When it comes to Trading, there are very few things classified as being 100% predictable. One of the definitively predictable traits about Trading is that if you do not keep your emotions in check while Trading, you are going to lose money. It is just that simple.
It does not matter how much training or market experience that you have. It does not matter what the data and technical analysis in front of you suggest. The second you forget to check your emotions at the door, you put yourself in a position to lose. And those losses may be huge.
Why is this the case, though? What is the deal with these evolutionary traits getting in the way of us trying to make some money?
Fear & Greed: Your worst enemies when Trading
Whenever we talk about emotional trading, we are referencing two particular emotions: Fear and Greed. It is these two emotions that will override any logical and factual thinking that you may have going on inside of your brain. Emotional Trading is the phenomenon that causes so many traders out there to buy high and sell low.
Let us take a look at a couple of examples related to Greed.
● It is 2000, and the freshly minted dot-com industry is absolutely booming. People are liquidating all of their assets solely to invest in these amazingly popular tech companies. They have heard so many other people getting rich, so they jump on board too.
● It is 2007, and so many investors are getting absolutely rich from the housing market and subprime lending. Hedge funds are emptying portfolios solely to buy up junk housing bonds.
● It’s December of 2017, and Bitcoin is just shy of $20,000 with a $334 Billion market cap. Budding investors and ‘wantrepreneurs’ have put everything they own into BTC in hopes of riding it to the top.
All three of the examples above are extreme, but everyone reading this is familiar with at least one of the three scenarios. These were greedy investors letting emotions dictate where their money should go. We all know what happened next: 2001 the dot-com bubble burst, 2008 the housing market crashed, 2018 the price of BTC dropped.
In light of recent events, we sum up fearful Trading with one example
● It is March of 2020. As the Covid-19 wrecks economies around the world, the American markets see a few terrible days. Many everyday Americans get fearful and empty their retirement accounts and stuffer penalties and fees in the process.
Here we are about to enter June of 2020, and the market has made some fantastic rebounds. Because these people fearfully emptied their retirement accounts, they missed out on the upswings that would have leveled their investments back out. Instead, they took a considerable loss and missed out on the potential rebound gains.
Beware Of The Herd Mentality
It is human nature for your emotions to want to take control. Your fight or flight response can literally kick in when it comes to your investments. We are not going to talk negatively about the groups of people in the examples above. They were doing precisely what humans evolved to do.
One of the easiest ways for new investors to tell whether or not they are Trading emotionally is to take a step back and see if they are simply following the herd or jumping on (or off of) the bandwagon.
Are you pumping a lot of money into this stock because you have done your due diligence and believe it to be a good investment? Or are you doing so because well-known investor or someone on r/WallStreetBets said you should?
How To Deal With Emotional Trading
Trading emotionally is so common that CNN Money actually has a Fear & Greed Index. Because emotional Trading often involves large groups, it can actually influence the market. But how can you hedge your bets and mitigate risks when it comes to emotional Trading?
● Make sure you properly understand all risks before Trading. Underestimating the risks involved can cause a knee-jerk reaction should the investment behave differently than you had anticipated
● Dollar-cost averaging mixed with a properly diversified portfolio is an excellent way to dampen the blow of market slumps. This can help ensure you do not impulsively liquidate your investments too early.
● Long-term investor success comes from not running away during short-term volatility. Just remember that all of the successful investors out there are likely staying put during short-term slumps. That is part of what makes them long-term success stories.
Trading with facts and logic is much easier said than done. Often, it takes experience to train your brain to understand your own internal risk tolerance, and to properly calculate the risks of any potential investments. Having an active understanding of both the markets and your own emotions are the keys to long-term success.