Fear-Induced Errors and How to Fix Them

02/24/2015 6:00 am EST

Focus: STRATEGIES

Fear of losing money is detrimental to traders, explains Tom Willard of RevolutionaryTrading.com, but there are some readily available tools that can help traders overcome this emotion.

There are a few different fears that many traders face at one time or another, but for this article, I want to focus on one of the main fears many traders have: the fear of losing money.

The fear of losing money can keep traders from pulling the trigger. This is obvious. The trader is afraid of taking any risk, and so when an opportunity to trade or invest arises based on the trader’s methodology of trading, they have a hard time putting in the order to take the trade.

Have you ever had this problem? I would bet that you have at some point. What is happening here?
Maybe you are starting to doubt your trading methodology/system. Maybe you have had a run of losing trades and you just can’t bear another one. Or maybe you have ten winners in a row and now you are getting hesitant because you think you are “overdue” for a loss.

Perhaps you are trading with “sacred” money, money you cannot afford to lose or money you need immediately to pay the bills and/or feed the family. There are numerous scenarios that can drive the trader/investor into paralysis when their trading methodology signals that it’s time to take action.

A key point is that the same exact situation can drive one trader to be fearful, another trader to be brave, and yet another trader to be reckless. The trader has the power to control how he/she interprets the signals.

Whatever happens, it happens to us all. It’s how one responds that will determine what steps are made towards one’s goals, or away from them.

Whatever the reason, the key solution to this fear is to reset to zero. That is, realize the next trade is a brand new trade. The past is the past, and this trade should not be impacted by a previous trade or series of trades; there is no relationship between them.

The way to objectively assess the quality of the trade is not if it wins or loses. You must verify that this trade fits your trading plan and trading methodology.

If it is, pull the trigger; if it is not, don’t.

See related: Why P&L Doesn’t Determine Success

If you are not sure, don’t pull the trigger and study your plan and method closer so you can figure it out. There will be trades that fall into a gray area, and those are trades that you should just stand aside and watch. Take notes. Mark the entry and the subsequent performance and go back and study it later to find out how you could have taken it or why it was good you avoided it.

The other big problem with trading in a state of fear is that it can give the trader an itchy trigger finger on the trades they are already in. They don’t want to give back the paper profits and want to ring the register as soon as possible because they are fearful, causing them to get out of their winning position too early.

For example, consider the scenario that you take a trade based on your plan, and if this trade hits the target you have established, you will make $1000.

So, you are in this trade, it’s cruising along, and at this moment, you are up $500. Not bad. But now the stock starts to pull back and your P&L reads that you are now up only $450. A minute later you are up only $300; and just a minute after that, your paper profits are now down to $100. You can sense that fear of loss creeping in and you get nervous.

If you are a fearful trader, you will most likely sell at the market to lock in whatever profit you can get as the stock moves back to your entry. So you may book $100 in profits, or maybe you break even. The amount is not important; it’s the fear that is.

Usually, because of the fear, you are blind to the fact that you should be holding on or adding to your position based on all the other evidence of the market, sector, and the market internals. But due to fear, a trader gets so buried in that emotion that they shut off their ability to see the objective truth.

Often after this retracement back down, where the fearful trader gets out of the position and is relieved to break even or make a small profit, the stock then moves back up and hits the target where they would’ve made their planned $1000.

This can be very detrimental to the trader’s mindset and can carry over to revenge trading and other reckless behaviors that can empty an account in short order.

So how do you stop this fear from controlling you?

Manage your trades to your plan…put it on autopilot. If your goal is either to hit the target or stop out, then "set it and forget it." There are so many techniques and tactics to manage trades that you have to find what works for you and your style of trading. Backtest it so you know it works, and then follow it, no questions asked.

See also: The Most Complete Backtest You Can Do

The key to success in trading and investing is eradicating fear and trading from a fearless state of mind. Using the techniques listed above can help you trade and invest in a fearless state of mind.

By Tom Willard, active trader, partner, RevolutionaryTrading.com

Related Articles on STRATEGIES