In part 1 on Controlling Your Emotions we discussed how to separate our self-esteem and worth from a trade. A trade is just a trade – nothing more and nothing less. The markets may trade intra-trade and this doesn’t mean our setup was wrong. But what are a few other techniques we can use to control our emotions when trading?
Take a Breather
I have no problems sitting and watching a stock for an hour before making a trade. But what happens to me if I am in a trade that breaks down and I am forced to exit? For some reason there is a part of me that wants back in the trade right away. Within seconds I try to take a new position. If that doesn’t work out I try another position. Pretty soon I am a dog chasing my tail.
When you enter a trade and it breaks down, take a minute or two before making another trade. Look at your chart – is there some flaw with your trendline? Is another trend possibly setting up but not yet fully formed? Did you really enter at the right time or were you being impatient since you already missed a big run?
Take a step back and re-draw your chart. Look for a new development. If you can’t figure out or draw a trend on what is happening (which happens a lot), decide to sit this out until the stock does begin to trend. Take your time and do not overtrade. Every trade costs you money and every trade puts you at risk. Don’t jump back into a trade just because your setup didn’t work out. Take a breather and reanalyze before each and every trade.
It Is Not About the Money
Okay, it is about the money but don’t allow your mind to think about that when trading. In most daytrading platforms there is a box that tells you realized and unrealized profits of every trade. You can look and see if you are $50 down or $127 up in that trade. Knowing this will mess you up badly.
I have been in a trade where the stock was popping and I was up $150. Then my mind starts thinking about how good $150 is for a quick trade. Prices spurt and the amount is down to $127 so I sell. Over the next half hour prices went up and that would’ve been a $500 trade. Looking back at the chart, I cannot find a single signal as to why I sold early. The culprit? I was watching the dollar value of the trade.
On the other hand it can play with your mind when deciding to sell. You are in a trade and prices fall. You are down $75 in the blink of an eye. You swear that if you get back to breakeven you will sell. Prices are inching upwards and you only have a $50 loss. Looking at the chart you can clearly see that the trend is broken but you hang on. After a valiant attempt prices go down hard as you are down $150. You swear to yourself that you’ll exit if you get back to a $75 loss. On and on it goes. The problem? You were watching your profit and loss numbers and not the chart. Looking at the dollar amount rise and fall will force emotions into your trade. Trading should be like a game of Tetris where you trade solely based on patterns, setups and price action but not the counter that displays your points or dollar amounts. Hide the profit and loss numbers!
Assess Your Risk Ahead of Time
But can’t you get wiped out if you don’t look at your profit and loss numbers? Not if you consider your risk ahead of time. This can be very simple. Look at the typical intra-day volatility of the stock. Looking over the last two days, how much does this stock trend up or down in a half-hour? 5 cents, 25 cents, two dollars? Then think about how much you want to risk on this trade. Are you hoping to gain a max of $200? You better only trade 100 shares on a stock that moves $2 in 30 minutes but you may need to trade up to 800 shares in the stock that moves only 25 cents. After you assess your share size based on typical prices moves – forget about the dollar amounts. You already computed reasonable parameters for your risk and now focus on price action trading once you place the trade.
There are dozens of books on how to manage emotions and trade in the zone and these are simply a few tips to get you on your way. Keep telling yourself that a trade is just a trade – nothing more or less. You are trading set-ups that have a statistically higher chance of being profitable than not. Take your time between trades – don’t just jump from one trade to the next. Focus on one stock at a time and re-analyze the chart between each trade. Don’t watch your dollar amount rise and fall –when you are not in a trade you can peek at it to see how you are doing for the day but this will still play on your emotions somewhat. Finally, figure out your risk before the trade and use the appropriate share size. While in the trade you already know that you covered that base so there is no need to look at how much money you are up or down. Just focus on the price chart and trade the patterns you see without emotionally trading money.