Friday, December 26, 2008

Emotions Control in Trading

Dear fellow options traders :

Emotions control is an important aspect in trading that every trader has to master. 2 of the most common emotions that traders would have to face during trading would be - Fear & Greed.

When a trade is profitable, a trader might take profit too quickly in the fear of losing it. Another trader might be greedy for more profit but saw his or her trade reverse into a losing trade and then regret not taking some profit when available. Yet another trader might encounter a string of successful trades, become complacent & greedy and then bet a large portion of the trading capital into the next trade and promptly lose it all in one failed trade. It is also very common for many traders to hold on to a losing position, hoping (another type of trading emotions) that the stock price would reverse back into a profitable position but instead the stock price keeps plunging & eventually widen the trading losses. The trader would then feel numb of the escalating trading losses and won't even bother to resolve or learn from the trading mistakes.

So how do you handle such emotions so that you would become a better trader? 2 things that I would like to share which would help you would be (1) money management (2) trade management.

Simply put, money management is the strict allocation of a certain percentage of your trading capital for every trade. It's advisable to allocate not more than 5% of your total trading capital for every trade. This percentage of allocation could be adjusted lower if your trading capital is substantial or adjusted higher (not more than 10%) if your trading capital is small. Once you have decided on a particular amount to allocate for each trade, you would then need to determine what is the stop loss level ie. the risks that you are willing to take for each trade. For instance, in stock trading, you should stop out your trade once the stock price losses about 20% of its value. The purpose of money management is to protect or preserve your trading capital if your trade(s) goes awfully wrong. Money management also helps avoid over-trading so that you would not increase your trading "bets" to take revenge of earlier losses. Let's face it, even if you have entered a so-called high probability winning trade, you could still very well lose money in that trade if unexpected circumstances happen in the market. Thus, by practising strict money management on each trade, you would not experience the fear of losing a large fortune if a single trade failed miserably. You could then put your focus more on refining your trading technique to find another trading opportunity and you would have sufficient trading capital left to take up such trading opportunities.

As more & more people are getting versatile with internet surfing and that broadband internet access is becoming more readily available, more traders are now trading with an online trading account. Thus, trade execution and trade management is simply a matter of making a few mouse clicks in an online trading account. There is of course a short learning curve in learning how to do trade online but most online brokerage houses have extensive help menus and real-time customer service representatives to guide you step by step. Setting up a stop-loss and the setting up of a trailing stop-loss are 2 important trade management procedures that every trader has to adhere to. As mentioned earlier, setting up a stop-loss in every trade is part of a good management habit to protect your capital in case a trade goes against you. I would recommend that you set up your stop-loss immediately after executing your trade to prevent you from hanging on to a losing trade once your stop-loss has been hit. There is no point in hanging on & hoping that your trade would recover. There would be other trading opportunities available to you in the market. If you keep letting your trading position hit past your stop loss level & feel frustrated as your losses pile higher, you would not have the confidence or composure to put up another trade which might turn out to be profitable. Thus, be disciplined in your trading and follow your stop-loss level strictly. This would usually be set as a conditional order in an online trade.

When your trade becomes profitable, it's then time to put up a trailing stop-loss so that you can ride your profit if the stock price keeps trending in the correct direction. The trailing stop-loss can also capture the maximum profit achievable if the stock price starts reversing and hit the trailing stop-loss level. This will somehow control your greed of hanging on too long on a profitable trade without taking any precaution that a dramatic price reversal would wipe out all your profits. It would also arrest your fear of taking your profits too soon when you can let the trailing stop loss ride your profit higher. Again, setting up a trailing stop-loss, either percentage based or dollar value based, is conveniently achieved with a click of the mouse in an online trade.

Thus, to handle your emotions of fear & greed during trading, exercising proper money management & trade management would be the two best ways to counteract them. You must remember that with a good trading setup, your trade might have a high probability of success but even such a trade could very well go wrong at times, and your best protection would be proper money management & setting up of an appropriate stop loss.

Regards,

Tony Chai

4 comments:

Option Trading Strategy said...

stop loss is very important to limit our losses. As long as we have capital, we still have hope to be successful in option trading.

Tony Ng said...

This is the most important aspect in trading. In fact one can have all the strategies but let his/her emotion control him/her would end up losing.

Aswin said...

I totally agree. Stop Loss is indeed very important. I always have a stop loss in every trade. Be it in my mind, or i put a stop loss order. However, it is also not prudent to place Stop Loss that is "too tight". One way to gauge how much Stop Loss you should put will be "Average True Range" indicator. I found it to be the most efficient indicator for Stop Loss.

Anonymous said...

Finally, right trading concepts. Have you not realised how dangerous fake investment or trading seminar are..