Investing with an Understanding of Psychological Factors in Market changes

Let’s face it, you are only human and when you have real money on the line, emotions such as fear and greed will surface from time to time even for seasoned traders. This is why paper trading is not a thorough lesson at all and the only way to truly learn how to trade is by risking real dollars. There are, however, numerous books dedicated to learning discipline and control over ones emotions when risking real dollars in the market. Many trading schools of thought focus on providing answers on how to control your own emotions. One attempt at this is made by creating a mechanical trigger system that trades based on data regardless of the trader’s “human” reaction. Despite the amusing advertisements and promises of wealth made by mechanical system creators, i.e. “I buy when the software shows a green arrow, sell when there’s a red one, and I have made $10,000 this month!”, our experience is that you can give a purely mechanical system to ten different traders and still end up with ten different results because it is impossible for humans to remove all emotion when their money is on the line. You may come to the conclusion that your money is better served in the market learning the game than on an expensive software system that promises automated wealth.

Instead, you may try to turn this emotions game on its head. Knowing that fear and greed are a very driving force when it comes to a trader taking a loss, learn market timing based on other’s errors rather than focusing on being correct. Buy from traders that are selling out of fear and sell to traders buying out of greed. When a market is moving, focus on who is in control and who has lost control. Let’s say the market is rising and buyers are in control. Prices have moved higher and continue moving up, obviously this will not last forever. There will come a time when those long traders that are enjoying a nice paper gain will want to take a profit, the market will lose its will to rise, the buyers will evaporate, and sellers will step in. Emotions will play a large role in this activity, and this may be overstating the obvious but bullish greed/hope is its worst at the top and bearish fear is its worst at the bottom. It is my experience that there is NO “holy-grail” type mechanical formula or rule of thumb for spotting this. The key to “knowing” when this will happen is in knowing the market you are trading better than the average trader playing it. This is no small task, and why should it be? You cannot step into a market you know little about and consistently extract money from market professionals at will. While some would have you believe that the markets are entirely unpredictable, successful traders know that the markets are not in a constant vacuous state and the fear/greed factor is responsible for many of the repeated patterns we see.

As for controlling your own emotions, you need to know yourself, as money and risk are relative to the operator. Likewise, there are many traders that could not keep their emotions out of the risky high leverage and volatility involved in certain types of trading, while for others there is no level of volatility that could scare them away. One of the easiest ways to keep your emotions curbed is by not engaging in positions that stand to cause such dramatic equity swings that invite emotions to begin with. Depending on how aggressively you trade and over what time frames, it may also help to treat each trade as very small piece to a larger puzzle thereby eliminating the emotional involvement in any one position. I believe that an individual must have certain emotions such as a passion for trading to become a successful trader. There is, however, little doubt that engaging in trading for excitement, buying out of greed, selling out of fear, and holding out of stubbornness will lead to rapid losses. There is no substitute for the confidence that comes from experience and long term consistency of well executed trading.