Lets illustrate the trading emotion using an Intraday Trades,similar emotions can occur over Swing trades and positional trades ranging for weeks or even months.
9:15 AM: You watch as the market opens. You are looking for a good buy entry point into Reliance Infra@330 based on your analysis you think that Reliance Infra has bottomed out after many days of correction stock has seen.
10:30 AM: Reliance Infra inches upward till 333 for an hour from you entry price ie.330,you are waiting for pullback near your buying point to take trade.Reliance Infra then takes a small dip. You think, “Great chance to buy on the dip!” Originally you were planning to buy 2000 shares, 1000 for intra-day trading and 1000 for positional trading.
2000 shares? That means even if you successfully catch a Rs 5 stock price move, you only make a measly 10K? Better double that.
You buy 4000 shares of Reliance Infra at 330 (Emotion: greed), contrary to your initial plan and risk guidelines. Based on your technical analysis, you plan to take profits on half of your shares at 335 and cut losses at 328.
12:30 PM: Reliance Infra zooms upwards along with the Nifty 332, 333 (Wow it broke its previous High ). 334 and finally 335 . you’ve reached your profit-taking point!
But wait! You don’t take profits yet (Emotion: greed) The rally isn’t over.336..338 340.. sweet! This is awesome! (Emotion: elation) You’re not sure why it’s going up this far, but who cares?
You’re making money. You pat yourself on the back. Maybe you’ll buy yourself an expensive lunch to celebrate.
1:15 PM: Reliance Infra rally starts to weaken.. then it starts to move sideways. C’mon, this rally has got to have another leg up, right? (Emotion: hope)
Then Reliance Infra starts to fall slowly… 338..336… Well, that doesn’t mean the rally is over, right?
Your technical indicators tell you a falling trend has began, but your heart tells you that this could be just a slightly over sized downward correction and that the rally hasn’t ended yet (Emotion: denial).
1:45 PM: Reliance Infra starts to trend down further. 334 .. 332 You want to bash your head against your keyboard. Why didn’t you sell earlier? Why is this dropping so much anyway?
Some FII or hedge fund must be short-selling huge amounts to manipulate the price. It’s not fair that hedge funds are bigger than I am. (Emotions: anger, frustration).Price starts falling on rapid scale 330 (Cost Price). 328 ( you’ve hit your stop loss point but you fail to hit the sell button. After all, Reliance Infra was having a great day. Surely the price will bounce back up eventually? (Emotion: hope)
2:00 PM: 325 , 322 320 the selling spree is not relenting. You minimize the window that shows your losses because it is too painful to watch. Why didn’t you sell earlier?
You’ve just erased everything you’ve made from weeks of trading. How are you going to ever make this money back? (Emotion: despair)
You stop caring about how much Reliance Infra can drops (Emotion: resignation). It’s already a huge loss anyway… what’s a couple more thousand matter anyway?
2:30 PM: 315… your technical analysis indicators show that right now may be a good buy entry point.
You know that you already have 2000 shares and you can’t afford to take any more risk. But you are mad at Reliance Infra and you want to get revenge.
You call your broker ask for extra leverage after few if and buts he aggress and you get more leverage. You double down and buy another 2000 shares, bringing your total share count to 4000 (Emotion: desperation).
2:45 PM:Reliance Infra starts to nosedive. Wait, what!? Reliance Infra dropped 5 rs in 1 min? 312..310 What is going on? What are you going to do? (Emotions: panic, fear)
You cringe as you submit a market order to sell all of your 4000 shares at 310. Almost immediately after you sell, Reliance Infra stops nosediving and recovers slightly.
You sold your shares at the worst possible price; if you weren’t so panicked, you could have divided your order into chunks and used limit orders and achieved better price execution. You want to cry. You are a failure. (Emotion: depression)
3:00 PM: You spend the rest of the trading day wallowing in misery without making trades. Next day Reliance Infra opens with a big gap up due to bullish sentiment of global market and it comes back to 323 and makes a high of 340 next day.
You stare in disbelief… but there is nothing you can do now – if only you had followed your initial plan… (Emotions: helplessness, regret).
If You Could Do It All Over…
What would an experienced trader have done in the above situation?
Actually, even experienced traders are affected by emotion – I’ve seen a white-haired trader at a bulge bracket investment bank turning red, swearing his head off, and pounding at his keyboard – but I’ve also met a trader in his early 30′s who never once lost his cool.
So the question should be, “What should this trader have done in the ideal scenario?”
In this example, the trader should have followed his own plan and rules strictly – he should have stayed within his risk limits and do not be excessive leveraged, sold the stock when the price hit the pre-determined stop-loss level, and he should have taken his profits when the stock reached the pre-determined profit-taking level.
In short, he should have sold immediately when the stock hit 335 – yes, that’s “only” a profit of 10000 INR, but it’s way better than loss.
Experienced traders know when to break their own rules because they have the discipline to not break the rules too often and to keep the risk-taking from getting out of hand.
Traders without such discipline such stick to strictly to their rules to protect themselves. As the saying goes, “plan your trades, and trade your plan.”You need to have a trade plan and a profitable trading system to survive in market for long run.
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