“Successful trading is always an emotional battle for the speculator, not an intelligence battle.”
-Jesse Livermore
Knowledge is paramount to trading well. There is no
doubt that an understanding of different indicators to apply to a chart
or understanding of the fundamental factors that show an economy’s
weakness or strength can help you gain an edge. However, knowledge can
only take you so far and those who focus only on knowledge or intellect
are often standing in harm’s way when their money is on the line.
That harm shows up in the form of emotions. Emotions
going unchecked often cause a trader to trash the concept of risk to
reward or trade a very large size, which is a common predecessor to
large losses. Therefore, the advanced trader would do well to know how
to limit the negative effect of emotions on your trading.
Why Emotions Are A Problem?
Certainty in an executed trading idea is often a
guise for greed and fear. As a trader, it is important to have a plan
which focuses on entry triggers, trade size,
and risk to reward ratios so that you’re acting in a mechanical manner.
However, you should also be willing to exit your trade or accept the
fact that moving forces in the markets can change quickly so you can
avoid the painful experience of holding on to and closing out larger losses than winners.
Learn Forex: Emotions Alone Would Cause a Trader to Hold This GBPAUD Trade Short
Presented by FXCM’s Marketscope Charts
The opportunities in the Forex market are almost
infinite. Any trader around the world can trade on any time frame using
nearly any strategy. In the end though, the market will either rise or
fall and regardless of your strategy for identifying an entry, you need
to know when to eject from the trade idea so that you’re not holding a
long position in a bear move or a short position in a bullish rip
higher.
3 Focal Points to Manage Emotions
1. Earlier this week, we discussed how key the concept of uncertainty is to our trading success
. This belief that anything can happen at any time should allow us to
be flexible on a mental level so that we’re willing to exit a trade with
mounting evidence. From the start of your trading career, you should be
able to avoid holding onto to any ‘Enron trades’ that can wipe a
trading career off the map because you’re looking for new data that causes you to exit the trade.
2. Trade size
is something that is more paramount to overall trading success than
many new traders realize. Most new traders will run out to find and buy
the hottest system on the market, which was likely optimized and back
tested in market conditions that aren’t present and won’t perform close
to their intended results. Here is a quote from a famous trader, Larry
Williams that many admire after his great trading book, How I Made One Million Dollars…Last Year…Trading Commodities, hit the shelves in 1979 that discusses trade size:
“Thus, what we need to do is
under-bet our system or approach. Do not put as much money behind the
system as the numbers from the past suggest you can. For most of us a 5%
risk factor is all that’s needed to do rather well in this
business…Under-trade, under-bet and you will be overwhelmed with your
results...”
-Larry R. Williams
Personally, I’ve noted that a
smaller trade size keeps me more objective on exiting a trade as well
as allows me to stay in trades longer. Objectivity leads me to focus on
reasons to exit a trade when the facts supporting the trade change. The
smaller trade size also encourages me to stay in a trend longer because
I’m not as eager to close at the trade at the current profit but rather
let the trend run its course which often surpasses what I expect. To
learn other ways to manage your risk, you can register for our free online course here.
Learn Forex: Small Trade Sizes Allow Traders to Emotionally Ride Out a Trend
3. Lastly, a focus on exiting strategies over entries will give you a healthier view of the market. Many traders use candlesticks or an overbought / oversold reading on the Relative Strength Index
(RSI) to get out of a move. The key point is that when traders focus
only on the entry, they’re often likely to hold onto a losing trade
until it breaks even and that is often the death-nail of a trader’s
career that we heartily recommend you to avoid.
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