Every trader needs to understand the basic principles of successful trading. These principles are more about big picture concepts than trade tactics and evolve around 5 profit killing emotions.
The following are the 5 emotions described by Selwyn Michael Gishen in his “The Artful Trader” book:
Everyone starts off being hopeful that they will be able to select a profitable trade. This kind of hope is necessary as a motivational force. Hope keeps you going. However, there is a difference between rational hope and blind hope, which is based on wishful thinking. Once again, if you are equipped with the necessary skill sets, you will be able to make rational decisions, including risk management, without being led astray by unrealistic hopefulness.size. At this point in the trade we can either follow our plan or succumb to the emotion of greed. Greed will drive a trader to ignore his plans and to take positions that ignore proper risk management, or ignore the probabilities.
If you take a position based on proper planning, then you have put hope into its right perspective. You stand to be tested by the second of the dominating emotions, which is greed. Greed usually follows as a result of our being right with a trade. We start out with the hope that our trade will be profitable and then once it is we start to believe that we are invincible. We then feel the desire to take more and more out of the market. This is a natural
Once a trader succumbs to greed and has too much at stake, which is the result of improper planning, then the trader’s level of anxiety increases.
The anxiety is driven by a fear of losing profits or of making losses. Unless the trader can manage this anxiety level, by being aware of the cause of the anxiety and reverting back to a rational, rather than an emotional management style, the dangerous emotions of fear and panic can set in.
Fear is a much stronger force than greed once it becomes entrenched. Once a trader starts losing money then he has to act quickly to stop the bleeding. If many traders are in the same position, as is often the case in bubble environments, then the results are a drastic collapse in prices causing the fear factor to magnify exponentially. This leads to more cuts and ultimately, a state of panic.
When panic floods into the market, the traders who have poor or no planning, find themselves forced to capitulate taking heavy losses. This cycle is typical of a herd mentality where everybody has jumped onto the band wagon in a desperate attempt to make money, usually in a situation where they have inadequate or no rational planning.
By managing your own emotions and by being disciplined, patient, objective and realistic, you can avoid the boom and bust cycle. The proper way to ensure that you do not succumb to your emotions is by conditioning yourself to have a trader’s mind-set, one that will set you apart and prevent you from being caught in the herd.