Don't Get Short Sighted by Market Volatility

10/24/2014 6:00 am EST

Focus: STRATEGIES

Alejandro Zambrano

Market Analyst, DailyFX

Alejandro Zambrano, of DailyFX.com, thinks that—while market swings do complicate trading—they can also be advantageous for the trader who can keep his emotions in check. Here, Alejandro offers some suggestions on how to become a more emotionally stable trader.

Taking Advantage of the Financial Roller Coaster

Trading the markets is not particularly easy and, if anything, they are financial roller coasters. Price can trade aggressively higher or lower with an absence of news to back the move. Sometimes price will even trade in contradiction to common sense.

As there is a high number of random market moves, it’s not surprising that the average trader has been right 59% of the time according to our statics. This means that our next trade will be probably be a winner 59% of the time and a losing trade 41% of the time. Our winning ratio is near the outcome of a coin toss, in the short-term, meaning there is no certainty if our next trade will be a winner or not.

If we take this fact and combine it with real money trading, then it makes sense that traders will experience strong mood swings as any given trade can quickly generate a gain or loss. This also explains how greed and fear is part of the market.

The swings of the markets does complicate trading but can also be an advantage to the trader that can keep their emotions in check.

The emotionally stable trader knows and acts like the next trade is just one trade out of many trades to come. One routine which can help traders to be less emotional is to have a trading plan and understanding the key components of the trading plan.

How Our Body Can Complicate Things Further

When the markets move in ways we do not predict, our body will react by producing hormones such as adrenaline, cortisol, and testosterone, which, in turn, place our body on high alert. The primary function behind the release of such hormones is to sharpen the senses and to prepare the body. As in the case of cortisol, to deal with the imminent stress by increasing blood sugar, suppressing the immune system and increasing its metabolism. Although this can, in the short-term, make us more alert, it also reduces our ability to think ahead. As a result, we may act less rational.

It is in this state of high alertness and stress that we tend to think less rationally, traders beginning to feel and behave as if it were their last ever trade. It is at this point that they begin to add to losing positions or refuse to cut their losses.

How Can We Limit the Impact of Emotions on Our Trading?

We should ultimately plan for different scenarios and create a plan contingent on such scenarios. Ideally, this should be done before placing a trade, the reason being that we will be in our most objective state given that neither pride nor money is at stake. Minimally, good levels for our stop loss, profit target, and entry should be worked out. When the time comes and our entry gets triggered, we must adhere to our rules created prior to the trade.

The Mood Swings

The mood swings will still be there even if we trade with rules, and there is no simple way around this, except by exposing ourselves to the market over time. The more we expose ourselves, the more comfortable we become in handling the pressure (the old maxim—practice makes perfect). The most successful traders will understand this and remain cool and just trade their system unshakably independently of any short-term gains and losses.

One way to get around the pressure is through small trading. Starting out with a low one fifth of your desired lot size can be a good start, eventually increasing the risk as you start to become more and more comfortable.

Conclusion

Price can trade aggressively higher or lower with an absence of news to back the move. Sometimes price will even trade in contradiction to common sense. This will cause strong mood swings with most traders, hence generate big swings in the markets. Our body can complicate things further by producing hormones such as adrenaline, cortisol, and testosterone, which can make us less rational in our trading. It’s important to understand that we might not act in our own interest at this point, which makes it important to plan your trade before your executive. Through regular trading, we can become better at handling the stress.

By Alejandro Zambrano, Contributor, DailyFX.com

Related Articles on STRATEGIES