Trading Lesson: 10 Emotional Mistakes And How to Avoid Them in Trading
03/08/2018 4:13 am EST
We’re all prone to make emotional mistakes. Check these 10 tips before your next trade. Do this until it becomes second nature. The next time you find yourself in a slump, re-read this and return to the basics, says Dave Landry, founder and president of DaveLandry.com.
Recently, I was leafing through the Layman's Guide To Trading Stocks for a pattern recognition project with a charting software vendor. Anyway, I found the following emotional checklist for trading. In my classic Random Thoughts blog style, I decided to expand upon it.
1. Are market conditions favorable for your methodology at the moment?
For trend following, this means that the market has been trending and not trading sideways. Draw your arrows and apply the Rip Van Winkle “sleep test.”
Random Thoughts (RT): This simply means to imagine that you went to sleep for a long time. When you awoke, you checked the market prices and noticed that they were relatively unchanged. This is the reoccurring net net issue that I often discuss. Many people claim to be trend followers, but they are often interested in stocks that have gone absolutely nowhere for weeks and even months.
2. Are you following sound money management?
Remember, money management will cure a multitude of sins. It will keep you in the game until the sun shines on you and your methodology.
RT: There’s a saying in the South: “The sun doesn't shine on the same dog’s butt every day.” I was once criticized for saying that momentum trading can be streaky. Well, it is. You print money for a while then you all-too-quickly go right back to grinding it out. Money management cures a multitude of sins by keeping your ego in check when the sun’s shining and mitigating the damage when it isn’t.
3. Have you lived through a variety of market conditions?
If you have only experienced a bull market, then trust me, you do not know what it is like to be in a bear market. We are all human. It is impossible not to get excited when things are going well and depressed when things are not. Knowing that market conditions change can help temper these emotions.
RT: Well said, Big Dave!
4. Do you know your methodology?
Knowing that your methodology has the potential to stop you out numerous times before catching the mother-of-all trends makes it a lot easier to handle losses when they occur.
RT: I’ve had many clients over the years come in at the perfect time. They print money and quickly think they get it. This trading thing is so easy. The Humphrey Neill quote, “Don’t confuse brains with a bull market” comes to mind, but I’ve also seen people do amazing things in one-sided bear markets.
Ego-driven behavior begins to rear its ugly head. They soon fire me because they get it, and want to do it all on their own. I’m not saying that I’m all that and a bag of crisps nor am I implying that I’m the Grand Poobah. I’ve been around the block a time or two and know that there will be good times and bad.
Conditions change and the monetary and emotional fall often comes shortly thereafter. My favorite clients are those who have stuck it out through the good, bad and indifferent times. They know that bad times often follow good. They keep me on staff to keep them on even keel-helping them to press (a little) in good times while keeping their egos in check and mostly sitting on their hands in bad (i.e. to be patient). I also like clients who return after going off to chase empty promises and Holy Grails. They realize that there is no magical bullet--other than grinding it out in a trading simplified manner.
5. Are you straying from your methodology?
If you are trading my swing-to-intermediate method, then you should not be making numerous trades daily. You should not be buying markets because they are oversold or shorting them because they are overbought.
RT: I’ve fixed a few clients by dissecting their portfolio--removing their day trades, breakouts (other than in IPOs), reversal trades and any other trades outside of the core methodology. Once these are removed, their portfolio is often profitable. The ah ha epiphany that follows is usually more of an I know, I know!
The main secret to trading is that there is no secret. If there were, someone would have found it and there would be no more markets. There are simple secrets such as doing just one thing. And, when the sun isn’t shining, you sit on your hands. You might want to write that down.
I once met a trader who claimed to be trading breakouts when the market was following through on breakouts and reversals when it wasn't. No one is that good. I can all but guarantee that you’ll be perpetually out of phase if you try.
6. Have you been trying to outsmart the market?
Are you trying to get in early: before a trigger early and exiting at the first minor signs of adversity? In other words, are you not following your plan?
RT: Well said, Big Dave!
7. Do you even have a plan?
RT: It’s cliche to say plan your trade and trade your plan, but do you do it? The reason that many don’t plan a trade is that the moment you plan is the exact moment that you have to accept the fact that you could be wrong. And, once in a trade, if you do follow the plan it means that you will accept what the market gives--or takes. It removes hope--and as humans, we’re not wired to be hopeless--otherwise, why bother?
8. Are you trading the best and leaving the rest?
RT: The same successful people, doctors, lawyers, and automatic transmission mechanics--who strive for perfection in life--often settle for mediocrity in the markets. After years of searching for why this is so, a client who is a psychiatrist explained it to me. In life, highly trained professionals don’t have the luxury of waiting for the ideal client. “...they have to take whatever train wreck comes along.”
9. Are you dealing with any major or not so major life events?
RT: Re-reading this one hits home. My father was recently diagnosed with leukemia and it took his life within a few short weeks. On nearly the same day, my mother was diagnosed with lymphoma. I’m now spending my time split between two offices, helping her in her battle three hours away, while trying to keep it all together at home--which includes downsizing from six+ acres with a guest house to something much smaller, maybe even a condo.
All of this is forcing me to look long and hard at each and every trade. Am I taking this trade to try to fix something in my personal life? Or is this a fantastic opportunity that must be taken? You know, even if things are going fairly well in your life, you might still want to ask yourself that question.
10. You know what you are doing wrong. What is it?
RT: I’ve made videos and have written extensively about this, both here at DaveLandry.com and in print. Provided that you've traded through a variety of conditions and know your methodology, then you know which of the above nine you’re violating. If not, ask me and I bet that I can get you to say, “I know, I know!”
We’re emotional beings, prone to make emotional mistakes. Embrace and accept this. Then, check this checklist before making your next trade.
May the trend be with you!