Have you wondered why it can be so easy to read a chart when you’re not in a trade? Or, on the other hand, how difficult it can be to read the same chart objectively when a live trade is running?
If so, I would like to walk you through two of the most commonly experienced emotions of traders. You will also learn how successful traders use these emotions in an opposite manner to losing traders.
Allow me to introduce you to Greed and Fear in their unrefined and refined state.
“Greed”, as we’re told by the fictional hedge fund manager in Wall Street, Gordon Gekko, “is good”. It’s good for the market maker and that’s about it when used improperly. Greed puts many traders in low probability trades and fear keeps them in the trade if they’re floating a loss. Fear also has new or unsuccessful traders closing out at a trade at very small profits over and over.
Greed and fear are natural emotions to be sure so the professional trader has them too in a sense. What you will notice when speaking to successful traders is their application of these emotions is tempered and purposely directed.
This means that the successful trader is fearful of letting a losing trade run away from him past his well defined money management system.
He is greedy, but only when the trade is working. This trader has earned the right to be greedy once in a profitable trade because he has confidence in his plan. Most importantly, he knows his edge only comes from getting more out of his winners than he gives away on losing trades.
This is why he holds on for dear life in a winning trade while removing as much trade risk as reasonable through a trailing stop.
He may stay in the trade until an indicator like the Parabolic SAR tells him to exit because the setup has completely exhausted.
(Created using FXCM’s Marketscope 2.0 charts)
Also of importance, a successful trader is never consumed by getting every pip out of a trend. She knows over the long run she must focus on letting the edge of her trading system play out. Looking over this chart of a 2,600 pip down trend on EUR/AUD, she can contently plan to pick up 25-50% of that within a high-probability type trend following system.
The famed trader during the 1920s, Jesse Livermore, expounded on the rare emotional ability to sit on a profitable trade. Sitting on a good trade allows the set up to become more profitable if the trend continues:
“It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market…. Men who can both be right and sit tight are uncommon.”
- Jesse Livermore in Reminiscences of a Stock Operator
Lastly, the smart trader knows that trade size is key. When trade size is set up properly, greed and fear will be tempered in the successful trader. Trade size is managed in respect to their account equity and allows them to achieve the results they’re after.
By knowing the best trade size for their system they focus on carving a proper amount of a move.
In summary, the successful trader knows to fear losses and fear them on every single trade.
When trade size is correctly set up, it’s easier to exit a trade that isn’t working out. Successful traders are on the other hand are greed when a trade is working out as they planned. To use the phrase from Warren Buffet, they are “Greedy where others are fearful (profits) and fearful when others are greedy (losses). “
I will leave you with this table to show you why successful traders leverage the emotion of fear towards losing trades getting out of hand. This walks you through the returns required to make up
for losses incurred.
---Written by Tyler Yell , Trading Instructor
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