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2011-07-19 12:29:39
There are many characteristics and skills required by traders in order for them
to be successful in the financial markets. The ability to understand the inner
workings of a company, its fundamentals and the ability to determine the
direction of the trend are a few of the key traits needed, but none of these is
as important as the ability to contain emotions and maintain discipline.
Trading Psychology
The psychological aspect of trading is extremely important, and the reason for
that is fairly simple. A trader is often darting in and out of stocks on short
notice, and is forced to make quick decisions. To accomplish this, they need a
certain presence of mind. They also, by extension, need discipline, so that
they stick with previously established trading plans and know when to book
profits and losses. Emotions simply can't get in the way. (To read more about
trading psychology, see Master Your Trading Mindtraps or discuss at Trading
Psychology forum.)
Understanding Fear
When a trader's screen is pulsating red (a sign that stocks are down) and bad
news comes about a certain stock or the general market, it's not uncommon for
the trader to get scared. When this happens, they may overreact and feel
compelled to liquidate their holdings and go to cash or to refrain from taking
any risks. Now, if they do that they may avoid certain losses - but they also
will miss out on the gains.
Traders need to understand what fear is - simply a natural reaction to what
they perceive as a threat (in this case perhaps to their profit or money-making
potential). Quantifying the fear might help. Or that they may be able to better
deal with fear by pondering what they are afraid of, and why they are afraid of
it.
Also, by pondering this issue ahead of time and knowing how they may
instinctively react to or perceive certain things, a trader can hope to isolate
and identify those feelings during a trading session, and then try to focus on
moving past the emotion. Of course this may not be easy, and may take practice,
but it's necessary to the health of an investor's portfolio. (For more, see
Understanding Investor Behavior.)
Greed Is Your Worst Enemy
There's an old saying on Wall Street that "pigs get slaughtered". These little
pigs want more and more. This greed in investors causes them to hang on to
winning positions too long, trying to get every last tick. This trait can be
devastating to returns because the trader is always running the risk of getting
whipsawed or blown out of a position.
Greed is not easy to overcome. That's because within many of us there seems to
be an instinct to always try to do better, to try to get just a little more. A
trader should recognize this instinct if it is present, and develop trade plans
based upon rational business decisions, not on what amounts to an emotional
whim or potentially harmful instinct. (Keep reading about this in When Fear And
Greed Take Over.)
The Importance Of Trading Rules
To get their heads in the right place before they feel the emotional or
psychological crunch, investors can look at creating trading rules ahead of
time. Traders can establish limits where they lay out guidelines based on their
risk-reward relationship for when they will exit a trade - regardless of
emotions. For example, if a stock is trading at $10/share, the trader might
choose to get out at $10.25, or at $9.75 to put a stop loss or stop limit in
and bail.
Of course, establishing price targets might not be the only rule. For example,
the trader might say if certain news, such as specific positive or negative
earnings or macroeconomic news, comes out, then he or she will buy (or sell) a
security. Also, if it becomes apparent that a large buyer or seller enters the
market, the trader might want to get out.
Traders might also consider setting limits on the amount they win or lose in a
day. In other words, if they reap an $X profit, they're done for the day, or if
they lose $Y they fold up their tent and go home. This works for investors
because sometimes it is better to just "go on take the money and run," like the
old Steve Miller song suggests even when those two birds in the tree look
better than the one in your hand. (For more, see Removing The Barriers To
Successful Investing.)
Creating A Trading Plan
Traders should try to learn about their area of interest as much as possible.
For example, if the trader deals heavily and is interested in
telecommunications stocks, it makes sense for him or her to become
knowledgeable about that business. Similarly, if he or she trades heavily in
energy stocks, it's fairly logical to want to become well versed in that arena.
To do this, start by formulating a plan to educate yourself. If possible, go to
trading seminars and attend sell-side conferences. Also, it makes sense to plan
out and devote as much time as possible to the research process. That means
studying charts, speaking with management (if applicable), reading trade
journals or doing other background work (such as macroeconomic analysis or
industry analysis) so that when the trading session starts the trader is up to
speed. A wealth of knowledge could help the trader overcome fear issues in
itself, so it's a handy tool.
In addition, it's important that the trader consider experimenting with new
things from time to time. For example, consider using options to mitigate risk,
or set stop losses at a different place. One of the best ways a trader can
learn is by experimenting - within reason. This experience may also help reduce
emotional influences.
Finally, traders should periodically review and assess their performance. This
means not only should they review their returns and their individual positions,
but also how they prepared for a trading session, how up-to-date they are on
the markets and how they're progressing in terms of ongoing education, among
other things. This periodic assessment can help the trader correct mistakes,
which may help enhance their overall returns. It may also help them to maintain
the right mindset and help them to be psychologically prepared to do business.
(For more, see Ten Steps To Building A Winning Trading Plan.)
Bottom Line
It's often important for a trader to be able to read a chart and have the right
technology so that their trades get executed, but there is often a
psychological component to trading that shouldn't be overlooked. Setting
trading rules, building a trading plan, doing research and getting experience
are all simple steps that can help a trader overcome these little mind matters.
by Glenn Curtis
Glenn Curtis started his career as an equity analyst at Cantone Research, a New
Jersey-based regional brokerage firm. He has since worked as an equity analyst
and a financial writer at a number of print/web publications and brokerage
firms including Registered Representative Magazine, Advanced Trading Magazine,
Worldlyinvestor.com, RealMoney.com, TheStreet.com and Prudential Securities.
Curtis has also held Series 6,7,24 and 63 securities licenses.