A popular market breadth indicator, the McClellan oscillator is one of the tools that MoneyShow's To...
4 Trading Fears and How to Overcome Them
08/25/2015 9:15 am EST
Frank Kollar of FibTimer.com explains how you can overcome your doubt and fear and still make solid, profitable trading decisions.
All market timers, traders, and investors in every kind of market feel fear at some level. Turn on the news one day and hear that a steep, unexpected selloff is taking place and most of us will get a queasy feeling in our stomachs.
But the key to successful, profitable market timing—in fact, in all trading—is in how we prepare ourselves to handle trading fears. How we prepare to deal with the risks inherent in trading.
Mark Douglas, an expert in trading psychology, says this about trading fears in his book, Trading in the Zone: "Most investors believe they know what is going to happen next. This causes traders to put too much weight on the outcome of the current trade, while not assessing their performance as a probability game that they are playing over time. This manifests itself in investors getting in too high and too low and causing them to react emotionally, with excessive fear or greed after a series of losses or wins."
As the importance of an individual trade increases in the trader's mind, the fear level tends to increase as well. A trader becomes more hesitant and cautious, seeking to avoid a mistake. The risk of choking under pressure increases as the trader feels the pressure build.
All traders have fear, but winning market timers manage their fear, while losing timers (as well as all traders) are controlled by it. When faced with a potentially dangerous situation, the instinctive tendency is to revert to the fight or flight response. We can either prepare to do battle against the perceived threat or we can flee from this danger.
When an investor interprets a state of arousal negatively as fear or stress, performance is likely to be impaired. A trader will tend to freeze.
There are four major trading fears. We will discuss them here, as well as how to handle them.
Fear of Losing
The fear of losing when making a trade often has several consequences. Fear of loss tends to make a timer hesitant to execute his or her timing strategy. This can often lead to an inability to pull the trigger on new entries as well as on new exits.
As a market timer, you know that you need to be decisive in taking action when your strategy dictates a new entry or exit, so when fear of loss holds you back from taking action, you also lose confidence in your ability to execute your timing strategy. This causes a lack of trust in the strategy, or more importantly, in your own ability to execute future signals.
For example, if you doubt you will actually be able to exit your position when your strategy tells you to get out, then as a self-preservation mechanism, you will also choose not to get into a new trade. Thus begins analysis paralysis, where you are merely looking at new trades but not getting the proper reinforcement to pull the trigger. In fact, the reinforcement is negative and actually pulls you away from making a move.
Looking deeper at why a timer cannot pull the trigger, a lack of confidence causes the timer to believe that by not trading, he is moving away from potential pain as opposed to moving toward future gain.
No one likes losses, but the reality is, of course, that even the best professionals will lose. The key is that they will lose much less, which allows them to remain in the game, both financially and psychologically. The longer you can remain in the trading game with a sound timing strategy, the more likely you will start to experience a better run of trades that will take you out of any temporary trading slumps.
When you're having trouble pulling the trigger, realize that you are worrying too much about results and are not focused on your execution process.
By following a strategy that unemotionally tells you when to enter and exit the market, you can avoid the pitfalls caused by fear.
Wealthy traders learned long ago that unemotional (non-discretionary) timing strategies prevent losses during emotional times in the market. They know the strategies work, so they put aside their fears and make the trades.
And remember, you must be able to take a loss. Consider them a part of trading. If you cannot, you will not be around for the big gains because you will be on the sidelines guarding your capital against that potential loss.
Remember that good timing strategies are designed to guard against big losses. Every trade you take has the potential to become a loss, so get used to this reality and take every buy and sell signal. That way, when the next big trend starts, you will be onboard and profit from it.
Fear of Missing Out
Every trend always has its doubters. As the trend progresses, skeptics will slowly become converts due to the fear of missing out on profits or the pain of losses in betting against that trend.
The fear of missing out can also be characterized as greed of sorts, for an investor is not acting based on some desire to own the stock or mutual fund other than the fact that it is going up without him onboard.
This fear is often fueled during runaway booms like the technology and Internet bubble of the late-1990s, as investors heard their friends talking about newfound riches. The fear of missing out came into play for those who wanted to experience the same type of euphoria.
When you think about it, this is a very dangerous situation, as at this stage, investors tend essentially to say, "Get me in at any price; I must participate in this hot trend!"
The effect of the fear of missing out is a blindness to any potential downside risk, as it seems clear to the investor that there can only be gains ahead from such a promising and obviously beneficial trend. But there's nothing obvious about it.
Remember the stories of the Internet and how it would revolutionize the way business was done. While the Internet has indeed had a significant impact on our lives, the hype and frenzy for these stocks ramped up supply of every possible technology stock that could be brought public and created a situation where the incredibly high expectations could not possibly be met in reality.
It is expectation gaps like this that often create serious risks for those who have piled into a trend late and well after it has been widely broadcast in the media to all investors.
It is not the timing strategies that keep timers from being profitable; it is the fears-which we all have at one time or another-that keep us from making the trades.
Fear of Letting a Profit Turn Into a Loss
Unfortunately, most market timers (and traders) do the opposite of "let your profits run and cut your losses short." Instead, they take quick profits while letting losers get out of control.
Why would a timer do this? Too many traders tend to equate their net worth with their self-worth. They want to lock in a quick profit to guarantee that they feel like a winner.
How should you take profits? At FibTimer, we trade trends. Once a trend begins, we stay with that trade until we have enough evidence that the trend has reversed. Only then do we exit the position. This could be days if the trend signal fails or months if it is a successful trend.
Does this sometimes result in small losses? Yes. If we have a false signal to start with, it can. But we must look at market history to understand this trading concept. History tells us that while there are times when the markets trade sideways or make failed moves, once a real trend begins, it usually lasts much longer than anyone expects.
That means for the few failed trends, the real ones last a very long time and generate huge profits. But because no one knows ahead of time which signal is the start of the next big trend, we must trade them all.
What happens in the short-term can be accepted because we are assured of profits in the long-term as long as we stay with our timing strategy. We do not try to quickly lock in profits. We stay with the trend until the trend changes.
This way we obtain every bit of profit that the markets will give us. And we do not have to worry about locking in gains. We let the markets themselves tell us when to do it.
Fear of Not Being Right
Too many market timers care too much about being proven right in their analysis on each trade, as opposed to looking at timing as a probability game in which they will be both right and wrong on individual trades.
In other words, by following the timing strategy, we create positive results over time.
The desire to focus on being right instead of making money is a function of the individual's ego, and to be successful, you must trade without ego at all costs.
Ego leads to equating the timer's net worth with his self-worth, which results in the desire to take winners too quickly and sit on losers in often-misguided hopes of exiting at breakeven.
Timing results are often a mirror for where you are in your life. If you feel any sort of conflict internally with making money or feel the need to be perfect in everything you do, you will not be able to stay with the timing strategy, but instead will allow your emotions to step into the timing process.
The ego's need to protect its version of the self must be let go in order to rid ourselves of the potential for self-sabotage.
If you have a perfectionist mentality when trading, you are really setting yourself up for failure because it is a given that you will experience losses along the way in timing, as in any trading.
You can't be a perfectionist and expect to be a great market timer. If you cannot take a loss when it is small because of the need to be perfect, then the loss will often times grow to a much larger loss, causing further pain.
The objective should be excellence in timing, not perfection. You should strive for excellence over a sustained period, as opposed to judging that each buy or sell signal must be perfect.
The great timers make losing trades, but they are able to keep the impact of those losses small.
For the market timer who is dealing with excessive ego challenges, this is one of the strongest arguments for mechanical systems. With mechanical systems, you grade yourself not on whether your trade analysis was right or wrong. Instead, you judge yourself based on how effectively you execute your system's entry and exit signals.
Mechanical systems are all that we use at FibTimer. Years of trading experience has taught us that there is no way to keep emotions from affecting trading, except by following unemotional, non-discretionary strategies.
As a market timer, you must move from a fearful mindset to a mental state of confidence. You have to believe in your ability to execute every trade, regardless of the current market sentiment (which is often at odds with the trade).
Knowing that the timing strategy you are following will be profitable over time builds the confidence needed to take all of the trades. It also makes it easier to continue to execute new trades after a string of small losing ones.
Psychologically, this is the critical point where many individuals will pull the plug, because they are too reactive to emotions as opposed to the longer-term mechanics of their timing strategy.
And typically, when traders pull the plug and exit their strategy, it is exactly at that time that the next profitable trend begins.
Too many investors have an "all-or-nothing" mentality. They're either going to get rich quick or blow out trying. You want to take the opposite mentality: one that signals that you are in this for the long haul.
As you focus on the execution of your timing strategy, while managing fear, you realize that giving up is the only way you can truly lose. You will win as you conquer the four major fears, gain confidence in your timing strategy, and over time, become a successful (profitable) market timer.
By Frank Kollar of FibTimer.com
Related Articles on TRADING
While fundamentalists delve into economic and financial data to analyze the market, technicians emp...