For almost everyone, having skin in the game, or a vested financial interest in something will stir up emotion. If a trader or investor is unable to manage their emotions, there is little chance that they will be successful in the long run. Being able to avoid the pitfalls of emotional decision making is one of the most useful skills that a trader/investor can learn to master.
Here are some helpful tips that can benefit both traders and investors.
Trade like a robot. Aim to be as rule-based and systematic as possible. The benefit of trading algorithms and any systematic computer-executed strategy is that the human element is absent from the process post creation. When a big red candle occurs, if it does not fit the system’s rules for changing positions, nothing happens. For many of us, when we see a big red candle it triggers an emotional response. Red symbolizes warning, stopping, and danger. While green can be said to have the opposite psychological effect, one that elicits feelings of greed, moving forward, and growth.
In trading, your goals mean nothing if your rules do not mean everything. Creating rules gets back to a point we made in an earlier article about having an axiomatic framework with which your approach is built on.
The most common rules for trading involve your setups, entries, exits, and risk limits. This means having predefined ideas regarding areas where we will exit a trade if it moves favorably, areas where we must forcefully exit if it moves unfavorably, and how much we are willing to risk on any given trade under the given conditions.
One other tip that is less commonly practiced by retail traders but that is consistently enforced on trading floors by risk managers are cut-offs. If a trader is out of sync with the market or experiencing a poor performance streak, they will reduce their trading or take a break completely until they begin to perform well on the demo again. This is why Phemex’s simulated crypto trading tool is so powerful. Ultimately, a trader should have well-defined criteria that must be fulfilled to enter a trade. If all the requirements are not met entirely, there should be no trade at all.
Educate yourself about yourself
It can be said that fear and greed play a role in every decision we make in life. One of the best things a person can do is to learn as much as possible about the type of behavioral shortcomings that we are most prone to making when captivated by these emotions.
Specifically, the most common cognitive biases that many of us fall victim to when capital is at stake.
Certain snap judgments might have served as survival mechanisms in the past, but in trading and investing these can lead to our demise. There are three pieces of literature on behavioral psychology that every trader should study. “Thinking Fast and Slow” by Daniel Kahneman, “The Psychology of Trading” by Brett N. Steenbarger, and “Trading in the Zone” by Mark Douglas.
Live a well-balanced life
In life, how we do anything determines how we do everything. If you expect to perform well emotionally in the market, you need to make sure the rest of your life is organized as well. Living a well-balanced life outside of the market will have a net positive effect on your ability to trade. If you are failing to maintain the advice presented above on creating and following rules, and as a result, your poor trading is also negatively affecting your life outside of the market, it is time to reset.
Balance entails living a healthy life outside of trading and investing. This means taking care of your mental and physical fitness. These positive changes resonate across all other areas of your life, including back into your trading performance. Eating well, exercising, and most importantly sleeping well; these things are of utmost importance. When we loosen our grip on these areas of life, we lose our ability to maintain clear judgment, logic, and reason.
Trading and investing are some of the most difficult pursuits to participate and succeed in. If you intend to become a successful trader, you must approach the task as the best and most disciplined version of yourself. Fuel your brain with the right nutrition, get an adequate amount of sleep, have other outlets outside of trading, and do not neglect your physical fitness.
By Ryan Scott (@CanteringClark)