Matthew Kerkhoff, options expert and editor of Dow Theory Letters, continues his 14-part educational...
Are You Falling into the Trap of “Revenge Trading?”
11/12/2010 12:01 am EST
“I just made my daily goal before lunch, but things are going well today so I’m going to try to make a little more. Shoot! I just lost $200. No big deal, I can just make it back. I will get into a bigger position and make back what I lost and then some. Damn! Another losing trade, this time in more share size. Now I’m negative on the day. How did I let this happen?”
The above scenario, while hypothetical, is an example of “revenge trading,” one of the most dangerous things you can do as a trader. Trying to make back lost money because you are either angry or “know” you are right can drive you right out of the business. While it happens to all of us at one point or another, the difference between the professional and the amateur is the ability to recognize those emotions and exercise restraint. Each trade must be judged independently of the others. If you let previous trades affect your mindset and decision making, you will always be trading on tilt.
It is the same way in baseball, basketball, or any other sport, for that matter. As a baseball player, you cannot strike out in the first inning, and then come back up again in the fourth swinging for the fences just because you are mad about striking out. You can learn from the first at bat, pick up some cues from the pitcher, and make level headed adjustments, but there cannot be any emotional carryover. Michael Jordan never let a shot he missed earlier in a game or a season affect his execution on the clutch shot in that moment. A golfer can’t worry about the bad chip previous when trying to make a 20-foot putt for par.
Trading is one of the most emotional professions out there. You cannot eliminate all emotion, but the most successful traders are the ones who learn to understand and control their emotions the best. An angry trader is not seeing things with 100% focus, thus, the chances of he or she making a successful trade after losing the one before diminish significantly.
Imagine yourself in the scenario I described in the opening paragraph. You were having a great morning, up $1,000 before lunch. You then make that extra trade and now you are only up $800. It is a frustrating feeling to throw away that money, but you only compound the problem if you press to make it back. The smart, level headed thing to do in that situation is to say, “OK, I shouldn’t have done that, but now I am going to lunch. I am still up good money and don’t want to give back more because I am angry.” The problem is that we as traders are competitive by nature and hate to give back what we feel is ours. When I am faced with that situation, I try my best to get out of my seat and walk away, even if just for ten minutes. There are times that I don’t, and I suffer the consequences.
One of the many questions I am asked a lot is, “How do you make money so consistently?” My answer is simple: When I am right, I constantly book money. That’s the easy part. But furthermore, I am disciplined in not revenge trading. The hard part is accepting that you are wrong, but when I’m wrong, I almost always move on to the next trade. When I am having my best runs, I very rarely revenge trade. I have learned from my countless mistakes, and realize that trying to make back what I lost immediately is a lose-lose situation. I accept being wrong is part of the business. I move on to the next trade and keep the same mentality I had before my losing trade. That way my head doesn’t play games with my trading.By Steve Levay of T3Live.com
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