Tuesday, June 24, 2014

Stress and anxiety in trading - a trend followers' approach

When using a trend following approach, a combination of your initial or trailing stops, and good risk control, should mean that you can let the markets do its thing without you being glued to your PC all day.

If you are fretting over every tick, either in the market in general, or in any of your existing positions, then it is clear that you are overly anxious - this may be caused by being over-leveraged or risking too much equity on each trade, or trading with money you can't afford to lose - either way, your stress and anxiety increase. When this occurs, irrational trading decisions, made on the spur of the moment, can easily be made.

Good traders know and accept that losses can come along at any time, on any trade. They allow for that in both their risk control and also their mindset. This allows them to trade in their chosen manner, while keeping the stress and anxiety out of their decision making.

When trend following, once you have placed any orders for the day, and updated any stops as per your rules, you do not need to watch the markets. All intra-day action is just noise.  Why stress yourself by following every minor move up or down, for you or against you? It's not going to change what is happening in the market, so why bother?

A trader can only control what he can control - when to enter or exit a trade, and how much is he to risk on that trade. Once a trade has been opened, it is out of his control. The market now has control, and you cannot control the market. The market will determine the price action, and whether you make a profit or a loss on a given trade. So getting yourself all wound up is a waste of time - it won't change anything.

Trading can be a stressful occupation, so you need to do whatever it takes to reduce the pressure on both yourself and your capital. Trading only a small amount of your equity on each position will help reduce stress - you need to cultivate the feeling of 'emotional indifference' towards every trade.

Try looking at charts like that shown in this post. It clearly shows entry and exits levels, but avoids giving you any ideas of what's happening each day. This is almost how a trend follower sees every trade - he knows the price level he wants to enter a trade, and his system logic will also tell him where to place his stops. On the most basic level, he doesn't need to know any other information to trade that position.

On the other side of the coin, you occasionally come across traders who get nervous or anxious when they are NOT in the market. This can stem from a fear of missing out of the beginning of a market move. Again, irrational decisions can easily be made.

As an example, no doubt there are some traders who have gone short in the market today, thinking (again) that the top is now in. Well, they may be right, but they haven't exactly had a high win rate over the last 18 months or so, as new highs have regularly appeared one after the other in the indices.

Trend followers avoid all this by not trying to pick a top or bottom in a market. We wait for price action to tell us if and when a trend has changed. This can vary from trader to trader, depending on their timeframe and/or system parameters. Either way, they have a clear plan of what to do should price hit a certain level, denoting a possible new trend. Again, combined with good risk control this allows us an emotional indifference towards each trade.

If we are wrong on a trade, so be it. I'm wrong more than 60% of the time, so I am used to it. In my own mind, as soon as I put a trade on, I consider that equity to be lost (that's one way to think which will help you keep your position size small). However, I also know that every losing trade brings me closer to a winning trade - maybe a big winner.  So, I ensure I keep my losses as small as possible, and my stress levels as low as possible, by cutting losses short and risking only a small amount of equity on each trade.

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