Trading is Buying and selling securities or commodities on a short-term basis, hoping to make quick profits.You might hear of rags to riches stories or traders boasting about the money they made in a trade. Its am exciting business but the fact is only 5% of traders are able to make money on a consistent basis.
If you have ever interacted with Successful traders he would say that psychology and emotions are 80% of the battle.
Do not overestimate your ability to be unaffected by emotion.
Neurofinance studies the relationship between the brain and money. We now know that trading activates the same primitive centers in the brain that are responsible for self-preservation. These are the primal emotional and defensive layers of the brain that do not respond to will power (self talk). In fact, the brain is hardwired to prevent you from turning off its primal circuits, its core defensive and reactive processes.
Why? These processes, such as fight, flight and pursuit have great survival value. When these ancient parts of the brain are in control of your trading, however, you will automatically do the opposite of what you consciously intend. It may feel like self-sabotage, but it is not diabolical… it is biological. It is just your self-preservation instincts taking control.
It is difficult to manage an instinct, which is one reason why so many traders underperform and eventually fail.
Real Life vs. the Trading Terminal
Have you ever imagined why doctors,engineers, and maths graduate who are quiet strong in analytical skills have burnt hands in trading ?
The pressure and stress you’ll face will be far greater than anything you’ve ever experienced.
When I first started trading, I was confident of my math and analytical skills – so I thought I could base all my trading decisions purely on analysis, unaffected by emotion.
Nothing could be further from the truth – to see why, let’s walk through the emotions of a trade.
Trading Highs and Lows
To simplify the matter 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 State Bank of India based on your analysis you think that SBI has given a breakdown below 323 and you are waiting for the confirmation signal during market hours to take the trade.
10:30 AM: SBI inches down till 322 for an hour from you entry price ie.323 ,you are waiting for pullback near your Selling point to take trade.SBI does a Small Rally You think, “Great chance to Sell the Rise!” Originally you were planning to SELL 2 Lots(6000 Shares) in Future , 1 Lot (3000 Shares )for intra-day trading and 1 Lot (3000 Shares ) for positional trading.
2 Lots ? That means even if you successfully catch a 3 stock price move, you only make a measly 18 K (6000*3)? Better double that.
You Short 4 Lot (12000 Shares) as Broker is giving 4 times leverage in Intraday of SBI at 323 (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 320 and cut losses at 325.
12:30 PM: Nifty fall down after European Market opens up. SBI fall along with the Nifty. 322. 321.. 320. you’ve reached your profit-taking point!
But wait! You don’t take profits yet (Emotion: greed) The Fall isn’t over. 318.316. sweet! This is awesome! (Emotion: elation) You’re not sure why it’s going down 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: SBI fall starts to weaken.. then it starts to move sideways. C’mon, this fall has got to have another leg down, right? (Emotion: hope)
Then SBI starts to rally slowly… 320… Well, that doesn’t mean the fall is over, right?
Your technical indicators tell you a rising trend has began, but your heart tells you that this could be just a Pullback and that the fall hasn’t ended yet (Emotion: denial).
1:45 PM: SBI starts to trend up further. 321.322 You want to bash your head against your keyboard. Why didn’t you cover your shorts earlier? Why is this Rising so much anyway?
Some FII or hedge fund must be Buying huge amounts to manipulate the price. It’s not fair that hedge funds are bigger than I am. (Emotions: anger, frustration).Price starts rising on rapid scale 323 (Cost Price).324 and 326 🙁 you’ve hit your stop loss point but you fail to hit the BUY button. After all, SBI was having a great day. Surely the price will fall back down eventually? (Emotion: hope)
2:00 PM: 329..331 the Buying spree is not relenting. You minimize the window that shows your losses because it is too painful to watch. Why didn’t you BUY 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 SBI can rally (Emotion: resignation). It’s already a huge loss anyway… what’s a couple more thousand matter anyway?
2:30 PM: 333… your technical analysis indicators show that right now may be a good SELL entry point.
You know that you already have 4 lot (12000 shares) and you can’t afford to take any more risk. But you are mad at SBI 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 Short another 4 Lots (12000 shares), bringing your total share count to 24000 (Emotion: desperation).
2:45 PM: SBI starts to Rally Big Time. Wait, what!? SBI rally 2 rs in 1 min? 335..336 What is going on? What are you going to do? (Emotions: panic, fear)
You cringe as you submit a market order to Cover all of your 24000 shares at 337. Almost immediately after you Buy , SBI stops rally and fall slightly.
You covered your shorts 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 SBI opens with a big gap down due to bearish sentiment of global market and it comes back to 323 and makes a high of 316 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 covered shorts immediately when the stock hit 320– yes, that’s “only” a profit of 36000 INR, but it’s way better than losing INR 2.4 Lakh as this trader did.
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.”