Saturday, March 24, 2007

The Emotional Roller Coaster Of Trading

These past two weeks of trading have me feeling as if I was on an emotional roller coaster because of the swings I've experienced. I came into the week with large open short profits in SPY, DIA and QQQQ only to see them vanish and actually turn into losers. Then I bought some oil and gold and made it back.

I guess when the market gets volatile, the emotional charge (good and bad) increases as the market decides where it wants to go. Obviously the more money we have at risk, the more our emotions come into play.

This past week though really got to me, not so much because of the P/L swings, but because of the strong opinion I had about the stock market going down. Having a strong directional opinion I think is what puts stress on ourselves when reality takes the market in the opposite direction.

So, what can we do to help reduce some of the emotions of trading. First of all I don't think we can ever eliminate the emotions of trading. In fact, if we did eliminate them, some of us might actually not want to trade anymore! That's right, some people enjoy the emotional rush they get when money is on the line. I personally trade to make money. That's my main reason for trading. I also find great satisfaction in trying to figure it out. I view the market as a puzzle and what I'm trying to do is see the picture before anyone else.

So for me the best way to reduce the stress I feel when trading is to not become so emotionally attached to my opinions and to think in terms of probabilities. I don't care how good you are, most people on average are right on about 50% of their trades. I know dozens of large traders over the years, and most of them are correct in the market anywhere from 40% to 60% of the time. Famous trader Steve Cohen said that his best trader in his office is only correct on about 65% of his trades. So 50% in the long run is the average based on my observations.

When I put a trade on, I must remind myself that there is a 50% chance of me making or losing money depending on which way you want to look at it. If I accept that, then when the trade doesn't work out, I'm not going to be stressed out over it because I've prepared myself mentally ahead of time that I'm right on about half my trades. So being aware of this I think is important and can help reduce much of the stress that we all feel when things don't go our way.

Another way to avoid being on that emotional roller coaster, is to not risk more than you normally do. Trading is a marathon not a sprint. If you plan on trading for many years, it's important to stay in the game by adhering to sound money management strategies. If you are trading too large and risking way too much money, not only do you run the risk of blowing out your account, but the stress you will feel when things don't go your way will be enough to get you sick. This is no way to trade or live in my opinion.

So the two best ways to get off the emotional roller coaster is to not risk a ridiculously large amount of money and to prepare yourself mentally ahead of time to think in probabilities and to realize that there is about a 50% chance of being right on a particular trade.

If any of you have some other ideas as to how we can reduce some of the stress and emotions of trading, please feel free to leave comments. This blog is about helping each other so let's make use of it.

7 comments:

Jim said...

Kevin,

As with most bloggers, regarding trading vehicles, your focus is on stocks, ETFs, options, and futures contracts, most of which have bid/ask spreads, and commissions, etc. which are expensive hurdles to overcome on each side of a short term trade.

Do you ever think of using no load mutual funds as trading vehicles?

The sector and index (some leveraged) funds at Rydex are but one example. Their Dynamic (leveraged) index funds can be traded intra day with 1030 am and 3:45pm deadlines. Simple, efficient, no transaction costs, market makers, or commissions.

Going beyond this, if you are biased to be long, why not use a managed mutual fund with a higher alpha manager, thereby increasing your potential for profit on the trade. Such funds are identifiable using relative strength analysis.

Just seems to me that by not including mutual funds as potential trading vehicles you are missing out on some good trading vehicles
with much reduced trading costs, slippage, etc.

This would be one way to reduce stress.

Regards, Jim P.

Kevin said...

Hi Jim,

I never really looked into trading no load mutual funds although I've heard them mentioned countless times throught the years. I'm just wondering what kind of volatility these no load mutual funds have intra day. They might not be volatile enough to trade over the short term but your other reasons for trading them are excellent. Thanks for taking the time out to comment.

gurlate said...

if an avg trader is only right about a coin toss (50%)..than what is the incentive in trading (a time consuming affair for sure)..trader should at least be able to live off trading..
i keep my day job..and i keep my trades for weeks and not for ours/minutes...
abt the market i still have strong feelings about its downside

HeadlineCharts said...

Hi, I completely agree with Jim regarding trading no load funds or the proshares. I also think it helps to step back and look at the weeklies and Monthly chart and add the perspective they provide.

Kevin said...

Hi Gurlate,

You can be right only 30% of the time and still make a very nice living trading. It's all about how much you make when you are right and ho much you lose when you are wrong.

If you make on average 2 times as much as you lose and you are right 50% of the time, you will make an enormous amount of money over time.

Dogwood said...

Nice post Kevin.

I've tried to eliminate the emotions from my long term trading by using a trend following system.

I don't try to guess the direction of the market, I just let the system do the work.

If the system starts issuing buy signals, then the market is going up. Simple. No guess work. Just execute the signals, place my stops, and get out of the way.

If the buy signals become few and far between, or nonexistent, then the market is either going sideways or down and I just wait, or day trade around my long positions until the buy signals return.

My challenge is finding an effective day trading strategy and keeping emotions out of that activity!

Missy said...

If you can actually get your winners to outperform your losers @ a minimum 3/1 clip, you can be even worse than 50% and make money. Just like poker, you need to lose many/most of the time before you can win. Its all in capital mgmt and taking the right risks to gain the appropriate rewards. That's why we play the trading game, it will never be perfect but the odds are definitely better than any table game including poker that I have found. Keep up the great posts.

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