Friday, June 05, 2015

Two examples of fear and greed

Below are a couple of examples of trading issues I've encountered relating to fear and greed. These are typical of people struggling to getting past the break-even stage of their own trading. As with all issues, identifying them and putting a suitable plan to eliminate them will help accelerate your progress.

Taking too big a risk

This normally occurs when people are all-too-eager to chase big gains on a "can't miss" trade. They may identify a great set up which meets their entry rules and decide to ‘load up’ in the anticipation (or maybe the expectation?) they could make a lot of money on this one trade. The problem is, when taking on too much risk people find it difficult to let their rules play themselves out.

A good example of this was given to me by a trader I now mentor. He took a position in a UK stock that started moving in his favour. He became concerned about taking the profit for fear of it evaporating, so he closed the trade. We looked at the chart from that time, and I discovered that he took profits when they were the equivalent of +2R.

Now, the kicker. The chart showed that, had he left the trade untouched, a pronounced trend took hold which could have generated profits in excess of +15R.

In pure monetary terms, the profit actually taken, and the potential profit available (had he used a sensible level of risk) were about the same. BUT, in order to achieve that, he had taken the trading using far too big a position size - in other words he was risking far more than he should have done.

This had a knock on effect from a psychological point of view. Because the level of risk taken was excessive, the position size played on his mind, and prevented him from following his exit rules – fear had got in the way.

He got lucky on this trade as it went in his favour and made some money. But what if that trade had failed? Well, it would have contributed to a far bigger drop in equity (and possibly created potential future psychological issues).

Remember that, to trade successfully, you need to have an ‘emotional indifference’ towards any trades you take. I have developed the mindset that every trade I take will fail, therefore I want to ensure that the position size I use, and the risk taken on the trade can not cause major damage to my equity or my mindset. Trust me, this is far easier to achieve if your risk levels are under control.

Overtrading - too many positions

When the general market starts making a move itself, people need to be wary of jumping into too many positions, too quickly. Again, this is fear rearing its head – this time, fear of missing out on potential profits. People can become so anxious to make money that they pile into a number of trades. While they may be only risking a small amount of equity on each trade, they massively increasing their level of portfolio risk in a very short period of time.

As we know, in percentage terms trend followers generally end up with more losing trades than winners. So, when market conditions appear to becoming more favourable towards your own style of trading, you still need to be selective in ensuring you take positions which meet all your criteria, and that you slowly increase your portfolio risk.

In my own case, I have strict rules about both the number of trades I can open on any given day, plus the number of trades I can have open at any time. I also employ a very aggressive stop methodology so that, if a trade does not quickly go in my favour, it will be cut. Once I am into a profitable position, then barring a price gap occurring against me, I am able to reduce my risk on that trade, so I can start to look for another set up to take.

Some traders feel that they have to be doing something every day in the markets. As I mentioned in my previous post, this may be appropriate in a strongly trending market, where you have been able to get into a number of profitable trades over a period of time, but when market conditions are tricky you need to rein yourself in, and in certain circumstances being 100% in cash may be the best place to be.

I regularly go through and review trading logs for people who I mentor. What has become a recurring theme (and last year in particular) was that, in a lot of cases, people had taken far more trades than myself over the same period. In one or two extreme cases, three or four times more trades than me. This was a major contributory factor as to why their results were so volatile.

And, the person who traded the least, and had even fewer trades than me, was the most profitable! Sometimes, less really is more...

These are just a couple of examples of fear and greed I have come across in my years of trading, mentoring and generally assisting other traders. If you feel that you suffer with these or similar issues in your own trading, then identifying and overcoming them will help you achieve long-term success as a trader.

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