- Fear and greed are two drives that have big impacts in our lives
- These impacts carry over to trading, but may be detrimental
- Traders can use logic to reverse these drives by looking at the big picture
The statement can be made that these two emotions will denominate many of the decisions that you will face you in your life…
But this is a trading article, we’ll leave the grandiose psychological questions to brighter minds. However, for our purposes as a speculator it can help to at the very least know how these two drives might impact your decision-making processes.
We taught you How to Lose Properly two articles ago; and in our last article, we showed you how to approach markets with a positive attitude, and the value that could come from it. In this article, we’re going to dig even deeper down the rabbit hole of the trader’s mind.
Fear and Greed Defined
There are numerous traces of the origins of these two drives, but if analyzed logically they derive to the innate human ability to survive. This is somewhat related to the fight-or-flight instinct that exists in each and every one of us.
Fear is what we feel when we recognize a threat, like if we were foraging for berries in the forest and we happened across a black bear. In this situation, you should be scared; fear is a natural instinct that could help keep you alive. Greed could get you killed. If you just kept on your merry way, picking berries to your heart’s content; the black bear might find a ‘more filling’ meal.
Threats (like losing trades) should invoke fear, fear keeps you alive
Image taken from Wikipedia, LINK
Greed, on the other hand, also helps you survive. If we go to the same analogy as earlier, but this time you happened across a grasshopper and decided to let fear rule the day, you wouldn’t find that many berries now would you? Likely, you’d end up starving to death. When you see a grasshopper, you shouldn’t be afraid; and in this situation you should be greedy so that you can accumulate some berries.
Greed and fear are really just survival instincts. And in trading, we’ve got to do a lot more than just ‘survive.’
How in the World does this relate to trading?
Fear and greed impact many of the decisions you make on a chart, but the big question is as to whether or not they actually help you.
Think about the last few trades that you’ve placed.
Imagine that you wake up in the morning; you saunter over to your computer with a fresh shot of espresso in hand, and you look at your trades from the day before.
Imagine that you notice that Euro trade that you took last night just hit the skids, and you’re down 200 pips. What do you do?
Most people will begin rationalizing: ‘This was because of that bad German inflation report, this thing will come back.’
Others will just get greedy: ‘If I double down, this thing will be at break-even when it gets to my original entry price!’
And yet others will begin the bargaining process: ‘if this gets back to break-even, I’ll close it out and never do this again.’
Each of these responses are greed speaking. It’s almost as if you tapped the black bear on the shoulder as you tried to pick berries in a nearby bushel.
This is when you want to be scared… the position has already shown you a 200 pip loss; the black bear is standing just around the corner ready to eat you! The greedier you get, the nastier it will be.
Let’s go back to the morning. You wake up; you stroll to your computer with a macchiato ready for consumption and you see that the Euro trade you placed last night is up 50 pips.
A small delight!
It’s only 25% to your profit target, but your brain is already racing….
‘What if this comes back against me? Remember that trade from x days ago, when I had 300 pips up and it all came right back? What if that happens here?’
Most human beings begin ascribing all kinds of emotional conflict to this situation; and a lot of it is surely baggage from other areas of life that we all go through.
Primarily – this is the fear of failure; and we all have it.
Most human beings in this situation will be scared. Scared that the Euro will come right back against them, and take out their stop. Scared that they had success in the palms of their hands, and they let it get away… they failed and it’s all their fault!
This type couldn’t be more wrong…
Just as you can’t predict the next price on the chart when you place the trade, your powers of prediction get no greater because of the newly acquired 50 pip profit. It simply means that you have a position in which your analysis has proven correct.
This is prime time to err on the greedy side, ladies and gentlemen. The position has shown you a profit; and this confirms that your initial analysis was correct. Most people get scared here, but this is where you want to be greedy.
When you win, that is the time to be greedy
Created with Marketscope/Trading Station II; GBPUSD, prepared by James Stanley
My advice to them: Chill out. It’s just one of a thousand insignificant trades that you’ll ever place.
Plan your trades ahead of time. You can try to get the probabilities on your side as much as possible such as the way we outlined in The Potent Combination of Fundamentals and Price Action.
Set your stop, and only risk an amount that you can afford to lose. If the trade moves against you, take the stop and look for greener pastures elsewhere.
-- Written by James Stanley
James is available on Twitter @JStanleyFX
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