When I first came into trading, I asked my mentor to recommend some books to me so that I could get on the fast track to trading well. He recommended several to me, most of which were psychological books. I remember being baffled about why he recommended these books. I was thinking, "why doesn't he just recommend a book to me that tells me when to enter trades and when to exit them?".
Soon after I started trading, I found myself making all sorts of errors. When I was testing, I started getting excited and started to interpret numbers in flawed ways. I began hoping that individual tests would yield positive results. I was convinced that I would come up with a unique, highly complicated system that would be better than everyone else's. Once I started trading, I hoped that my trading would be fast paced, with lots of quick moves and split-second decisions because it would make me feel sophisticated, unique and smart. I also found myself getting bullish when everyone else did and bearish at the same time as everyone else. It was because I was not aware that daily news affected my perception of the markets.
Soon I found out that the errors I was making had less to do with trading and more to do with emotions and my ego. I interpreted numbers in the wrong ways because I wanted to be special, not because it was the appropriate way to interpret the data. I jumped to conclusions in testing because I wanted to look good to my peers and to my superiors, not because the data was conclusive. I got bearish and bullish at the wrong times because I was afraid of missing out on call opportunities when the market reached tops, and I felt like I was missing out on put opportunities at market bottoms. It was the need to be right and my fear of being wrong that drove this erroneous thinking and behavior. I finally learned one of the most important lessons in trading! Trading has more to do with psychology and less to do with technical and fundamental factors. All law-abiding traders have access to the same data. It's what they DO with that data that makes the difference between profit and loss. Today, we will discuss emotional accounting, trading goals, and emotions.
Is it possible that a person would have $1000 cash in one place, and a $1000 in cash in another place and value the two differently? $1000 is a $1000 right? Not for some people. Have you ever heard a friend say this? "I just made a lot of money on a gambling trade and I feel like it's not even my money. I can just blow it and there's no loss." Or, "I just won a ton of money gambling. Heck, it's not even my money. I've got nothing to lose."
I bet you've heard something like this before. Congratulations, you've just encountered new trading knowledge. Namely, you now know what emotional accounting is and how it can affect your trading. It's true that you should treat your retirement money differently from your discretionary income, but when it comes to trading, all cash should be respected, lest you lose your shirt and your cash. I've heard a story of trader working a system that produced 26 profitable trades in the row, then he bet his whole account on the 27th trade only to give back ALL of his profits and quit the game altogether. Does this surprise you? Don't' be too shocked because it happens every day. It's happening this very moment. So remember this: respect your cash! Your cash represents your blood sweat and tears that you worked for. More importantly, recognize your change in emotions when you get overly excited, and be careful with how much you marvel at your own genius. Operate by a money management system rigidly so that you don't' fall victim to the "bet-the-farm" mentality or the "may as well lose it all" approach to trading. $15,000 is still $15,000, no matter how you made it. If you trade your profits recklessly, you'll never get ahead in the game. Stay disciplined and systematic.
Here's another note on emotions. Remember this. It is very common for traders to begin evaluating THEMSELVES because of short-term results in the market. For example, it is common for a trader to get out 3 trades in a row too early then ask himself, "Am I much too conservative a trader?" Or in many cases, the opposite occurs by a trader who becomes too aggressive. The point is, beware of this. Don't' evaluate YOURSELF too often because of short term results. Many times, things just happen because the market makes it happen. You have no control once you enter a trade. The market is in control and you simply have to let go and realize there is an element of luck and of chance in trading. Stick to your system!
Everyone knows that setting goals for your life and for trading will reap huge benefits. But is there a drawback to setting trading goals? It depends on how you set them. For example, if you set a goal of a 5000% annual profit target, it's likely that you set that goal arbitrarily. Do you believe you can hit that goal? If so, you will likely set plans to achieve the goal. If you don't' believe you can hit 5000% annually, then you probably won't make make an actionable plan to do it. The point is, traders should set realistic goals that they believe they can hit. Also, never forget this: the higher your goal is, the more risk you will have to take on to hit that number. That means if you are willing to take the necessary risk to reach 100% annually, you'll have to be willing to lose at least 30% annually as well. The additional expected risk is unavoidable so long as you are talking about trading in a law-abiding way.
To conclude, always keep these concepts in mind while trading:
- Take note of your tendency to account differently for the same amounts of money. Respect all of your trading capital- especially realized profits.
- Recognize your tendency to get emotional and to over evaluate yourself according to short term fluctuations
- Realize that your ego is involved in trading. Keep your ego at bay by being systematic in execution and system development
- Only set goals you can see yourself achieving and be aware of the unavoidable risk necessary to reach higher goals.
Be disciplined and trade well!
Price Headley is the founder and chief analyst of BigTrends.com.