Editor’s note: Today, we’re keeping the spotlight on our colleague Market Wizard Larry Benedict.
In today’s essay, Larry writes about a vicious emotional cycle that’ll quickly burn a hole in your trading account… and potentially put you out of the game.
Read on for more from Larry…
It doesn’t matter how long you’ve been trading, sometimes the markets can really mess with your head…
For example, let’s say you enter what looks like a promising trade, but the stock rolls over and falls.
Or after waiting patiently for a stock price to rally, you bail out of the position just before the stock jumps higher.
It can leave you feeling frustrated, causing you to start trading with your emotions instead of acting rationally.
So then, instead of stepping back and letting a trade go, you start chasing them. That stock you sold out of just before it rallied… well, you buy it back in fear of missing out just before it slumps.
Now, not only have you missed the first trade (which would’ve been profitable), you’re losing money on your second bite at the trade. It’s like you’re always a step behind the play…
This can be dangerous for a trader. It can create a vicious emotional cycle that’ll quickly burn a hole in your trading account… and potentially put you out of the game.
It also means that while you’re tying yourself up in one trade, you could be missing out on plenty of other profitable trades.
The truth is, there are just going to be times when things don’t go your way.
The difference between a professional trader and others is how they deal with it…
Instead of reacting to what’s happened, you need to put yourself ahead of the trade. Meaning, you need to know exactly how you’re going to manage a trade before you place it…
If that means you get stopped out, then you get stopped out. You don’t waste valuable time trying to work out why you were right, and the market was wrong – it achieves nothing.
And like our earlier example, if you close out of a position just before it rallies, then you’ve just got to cop that on the chin. It’s going to happen to every trader at some point.
Instead of trying to get back in, you just need to move onto the next trade. Doing so will you keep ahead of what’s going on.
No matter what size your account is, we’ve all got a limited amount of capital. No one can afford to tie their money up in a long-term trade that’s going nowhere. As a trader, you have to keep that capital flowing.
To help keep the emotion out, you need to think of your trades in terms of risk/reward… not what it might mean if that trade comes off. Thinking that a trade might potentially pay off a personal loan or for your next holiday will simply attach too much emotion to it.
You also need to know exactly where you’re going to exit a trade before you enter it. For some, it might be a stop loss with a fixed dollar or percentage amount.
Some might use a trailing stop that follows a fixed percentage behind their trade (but never moves back lower), and others will use time stops to set their exit.
Whichever method you use, you have to stick with it. The moment you start second guessing your strategy in a trade, you’re going to be vulnerable to your emotions and bring yourself undone.
You simply need to enter a trade based on your analysis, and close out of a position based off of your pre-defined exit strategy.
That’s how you put yourself ahead of the trade.
By applying this consistently over the years, I was able to take the emotion out of my trading. And in doing so, this principle enabled me to become a successful trader.
Good trading,
Larry Benedict
Editor, Trading With Larry Benedict