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Anatomy of an Emotional Trade


Never get excited when you deviate from your rules and it goes well, as it always compounds the problem.

Two hundred years ago, if you sat with someone and said to them, "Believe it or not, there is this 'thing' that can't be seen by the naked eye that can literally wipe out an entire population, and it's called a 'germ'," they may have locked you away. Had you informed them that these invisible creatures often caused mass death, they may have just tied you to a rope for all to see. Thankfully, today we all accept that germs are very real and something we need to be mindful of in order to remain healthy. Furthermore, we have gone another step and developed medicine to help us fight these invisible creatures as well as limit their spreading.

Today, a similar conversation could be had with a trader regarding emotions. It would go something like this. "You know, there is one thing that can't be seen that can really kill a trade and it's called emotions. Actually, these invisible things have been known to wipe out entire portfolios."

With some humor aside, traders today must be keenly aware of the damage that can be created when one does not hold their emotions firmly in check. One of the biggest detriments of being overly emotional is the loss of control. When emotions are running high, more often than not, you have already lost control and have moved into an area of hope.

Fortunately, emotions are the outside variable always trying to creep into trading, rather than the other way around. If we tried to fit trading into our emotions there would be no clear delineation between the two, however typically a trader always knows, even if it is subtle, when they have started to allow emotions to creep in and have started losing control of the trade.

This is the primary reason we adhere to discipline stop losses, as it serves as the clear border between Controlville and Emotionville. When a stock crosses the border you have lost control and should you not adhere to your rule of cutting the stock, you are letting emotions take over and are now subject to all other variables rather than those that remain in your control.

Furthermore, there can also be a variety of different ways in which you become subject to your emotions in addition to simply letting a stock slip. While I am pleased to admit I rarely have a problem cutting a stock that crosses its border, I do continue to struggle with taking stocks or trades that are outside of my normal style. While the rationale for entering the trade may often differ, I can tell immediately after I place the trade that I am out of my comfort zone and subject not only to my emotions but many other outside variables that I normally don't contend with in my normal course of trading. If I am smart, I correct my error quickly, cutting the stock and moving on, but there are still times I pay the price for deviating.

I recall not so fondly my most notable emotional trade. I had entered a hot Chinese tech stock (I will spare myself the embarrassment and not mention the name) as it bounced off its trend line support level. The stock had been moving higher for a few weeks and the pattern was quite predictable. I liked the risk reward and the upside seemed favorable.

Shortly after entering the trade, the stock showed a profit, of which I got excited about (Mistake #1: Expect gains, don't be surprised by them). A few days later, however, the stock faltered back to its trend line, which was fine and healthy as it was higher than its previous point of support and still showing me a profit.

It also happened to be my line in the sand, or stop level. Unfortunately, the stock breached the level in the late afternoon, and rather than cut it and move on, you guessed it, I said to myself, "I'll give it another day, surely this is just a shake out." The next day, I came in and the stock advanced slightly confirming my suspicion and making me rather pleased (Mistake #2: Never get excited when you deviate from your rules and it goes well, as it always compounds the problem).

Later that day, however, the stock reversed, taking out once again my line in the sand. Because I had done it once, I was confident enough to try again, so I kept the stock overnight and decided to see what would happen (URGH). Sure enough, the next day the stock gapped lower, but was still above my original purchase price. While I had already crossed the line from control to emotion, it was at this point it got really bad. I changed the line. My rationale was simple: "Well, I already lost just about all my profit, so I will change my line to my purchase price and see if it holds." Shall I continue?

The stock broke my line, again, and I held, again, coming up with some new rationale that I don't even remember. I am sure at this time, I was probably digging for news stories and trying to find out why the stock was dipping, rather than just cutting and moving on. Days went on and the stock continued to drop and my emotional capital was quickly being drained, while the financial losses were mounting. I think at some point I even added to my position (DOUBLE URGH).

Needless to say, finally I had had enough and needed out. The position was done and I learned a very valuable lesson. My first stop price was so far above, had I just stuck with it, I would have been fine. Not to mention I missed about ten other great ideas because I did not have the luxury of having enough capital to play them. All my money was tied up in this stupid stock that would probably go out of business one day. (ARGGGH, it has since doubled several times). When the pain got to be too great, I sold and not only swore off becoming emotionally involved with a stock, but blacklisted this stock altogether. (Boy, was that dumb.)

Of course, you know exactly what happened a few days after I sold it and the rest, well the rest is history.

There is a fine line between remaining in control and becoming subject to emotions. Resolve to identify this area and stand firm in never crossing that border. But, if by chance, you lift your head and feel out of place, knowing that some way, somehow you managed to cross the border into an area you don't belong, get out quickly. Don't stick around to try and make it a vacation.
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