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Handling Fear and Greed in Your Trading
By Price Headley | Published  12/7/2005 | Currency , Futures , Options , Stocks | Unrated
Handling Fear and Greed in Your Trading

One of the most difficult aspects of trading in today's market is handling your own emotions. For more than four years now we've struggled through a market and an economy that seems intent on remaining an emotional yo-yo. To say "don't get emotional" is pointless, as we are all emotional about our money. I wish there was an easy solution for that problem, but all we can offer today some insight behind the issue.

While there are literally volumes of books on the mental side of trading alone, the real challenge for most true traders is living in the past. A loss is a tough thing to get over, and the bigger the loss, the tougher it gets. But getting over a loss is not the only problem. As odd as it may be to read or hear, you often have to forget about your big winners as well. The most effective traders seem to have a short-term memory. In other words, the best traders only see the trade they're about to enter, or the one they're currently in. The rest are out of sight and out of mind (note that there's a difference between learning from past mistakes, and letting past mistakes cause more in the future). Why is that the difference between successful and unsuccessful traders? Successful traders are wise enough to know that fear and greed will ultimately lead them down the wrong path.

So what do fear and greed have to do with forgetting about the past? Plenty.

Fear doesn't form in a vacuum. It is a learned response to a particular event or probability. In the case of trading, when you have a trade that goes bad, the regret and frustration can carry over into the NEXT trade. Or worse, the fear is so consuming, that you don't enter your next trade. Of course, Murphy's Law dictates that the trade you don't enter is the one you should have entered, which only compounds greed (and frustration). This particular problem is fueled by the expectation that every trade you enter should be profitable. If you truly believe that, then here is an important piece of information for you - not every trade will be profitable!

Greed creates the opposite problem. With a couple of consecutive winning trades, the ego can enlarge and feeling invincible overcomes being logical. This will ultimately lead you to trades that you normally would not have entered. Finding good trades is hard enough, while finding poor trades seems to get much easier after a couple of winners. Never mistake genius for a little luck.

So now we come to our point about being emotional.

There is a critical difference between 'being emotional' and 'being blinded by fear and greed'. Experienced traders know this. In my book there is an entire chapter regarding trading psychology, yet there is one sentence that summarizes a great deal of that chapter:

"Fear blinds us to opportunity; greed blinds us to danger - emotions cause 'perceptual distortion' where we only see the part of the picture that our beliefs allow us to see."  

It's important to recognize your emotions, and more importantly, how they affect your investing approach. In general, we all want to be bullish, and are eager to see any upward market movement as a rally, even when it's not. Simultaneously, after a volatile beginning for the year we are all somewhat gun-shy right now, especially in the face of mixed messages. Regardless of your current opinion, you are better served by feeling with your heart, while investing with your head. Are fear and greed driving your investment decisions right now, or or you in control of your emotions? If you're not sure, I'd recommend taking a step back and looking at the market from a different unemotional one.

Price Headley is the founder and chief analyst of