Controlling Emotions

If you’re in it for the fun, then don’t worry about this chapter, but make sure you have plenty of funds. If you want to make money consistently spread betting, then you do have to be concerned about controlling your emotions. Successful spread traders have to learn how to control their emotions and you would be surprised how difficult it can be. You may think you can control yourself, but once it is real money on the line, emotions can take over.

Controlling Emotions

In fact it is too easy to become emotionally attached to trades and subsequently make wrong decisions. There is a lot of academic research that suggests that people like to ignore evidence that contradicts their beliefs. For instance, a spread trader can be in a profitable spread bet which then starts to pull back and thereby reduce his possible gains in the process. Faced with these circumstances, a spreadbetter might opt to close the trade immediately, not wanting to lose any more of his gains. This is an example of emotion ruling a spread betting decision. And let’s suppose that shortly after you close your spread betting trade, the market moves back in the direction you originally anticipated, what would you do?

Emotional trading will wipe you out from over trading, trading costs, personal depression and low self esteem, eventually you end up blaming everyone and everything except yourself. It’s the market because its out to get you. It’s the market because its out to get you, it’s an impossible game to win, it’s the Market Makers stitching you up. You hear it all the time. Losers sliding down the slippery slope.

“Spread betting usually involves leverage – i.e. the financial impact of any share price or index movement is magnified – requiring quicker decisions. Greater scope for panic and nerviness. So no surprise that spreadbettors encounter greater tensions in managing their positions, and stumble more easily ;o)”.
“In particular financial spread betting is prone to the problem area of ‘behavioural finance’ which suggests that people are more prone to making certain mistakes. For instance, investors tend to follow the crowd and are more likely to remember the good times they’ve had rather than the bad and thus believe that they are more skillful that they really are .”
“We may believe that it is the markets that we are trading against, but professional traders know that they are really trading against themselves.”

FEAR and GREED are often named as the two emotions to control when you are dealing in the financial markets. They certainly seem to be the most prominent, but several others can make you act irrationally, and spoil your plan.

Trading Psychology: Handling your Emotions in Trading

Human nature, even within the context of financial ascension through seemingly profitable trading mechanisms, is always wide open for psychological based complete failure. The inability to interact with real-time or long term reality, through psychological misdirectives such as EGO and PRIDE alone, can in an instant set you on a perilous financial course. The decision string of actions created from wrongfully based mentalities, triggered from improper psychology, will place you on a path of doom even as you enjoy short term gains in a realm of invincibility.

‘I have 6 years of stock trading experience, tried all strategies that can give any profit. All my life I depended from my boss or employer, but I hated all that work . So when I learned about stock trading, I really liked the idea. I never felt so easy and relaxed, and saw my great future in trading. That was only the beginning. Then disappointment, a lot of work, the nerves. There was a time when everything works and you earn lot, and then you lose a lot. There was no stability. I was searching everywhere for it, read many books but all was as before. Smoothly in the selection of literature, I switched to psychology, and in my trading began to notice that the stability can be provided only if there is discipline. I began to understand that this work is not for everyone…’

The most worrying fact is that 80% of amateur traders lose money. I have made a lot of money in the markets over the last 3 years. So I am still up on my investing as I am more of a long term holder. But the stress, the heart beat in the throat, the blood running from my legs when the losses mount…it’s not for me. I have been six figures down on one stock before, held it and ended up making six figures. But with spread betting, you either get stopped out or margin called – and there’s a huge feeling of injustice in the whole thing, as a position you’ve lost a load of money on, stops you out (or you close it) and then the market starts moving in the direction you thought it would. Then you start torturing yourself on the money you could have made if only your position was still open. I have learnt that I am a mid-long term investor – not a speculator. It has cost me enough, this little lesson but I will never forget the figure I have lost in aggregate. I am determined now to make it up via other means.

My advice would be to trade very little or nothing at all until you develop a system. Trading as in day trading is a very hard thing to learn -:

Greed can make you hold on too long to a winning bet, thinking that it has more to give you even when it has passed the point where you know you should take your profit. Certainly, you want to maximize the amount to get out of the winners, but sometimes they overextend and you need to be quick to close the bet when the price comes crashing down.

Fear is possibly stronger than greed, and can show itself in several forms. The obvious fear is that of losing your money. You may fear what others think of your betting, particularly if you have a losing day. You might even be afraid of succeeding, and secretly sabotage yourself. Whatever your fears are, you must not let them play any part in not executing your trading plan properly.

One word of caution…more often than not it is the emotions of greed and fear that tend to cloud peoples’ judgement…fear that they will miss opportunities to profit…they need income now… This state of mind makes spread traders see trades and opportunities that simply aren’t there.

“Spreadbets are much easier to buy and sell but the ‘heart stopping moment’ when the number turns negative and red appears is something you have to master. Learning to manage your own emotions is no simple feat. If you get emotion involved you end up feeling that a share owes you something. Forget it. They don’t. If things aren’t going the right way and you want to cling onto it because you feel ‘this shouldn’t be happening to a solid company like this’ etc, you’re emotionally tied. You can keep going back to the same share over and over if it keeps giving you the signals you look for when entering or exiting a trade. Those are the only two things you should concern yourself with.”
“You need to train yourself to become almost robot like in your spread trading if you are to make consistent profits. The ‘trendy’ days will come where you will make >10pts. However you mustn’t make the mistake of thinking EVERY day will be like this. It won’t. Otherwise you will lose money by hanging on and not closing out”

Other emotions that have no place when you are trading on the market include hope, optimism, and faith. Sometimes a trade starts off in the wrong direction, but you know all the indicators were right and you are sure that it will turn around. So you hold on in hope, convinced that it will suddenly come back even though it has gone past the place where you know you should close the trade. Even more serious is the irrational escalation phenomenon where traders chase their losses and double-up on losing trades despite evidence suggesting they’ve probably got the market direction wrong. Doubling up (averaging down) on losing trades is particularly dangerous as it can result in wipe-out. It is human nature to want to be right. That is why, where possible, you need to place a stop loss order with your broker, so you don’t second-guess yourself if the trade starts to fail. You must treat spread betting as a business, and not allow emotions to override your planning.

Similarly being overly confident, or even under confident is also likely to impact your bank balance in the long run. With regards to optimism; people prefer to look at the bright side. For most, it tends to be more fun, and it is why spread betting providers witness more clients going long (betting that a share or index will rise) than going short (betting it will fall). One of the key advantages of financial spread betting is that you can make money from falling markets by going short. You might as well use it. Sometimes bad news (for a company’s shareholders) can be good news for a bearish trader.

Confirmation Bias: This is a just a nice title which psychologists refer to for the tendency to look for (or interpret) information to confirm your preconceptions. So, for instance, you think that Vodafone shares will rise. You may even have shared your hunch with an old telecom banker mate about your theory in the pub. He tells you you’re talking rubbish, but you then stumble across a posting on a forum that backs your perspective. ‘Aha!’ you say as you log on to your spread betting provider’s account. ‘I knew I should ignore my pal. This guy also thinks Vodafone is going up too, and he says he’s a successful spread trader. I was right after all!’ Unless, of course, you are both wrong.

Anchoring: This refers to the tendency of relying too much one a little bit of information when making decisions. You may be putting too much weight on some piece of data when other factors may be more important and may also be driving the stock’s price you are spread betting on. Blind faith that one or two factors will warrant a higher stock price and give you a winning trade does not ensure a rise. Conversely, it may contribute to running greater losses than you otherwise would.

Normalcy Bias: This refers to the refusal to have a contingency plan for or react to ‘disaster events’. It is less of a newbie’s mistake and is to some extent more forgiveable, as you have been trading this particular instrument profitably for a while. However, it is always one to guard against when you are familiar with, and successful at spread trading, a market.

So how do you control your emotions?

To a certain degree, emotions are a necessary evil in financial spread betting. It helps to be worried about the downside risks as this means you will manage them more effectively. It also helps to be greedy at the right moments so as to let profitable spread bets continue to run. That said, you definitely cannot allow your heart rule your head in the heat of the moment.

The trading pundits say that to be a successful trader, you must control your emotions. The general consensus seems to be that on the road to trading profitability, your emotions are your biggest enemy. The advice these experts give is to become more disciplined, to put all emotion aside.

The problem is none of the trading experts can tell you how to get rid of emotions. That’s because the experts are all missing a basic concept about emotions: emotions are not the enemy; emotions are information. Most of the time, say 95%, the information is about you…not about the market. But you treat is as though it is about the market. Big mistake. Really big mistake.

Why do we misinterpret this emotional data? Ambiguity. The thing about the market is its ambiguity: We don’t know what the market is going to do next. Sure, we have indicators and systems that help predict market movement, but none of these can tell us with certainty what the market is going to do each and every time. When we are faced with this ambiguity, we feel uncomfortable and unsure. Not knowing what is going to happen next makes us feel out of control — this is the perfect scenario for our emotions to run wild.

Whatever is going on inside of us gets projected on the market. If you feel scared because your last trade was a loser, you may hesitate to get in the next trade even though your system clearly says to enter. What’s changed? The trade set-up hasn’t changed; the risk to reward ratio hasn’t changed; the percentage of wins hasn’t changed, the market is the same old market. But you missed a great trade because your feelings changed. We have all made the mistake of acting as though what we are feeling is a reflection of what’s going on in the market.

There is a lot of talk about the two emotions of fear and greed, but it is really a lot more complicated than that. We can feel inadequate (I’ll never learn how to do this); angry at the market (I’ll show you I can trade, I’ll double my lots); angry at self (How could I be so stupid? I moved my stop again.); despair (I just can’t take another loss, what is my wife going to say?); elated (I’m so hot today I can trade anything!), and so on. In all of these examples, the emotion is information about the trader, not about the market.

So, the first step to becoming a more profitable trader is to get the emotions you are feeling up to a consciousness level where you can deal with them. One of the best ways to do this is to talk out loud. Whenever you are aware of being anxious, angry, hesitant etc., say what you are feeling. Speak out loud what you are saying to yourself internally… about the market, about your ability to trade, about the money, about what others are going to think, and so on. Remember that all feelings are acceptable; it’s what you do with them that is the important part.

What you are now saying out loud is the raw data, the information you need, to change your behavior patterns. Ask first “What is the emotion I’m feeling?” Then ask, “What am I saying to myself that makes me feel that way?” Next, ask “Is it true?”

Just going through this process will put you in a different emotional state, one in which you have more conscious control over your actions. You’ll come to recognize that you emotions are more about you than about the market.

Now you’ll want to ask, “Is the strategy I’m using to handle my emotions working to make me profitable?” In other words, when I feel this way, how does it play out in my trading?

So how do you become a disciplined trader?

“The goal of discipline is not to get rid or emotions or even to limit emotions. The goal of discipline is to trade one’s process/plan/method/system etc etc as one would wish notwithstanding one’s emotions.

I have traded a few styles to see what suits – from pure option market making, trend trading – short term scalping, fading breakouts, taking breakouts. Ultimately the conclusion I found is the obvious one – match the style to the personality of the trader. That makes dealing with the emotional issues far simpler and more natural to handle – as the style that makes sense and is easier to trust is the one that will be easiest to stick to when there are inevitable losses. Remember (no matter what people say otherwise) the only way to make money spread betting is to be long the instruments that go up, and short the ones that go down.

Every trader knows that you should ‘cut your losses, and let your winners run’. This requires the ability to stick with your plan, and surprisingly it has been found that traders stay twice as long in their losers, going down, as they do in the winners when they are rising. There is a certain satisfaction in closing a trade for profit, particularly if you have suffered a few losses, but unfortunately this can lead you to close your bet too early, and miss out on some of those winnings. The fact is that the majority of traders will lose money and give up, so you need to avoid being like them.

If you’re the type of person who does not like losing, you may find it difficult to spread bet. Trading on the markets is not for everyone, and you have to be prepared to admit that some of your trades have lost. Sometimes you will do something wrong, such as opening the bet at the wrong time, and at other times you will do nothing wrong and you will still lose. You must be prepared to say “Oh well” and move on from such an experience. That can be very difficult for some people, who will keep going over the losing trade in their mind. If you keep trading diary, as recommended, then you should forget about the losing trade and move on until the time comes for you to review your performance.

# Undisciplined people will turn a good strategy bad because they run for the next holy grail the moment they have a few losing trades.

# Undisciplined people revenge trade.

# Undisciplined people manage their money poorly.

# Undisciplined people don’t take the time to see if market conditions are right for their particular type of trade.

# Undisciplined people allow greed to cloud their judgement.

# Undisciplined traders are like alcoholics they never admit they have a prooblem with discipline.

“Spread betting can end up being a very addictive form of short-term trading or investing, both for losing traders who want to get even and winning spreadbetters that are on a roll, so it is important that, from the outset, investors know when to cut their losses.”

Some spread traders become so emotionally attached to their positions that they are prone to take impulsive decisions in the heat of the moment. Some traders refuse to let profitable positions run for fear of losing unrealised gains. To some extent, such emotions are part and parcel of trading and to some extent it helps to be aware of the risks as this means you will manage them more effectively. What you really need is to be disciplined and plan your entry/exit points, stop and limit orders before you place a spread bet. Testing and optimising your spread betting strategy can be a lengthy process, but a reliable trading plan will help you trade with a calm head: the most valuable commodity in financial spread betting.

The point is, that you do not have to be right most of the time, or even half the time, as long as you control your betting. Successful traders are pleased if 70% of the trades are winners; some successful traders score less than half as winners. As long as you have in mind the overall picture, so that when you win, you win a lot more money than what you lose on any losing bets, then you will be able to bear your losses.

Academic research suggests that people tend to ignore evidence that contradicts their beliefs. ‘You shut down your receptors to learning, and persuade yourself that the markets are wrong. But it may well be that you were wrong and it is best to cut losses at an early point and minimise the downside.’

The problem with most traders comes down to psychology. In a nutshell most people love to win and nobody likes to be wrong. Most traders who fail have a nasty habit of taking profits too early while letting losing trades run indefinitely hoping things will turn alright in the end. Traders may end up spending too much time planning when they could better invest their time planning their exit strategy and trade size.

Although bringing your emotions to the trading arena is never a good idea, having preset entry and exit points built into your spread betting strategy can help reduce the risk of having your emotions interfering with your decision-making process. By setting a stop loss order in advance of entering a trade you remove the emotions of fear from the equation as you cannot lose more than you are willing to risk and likewise a limit order linked to an open trade at which you would like to close your spreadbet position for a profit makes sure that greed does not cloud your judgement either.

Imagine a competition where the goal was to predict if the FTSE would be higher or lower at the end of the month. At the end of each month, the winners stayed in, and the losers were kicked out. Imagine that the entrants were 10,000 monkeys. At the end of the year statistically there would be 2 monkeys who had called every single month correctly. They might brag about their “ability” (if they could talk) and ridicule their evicted brethren, but should you listen to their words of wisdom?.’

Both the investing business and the trading business is littered with tales of woe: “if it hadn’t been for such-and-such I would have made a fortune“, or “I got my timing a bit wrong”. Of course, the successes receive more publicity than the losses: just like betting on the lottery. Brutal honesty and humility is a key ingredient in this game, and one that is often in short supply on investor discussion boards. Survivor bias ensures that many members remain posting because they are profitable. Being profitable is not the same as being smart. Its overconfidence (in one’s own abilities) that is the ruin of many and something I have seen time and time again over the years.

Related: How to ride the Emotional Trading Roller Coaster