Monday, August 27, 2012

Fear and sabotage in trading

The biggest danger that an inexperienced trend follower would have encountered over the last week or so would have been fear. This is as a result of the general markets pulling back over the last few sessions, dragging traders' long positions down with them.

Dealing with this is a critical element of being able to successfully follow trends in the market. Nothing ever moves straight up (or straight down) in price. There are always minor retracements, pullbacks etc created by all the market participants and their buying and selling activity, while reacting to news flow, price levels, technical indicators, along with anything else that market participants refer to.

As a result, you can get days where seemingly all your positions go against you. I've had plenty of days when my long positions go down, yet my short positions go up, and vice versa.

To succeed, you need to treat this as market 'noise'. The design of a robust trend following system will tell you when the existing uptrend is over. Adherence to your stop levels, as well as prudent risk control, will help you deal with fear.

The absolute worst thing a trend follower can do is panic, and close their positons when no exit signal has been given. Why is this?

Trend following works on the principle that you control your losses, and let your profits run. It is entirely possible that you can lose 100% of your open profits on a position, yet still not receive an exit signal. Accepting and embracing this is crucial in a trend followers' development.

Trend following goes for absolute returns. There are no profit targets on any position - you simply follow the trend until you get the exit signal. How would you feel if you panicked and exited a position (or a number of positions) at the exact bottom of a pullback or retracement, within the context of an existing trend, which then went back in the intended direction?

Put another way - what is the point in having rules when to exit positions if you override them?

The inexperienced trader will tend to blame the market or other external factors should a position not work. What do these people do when they exit perfectly valid positions before getting an exit signal, like in the scenario described above? Who do they blame? Fear has led to self-sabotage of the traders' own rules. You cannot blame anyone else for those actions - they are 100% down to you.

Fear can be triggered by a number of factors, which can be traced back to your system parameters. Obvious candidates are the number of positions you hold, as well as the risk per trade. Overtrading, or trading too large a position, can do funny things to your self control. People who are normally well balanced can end up doing totally irrational things in the market.

Being consistent in applying your trading rules, and having the correct mindset to to deal psychologically with these counter trend movements will almost certainly end up being a bigger factor in your future profitability as a trend follower than the actual system signals themselves.

This is one of the reasons why I speak and correspond regularly with those who are keen to learn how to trend follow as part of my mentoring programme, so that not only do they learn the nuts and bolts of the system, but also develop the necessary mindset to confidently and consistently follow the system rules, and avoid sabotaging themselves in the market.

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