Jekyll & Hyde – Tips on Controlling Your Emotions While Trading

In the years that I have been assisting traders, the one experience that is common amongst all who choose to be part of this crazy trading game is a trade or trades that were take on the basis of emotion rather than sound analytical logic and probability.

We have all been there, myself included and it is not a nice feeling when your looking at your computer screen, palms sweaty, heart beating a million miles an hour staring down the barrel of a large loss but this feeling can be avoided by sticking to a few simple truths. I’m not going to discuss having a trading plan here – everyone talks about having a trading plan as though it will solve all your emotional woes. If you don’t have a trading plan then your simply gambling anyway. Whilst a trading plan is essential – it’s only one part of keeping the emotional monster at bay. Let’s take a look:

You will have losing trades

Let me say this again to make it clear and hit home for you. You will have losing trades there is no way to avoid it so you might as well just accept it as fact. As traders we are essentially predictors of direction. – trading is a game of probability. We use a series of age old techniques to tell us what direction a stock or market is likely to head and if correct we profit. If the market goes against your prediction, it’s not a bad thing, it simply means the market didn’t unfold as expected – get over it and move on. As long as your strategy or trading method is sound you will make money.

Winning percentages mean nothing

Some of the best traders in the world – those who have made millions of dollars work on a win percentage of 40% or less – let me say that again, great traders work on the fact – and make a heap of cash in the process – they will lose at least 60% of the time.

What makes them different from everyone else and the reason they do make so much money is because they have strict money management rules in place that allows them to make many small losses but their winning trade profits far out rank any losses that may be incurred in the process.

Winning percentages mean nothing.  If a trader tells me their strategy works 90% plus of the time there are usually three options I consider:

  1. They’re flat out lying – which is not an unusual situation unfortunately
  2. They don’t actually apply their strategy correctly and this sudden high win rate is simply based on luck and will come undone pretty soon
  3. The high win rate is based on a plan where profits gained are much smaller than their losses. In essence they may have more winning trades but they hang onto losses thereby negating the relevance of a high winning percentage

Strangely enough most traders are actually right more than they are wrong; the problem lies with money management. You can have a 50% win/loss ratio and easily make 100% on your account. For example let’s assume you have 20 trades through the course of a year and your starting capital is $10,000. You have set a risk/reward ratio of 2:1. That is for every winning trade you have, your profit is double a potential loss. Now let’s assume that each of your winning trades resulted in a $2000 profit and your maximum loss was $1000. With the 50% win rate you would have 10 trades that produced a $2000 profit ($20,000) and 10 that produced a $1000 loss ($10,000). $20,000 minus $10,000 is – you guessed it $10,000. Well done you just made 100% on your trading account – this is a superb return in anyone’s book.

Don’t back test yourself into fear

Back testing or paper trading is an essential component to any serious trader’s strategy. Let’s face it you have to test your strategy in order to have confidence that it will actually work and provide you with your desired result which as traders is a consistent profit over long term. But don’t drive yourself bonkers by over back testing. This is most likely a concept that most of you may not have heard of but is quite common in new traders. Over back testing comes as a result of not wanting to lose – essentially this trait is a direct result of our old friend fear. Over back testing results in three serious problems:

  1. Your trading plan becomes far too complicated – You are over the moon that the trading strategy that has taken you a full three months to achieve and includes 100 differing components, triggers and rules has given you a win ratio of 100%. Never mind the three page document of text that details exactly what needs to occur for you to enter this stock – your in the money right? Wrong. You’ve just become a slave to static plan where if one thinggoes wrong or doesn’t line up your confidence will be shattered and you’ll be back at square one. The best traders keep things simple
  2. You become too afraid to pull the trigger on a trade because 1 of your 100 clauses of your seriously over-complicated trading plan – a plan so complex is not even a Nobel prize winning mathematician could work out – is not met. This follows on from point 1. If your chosen trading method or strategy is too complex and relies on too many targets to line up you will become emotional at the thought of entering a trade.  Again, the best traders keep things simple.
  3. You waste a hell of a lot of time – Over back testing wastes a lot of time that could otherwise be spent doing what you should be doing in the first place – actually trading and doing so in a simple

The fact is trading losses are a blessing in disguise. Think about it this way. If from today no trader ever had a losing trade again, how long do you think it would take for everyone else in the world to cotton on to this and the markets would essentially become non – existent because no-one lost? Markets are non-linear, buy and sell orders work together, out of sync to produce momentum. Someone has to lose, just make sure most of the time that’s not you.

Blake Sterling
Analyst
Wealth Within