Greed and fear are the two dominant emotions that affect the stock market. Although there are many other factors that influence the change in stock price, these two emotions are the underlying cause for the unpredictable fluctuation of stock price. As emotional creatures, humans make trade decisions all the time based on their feelings about the given market conditions. However, trading decisions influenced by emotions of greed and fear and stock trading success are two things that generally don’t go hand in hand.
So how do these emotions really influence the individual traders decisions? More importantly, how can a trader avoid emotional trading?
Holding a stock in fear as it drops in price is a classic way traders lose money.
Say the typical trader buys a stock and it slowly goes down for a few days after the purchase. The trader is a bit worried but he still keeps his composer because he is certain that the stock will come back up. He holds for a few more days and the stock continues to inch downward. At this point the trader has lost a large percent of his original position.
Now the panic starts to kick in…
The trader begins to panic but he doesn’t sell off because this is too much of a loss to bear. He can’t afford to lose such a large chunk of his portfolio especially since he thinks the stock will come back up any day. The trader is praying that it will bounce back up just enough so he can at least break even. Yet as he clings to his position in fear, stock continues to fall. Finally he sells the stock partially out of fear that it will drop even lower and also because he can’t bear the pain of holding the failing positions anymore.
This is a prime example of how the fear affects traders. Holding onto a stock because you have a hunch that the price will bounce back up is a dangerous way to interact with the stock market. Because of the markets unpredictable nature, you can never be completely certain of what might happen next.
So how would the greed influence this same unfortunate trader?
Keep in mind that after the trader lost such a large sum of money, he wants to earn it back as quickly as possible. Eager to find opportunities to make the most money back to cover his loss, he searches for riskier stocks. After running some scans he spots a penny stock that is moving ten, twenty, even 30 percent every day. With moves like this the trader figures that he could make back the money and more in the next week.
This particular stock’s price pattern is extremely volatile and sporadic. The trader has no way to gauge where the price might move next. However, the trader still impulsively takes a position while holding onto the belief that the stock will make him a fortune. The trader is completely engrossed in the prospect of making a large sum of money in such a short amount of time. Because he was so eager and impatient, the trader had placed his trade without assessing any of the safer, more predictable stocks.
Nevertheless, the stock does not make him a fortune. The stock abruptly reverses downward in the next few days.
These are two classic scenarios of how many traders play the market. They let their emotions get the best of them and their trading success suffers as a result. Making trading decisions influenced by greed and fear will never produce profitable results.
So how do you take the emotions of greed and fear out of trading? The answer is simple. Lay out a solid strategy and stick to it.
This of course is often easier said than done. However, trading in a strict and systematic way limits the emotional element of trading significantly. Disciplined trading according to a plan is the antidote to emotional trading.
As mentioned before, trading based on predictions and emotion never leads to a profitable outcome. This is why sticking to a strategy is so important.
Stop-losses in particular are extremely important components in the strategy. When a stock hits your stop-loss it is extremely tempting to ignore it thinking a reversal is right around the corner. However, the truth is that you just don’t know if it’s going to go up. When the stock hits your stop-loss, simply step back and take you position out of the market. If you made some profit off of the stock then that’s great. If you lost some money, just wait and see if you get another buy signal from the stock and step back in.
Hope this will help you in trading.
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