Fear, hope and greed are probably the three most common emotions traders deal with. Holding on to losers, exiting too early, or jumping in before confirmation are just a few examples of the things we do when emotion manages our trades for us. Trading without well-defined boundaries can be tempting, especially when things like intuition and “gut feeling” are things we take pride in as human beings.
We’ve all heard stories about how someone’s gut instinct helped them to avoid a dangerous situation or how someone’s intuition led them to make a perfect decision with little or no substantive information to guide them. As powerful as these abilities may be in our human experience, I’ve learned that they have no place in trading. I have found that what we perceive as gut instinct or intuition while trading is usually just fear, hope, or greed in disguise.
I address these three specific emotions using three boundaries:
1. Stop Loss- At what price point is my idea proven wrong?
This boundary addresses the fear of realizing a loss.
2. Time limit- How long do I give this trade to work?
Hoping that a trade will eventually work out as price goes no where only ties up capital that could be used for better trades.
3. Target- At what price point does my idea come to an end?
Having a clear target for your idea keeps you from being greedy (Exiting the majority of a position at the target and letting profits run on the remainder is an effective way to address greed with winning positions).