MAIN TALKING POINTS FOR MANAGING FEAR AND GREED WHILE TRADING
- Fear and greed are two motivators that affect how we conduct our daily lives.
- These factors might have a negative impact on trade.
- By considering the larger picture and making advance plans, traders may get rid of these forces.
Financial markets are often said to be driven mainly by greed and fear. Although this is oversimplified, fear and greed significantly impact the psychology of trading. Knowing whether to let these emotions run wild or control them might be the difference between a lucrative deal and a short-lived trading career.
Read on to learn more about fear and greed in trading, including when they are most likely to manifest and the best ways to deal with them.
THE REALITY OF GREED AND FEAR IN TRADING
Fear and greed are widespread among traders and may be harmful if controlled. Fear is often seen as the unwillingness to initiate a transaction or the early closure of a profitable deal. On the other side, greed shows itself when traders use excessive leverage to benefit from little market movements or add additional cash to profitable deals.
There are many indications about the origins of these two motivators, but rational analysis reveals that greed and fear are both products of the primal human urge for survival.
Fear: What is it?
We are aware that the fight-or-flight response that occurs in each one of us has some relationship to fear. It is the sensation we get when we perceive a danger. When positions go against them, traders get terrified since their trading account is at risk.
The fear of suffering a loss when a position moves against you causes traders to hang onto losing positions far longer than they should.
Right before entering the market is a second situation when traders often succumb to fear. Despite the research suggesting a good entrance, traders may get paralyzed by their fear of losing and abandon a well-thought-out strategy.
When markets have plummeted, fear is often evident, and traders are hesitant to purchase at the bottom. Traders often opt out of a transaction in this situation for concern that the market will continue to fall and they will lose the opportunity to profit from the upturn.
Greed: What is it?
Greed is considerably different from fear, yet it may quickly put traders through just as much difficulty if it is not controlled. It often occurs when a trader chooses to increase their investment in a successful transaction in the hopes that the market will continue to move in their favor.
Greed may also manifest when traders opt to “double down” after placing a lost trade in the hopes that adding more capital to the issue would make the position profitable. If the market continues to move against the trader, this is very difficult from the perspective of risk management and may soon result in a margin call.
The financial markets have seen plenty of instances of greed. One such instance was the dot-com bubble, when people acquired an increasing number of online stocks, greatly inflating their value before everything crashed. Bitcoin is a more contemporary example; investors flocked to the cryptocurrency in the belief that its value would only rise until it, too, fell.
MANAGING GREED AND FEAR TO BE A SUCCESSFUL TRADER
There are several strategies to manage your emotions and prevent fear and greed from affecting your trading choices or overall performance.
1) Designing a trading strategy
To prevent any irrational emotional impulses that vary from the plan, traders should have a trading strategy. Overleveraging, removing stops from lost trades, and doubling down on losing bets are a few instances of this.
2) Decreased Trade Sizes
“Lowering your transaction size is one of the simplest strategies to lessen the emotional impact of your trades.”
The article says that because there is no real financial risk, making a big move on a demo account won’t make you lose any sleep. However, traders would undoubtedly feel stressed after seeing significant price changes on a live deal. It is essential to control such tension since it might result in poor choices that could negatively influence the trading account.
3) Maintain a trading journal
When trading, traders must also be responsible for themselves. Making a trade log is the most effective approach to achieving this. Trading diaries let traders keep track of their deals, identify successful trading tactics, and tweak unsuccessful ones. When analyzing the outcomes of your trades and eliminating ineffective tactics, it’s critical to do it without emotion.
4) Study Others’ Experiences
This study demonstrates the importance of emotion in trading since it was shown that traders lost money on average despite making more winning transactions than losing ones. This was because traders stood to lose more when the market moved against them than they would get if the market moved in the traders’ way, so losing transactions exceeded winning ones.
Traders may combat fear and greed in trading by using the premise from this study, as stated by David Rodriguez:
‘Traders are right more than 50% of the time but lose more money on losing trades than they win on winning trades. Traders should use stops and limits to enforce risk/reward ratio of 1:1 or higher.’