towel and give up?

One of the reasons guys like Tom Brady or Wayne Gretzky are winners is when they step on the field or ice it is all business.  They do not succumb to the emotions of what happened but stick with the strategy and plan of grinding it out.

Do you think the young Wayne Gretzky learned about being too confident in the playoff game against the LA Kings in 1982 and getting knocked out of the playoffs after being heavily favored?  Well four championships later and arguably the best player to ever take the ice I would imagine.

Summary

There are numerous ways our emotions control our decision making.  Often we believe that we are controlling our emotions but in reality we simply are not.  Bragging about your wins, leads to over confidence though you may not initially believe it.  The same is true on the other side, where taking a loss bothers one’s ego and they “feel” they were better than that or simply give up.

Life in general is not kind to those who are unable to control their emotions when making decisions, the markets are unkinder.   You think Wayne gave up or realized his mistake and hit the ice in the future as if it was a business?  What makes these guys great in their related sports is what makes traders great in the long term.  Business as usual.

I learned this from a great coach, and it improved my coaching skill greatly once I disciplined myself to control my emotions on the sidelines.  Soon I realized this applies to more than just coaching, but trading and life as well.  We all can learn from the greats be it Tom Brady, Wayne Gretzky or others that have overcome this challenge.

Having a strategy and plan helps subside these emotional tenancies that often we do not even realize exist.  Realizing these emotions exist we can take steps to minimize their influence in our trading and investing. Taking the steps to remove these emotions is as important as positioning and chart analysis themselves.

In closing we are all driven by our emotions sub-consciously, those who realize this and take actions to minimize external emotions in the end will outperform the market.  Do you have what it takes to look in the mirror every day, and approach trading and investing as another day on the field?  Recognizing our own emotions are more important than recognizing others.  I will get more into strategies, plans, and rules in a follow up article.

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