Analysis and Prevention of Revenge Trading in Forex

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FX Signals – Here, the paper analyzes and shows the type of person engaged in revenge trading and proves how this can destroy the Forex market. Various attributes, behaviors, and psychology of a revenge trader are given, and final suggestions to traders as well as the market as a whole are made.

The forex market is unique, and it is often said that, like a sea for swimming, there are people who are born to swim in it. To swim here without drowning, one has to understand and investigate every pattern and cope with different trends. With the technological evolution, there are now a zillion trading tools which a trader could exploit to draw maximum benefit, but the question is how much risk a trader can take to use a particular tool. Not all evolved tools help profit traders in forex. Some others are there whose negatives come with a huge cost to the trader. One such hazard that tampers with forex traders is called “Revenge Trading”. Trying to revenge the market can raise your losses.

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Forex is the game of profit for some and modification for others. Revenge trading becomes a penalty then, which can raise the cost associated with the modified trader and, which may moreover drop down the costs of commodities. Trading is a platform of market dynamics for various legitimate reasons. It involves managerial, financial, and ethical concerns and has long held the attention of researchers because of its perceived importance. The ideas and debates in the literature that form each of those three streams of research thus speak to a broader theoretical landscape in which to locate an analysis of Interpreting Emergent Practices in forex trading.

1.1. Definition of Revenge Trading

Though the term ‘revenge trading’ does sometimes come up in other investment fields, such as stocks, this short study focuses mainly on the phenomenon found in the currency markets, or Forex. As stated in the introduction, we define ‘revenge trading’ as a situation where the trader tries to get back at the markets when they lose more money than pragmatically acceptable. In other words, revenge trading is the attempt to break even even after the trader has lost his streak of rationality or he has come to the conclusion that things are going terribly wrong. It is when he cannot stop himself from trading even though he is, at that time, extremely vulnerable to making more and bigger mistakes, and consequently losing even more money.

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For a trader to start seeking revenge on the market, it is our claim that a set of intertwined cognitive and emotional misfirings, or bugs, must be at play, rendering him especially prone to suboptimal and loss-enhancing investment behaviour. Revenge trades are thus those trades that the trader should have conducted, in hindsight, if he wanted to lose even more money. In other words, they are trades that go against the original short- or long-term speculative strategy that the trader uses in his regular trading activity. Examples of revenge trades could be a long trade in a bearish market or a huge trade when it is already clear that the trader’s position is being challenged.

2. Psychological and Emotional Factors

In his article “Currency trading: ‘Revenge’ fuels big price swings,” Yamarone (2006) stated that many Forex traders act partly from emotion and that this emotion was most noticeable when they were losing money. Although a number of researchers have measured psychological factors and related these characteristics to investment decisions of Forex traders, very little research has focused on emotion and revenge or the concept of revenge in Forex trading. Psychological problems were significantly negative for performance for each skill level, trading with higher income, and the majority of ages. As for character, there is a significant negative mean difference between traders who have psychological problems and traders who do not have psychological problems in terms of fear and tension.

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Trading may be psychologically difficult for many people. According to beginners-psychology-records, 95% of day traders failed within a short period of entry into the trading world. A report by Brad M. Barber, University of California, advised that trading is a psychologically difficult skill and encouraged traders to obtain a long-term portfolio rather than keep on trading for a short period. Emotions like fear and greed often lead people to make the wrong decisions when placing orders, more than 80% of the time. Researchers can expect to see a link between the emotions of fear and greed. It’s always different between hobbyists and full-time traders. It’s a thing that thoroughly brings down full-time trader owners. When placing a Forex trade, traders can make a decision between fear and greed. Many of them make a decision based on their depression or greed. The basic concept outlined is that when the market is plummeting, Forex traders act out of fear, and the opposite is true when the market is soaring. Greed in the forex market tends to concentrate too. In fact, about trend following, the degree of greed in the market tends to follow the trend, but there is a small chance of getting it right.

2.1. Impact of Emotions on Trading Decisions

The efficient market theorem asserts that agents involved in financial markets act based on thorough analysis and statistical factors, without subjective feelings or emotions that could obstruct their judgment. However, this is not the case. Traders in financial markets are too influenced by their emotions, reacting to events based on their subjective feelings rather than taking action that may lead to the greatest profit. Empirical evidence can be observed in the stock market crash of 1987 or the 2004 tsunami in Asia, causing panic withdrawals from the market.

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From a small survey carried out by the authors, price action traders and investors seek to achieve a profit ranging from 5% to 10% per month on an initial investment. As a result, investors and traders that do not achieve this can lose hope. In a study of online trading data over the coming of age of one technology-driven brokerage security, observe that, though the change in the value of the investor’s account is relatively large, the traders in the dataset show a strong preference for buying stocks that are performing poorly and their favorite buys are stocks that performed extraordinarily poorly in the month before. Goal setting is critical to individual success and failing to achieve established targets could lead to emotional despair for those investors or traders.

3. Risk Management Strategies

The secret of successful trading is risk management. Most strategies involve cutting losses and letting profits run, so each trade position should have a minimum reward-to-risk ratio. Some advanced strategies involve statistics and psychology in trading. Strategies for risk management ensure that traders never enter any position that would be too risky to handle psychologically.

The accepted percentage of investment capital that one should be willing to lose per trade is 2%. This is a generalized rule but remains standard across most forex trading communities. It means that if one has a $1000 account balance, he should never open a position that could put him at a possible loss of more than $20, as 2% of $1000 is $20. A stop-loss is a position one should never get to, as it would be very risky for them. It serves as a psychological restriction and prevents a trader from getting into the abyss of revenge trading. Trading is a long-term activity. Anything that depletes one’s trading account will terminate his trading activities. The position size should determine the size of the trade rather than planning to open a position and then adjusting the size of the trade to it.

3.1. Position Sizing and Stop Loss Orders

Effective risk management is crucial when trading. Position sizing is a common risk management tactic used by experienced traders to minimize potential losses and avoid the temptation of revenge trading. The position size traded is typically a fraction of a trader’s account, often a small percentage of between 1% and 3%. This strict risk management tactic can limit the temptation of revenge trading by minimizing the overall downside when a trade goes against the trader. This reduced downside incentivizes the trader to stick to their trading plan, rather than revenge trading, as losses will be easier to absorb, psychologically allowing for more disciplined behavior.

Stop loss orders are often used by traders to minimize the downside of a bad trade. Unlike a mental stop loss order, using a physical stop loss has the added advantage of forcing a trader to absorb a loss, regardless of emotion or psychological state. Furthermore, setting a stop loss before initiating a trade limits downside and is seen as a good disciplined practice, adhering to a trading plan. For these reasons, using a stop loss order can act as a safeguard against engaging in revenge trading. When a position moves against a trader and is stopped out at their predetermined stop loss, the finality of the decision can act as an anchor against entering another position based on the same rational flawed decision-making that initiated the losing trade in the first place.

Most of the literature investigating the use of stop loss orders focuses on stock markets and futures. There has been a shift in the stock market when it comes to using stop loss orders. Prior studies showed that the use of stop loss orders can lead to negative abnormal returns due to losing stock too early in bull markets, before the stock continued to increase. However, there is new evidence showing that stop loss orders in the stock market can increase profits. Hedger et al. found that the use of stop loss orders decreased losses and increased gains for the years 1988 to 1994. The buying of stop loss orders is common in the forex market. Loki and Jeffrey conducted a study and found that the buying of stop loss orders reduced the impact of interference of traders.

4. Technical Analysis Tools

In essence, the technical analysis tools help traders identify optimal entry and exit points. Fundamental analysis provides information about what happens now, while technical analysis allows us to further predict the direction of the price via the study of market sentiment, fluctuations, and trading waves regarding the asset. Analyzing the number of trades as well as the volumes exchanged, we are able to understand the behavior of investors. Due to the fact that we should defend investors’ capital, our analysis should be based more on their behavior rather than on the price movement itself. The correlation between both of them can help us identify the reversals as well as the exact point of entry for revenge trading. Using those tools, traders can easily prevent any chance for revenge trading. Prices are quite informative and could potentially receive new highs or lows. In general, there are four types of technical indicators: (i) Trend indicators: ushering traders toward identifying new trends as well as whether the price will move upwards, laterally or downwards; (ii) Volume indicators: useful for the measurement of the total revenue fluctuation regarding the asset, market direction, or times when the trend is not valid any longer; (iii) Volatility indicators: useful for determining whether or not the price is ending a range; and (iv) Momentum indicators: used to measure the rate of change of a price with the aim of potentially predicting forthcoming reversals.

“The money flow index indicator uses both the volumes of a stock and the close prices of the security in implementing a price on balance volume. The average of the high, the low and the close prices over a certain period usually is more sensitive as an approximate and can be more volatile when implementing the momentum. Not recommended for the sole use and ideal for confirmation when employed with the different technical indicators. It is a normalized oscillator with a value fluctuating from 0 to 100 continually.”

4.1. Identifying Entry and Exit Points

Analysis of Technical Indicators in Action

4.1. Identifying Entry and Exit Points

To minimize emotional trading and/or impulsive trading, a trader can make use of the following tools and indicators to spot probable entry and exit points. Techniques or indicators such as the following may be employed to conduct technical analysis and spot important potential entry points:

– Trend lines – this refers to drawing a line (diagonally down or up) on a chart to depict an emerging or broken trend. For instance, should the Euro – U.S. dollar pair follow a trend from (an uptrend), the trader can buy it before it gets to the resistance levels. The opposite applies when there is a downtrend.

– Fibonacci retracement – this is employed to identify the level at which the latest trend ought to resume after a small reversal. Normally, traders buy at levels such as at 38.2% and 61.8% and sell at levels such as at 78.6%. The retracements are featured in a charting software.

Techniques or indicators such as the following may be employed to conduct technical analysis and spot major potential exit points:

– Resistance and support levels – these levels depict the maximum and minimum price points.

Psychological factors typically direct Forex trading and, therefore, traders must have disciplined trading plans. In addition, traders need to withdraw from a trade as soon as possible when the advantage is too minimal or not present at all. Consequently, profits can be secured by getting out of a trade rapidly. The process of selecting the entry points and exit points without experiencing emotional trading, which results from a frequent need to anticipate the correct point of the entry to a trade, is indispensable. If one cannot manipulate his or her brain function, trading through a Forex account will be a never-ending investment. Hence, using technical analysis, the pattern of indicators needs to be investigated to ascertain the entering point of a position. Unsuspectingly, emotional trading competitors did not seem as strong as the group that had investigated different indicators in analyzing the patterns, even though these freely available indicators were utilized by the emotional traders, which did not entail predicting the Forex trading activity. It is important for the traders or the engineers who aid them in decision making to examine varieties of technical analysis used in Forex trading regularly to secure chances to profit.

5. Case Studies and Examples

We begin this section with the richest source of case study examples of revenge trading in the forex market to date. This is a review of public forum threads, Twitter posts, and blog content that mention forex trading and revenge trading. We include concise quotes from forex traders discussing how they have experienced being in a position of revenge trading or observing it in others. Any personally identifying information, if unalterable in individual posts, has been changed. Posts have been edited only for spelling and grammar for clarity.

1.1. Case Study 1: Forex Forum Example

Bane M., an experienced trader who has his own strategy, often retaliates to his loss and tries to get his money back by making overtrading trading decisions. He said, “One or 2 losses would have a 2% or 4% drawdown and to recoup that loss I’d occasionally get aggressive and work that figure back, to zero out where the price started falling against me.” Bane recently publicly posted his real-time forex trades to the ZuluTrade social trading network until his strategy had a drawdown. “Then, in an impatient blip, I’d add a loss to the growing list and close the account to regroup,” he said. Ultimately, Bane deletes the copy trading account and withdraws his remaining equity to quit forex trading for a while. When reposting his new strategies (demo accounts without my investment), he realizes the problem of revenge trading, “I’m hoping that I can’t be tempted by any revenge trading,” he said. Petronia described how she sought out revenge trading after a losing streak of trades affected a successful trade in 2013, “I had three successful trades and then I had four losses in a row. For some reason, I wanted to make a revenge trade to get back the loss on the last trade and guess what? I have lost that trade too.”

6. Conclusion and Future Directions

V. Conclusion and Future Directions.

This paper explores the technical details of what is generally known in the trading community as revenge trading. We compare an expert advisor-based trading system in two versions: one that is a purely quantitative mechanical trading without manipulation, and the second, which employs an inner score to identify the necessity of revenge trading in addition to the mechanical trading. We showed that this additional feature comes at the expected cost of more numerous trades. However, we also confirmed the hypothesis that the second trading system is likely to be seen as less profitable by traders in the real world, as it triggers the infamous soul-bruising revenge trades that many traders are likely to feel strongly about. Indeed, the system that allows for revenge trading suggests a statistically significant and economically meaningful smaller average trade profit, as well as the statistical significance of a lower probability that daily profits per position will be above the unleveraged profit size.

Our approach has limitations and can be developed with further analytical, empirical, and computational analysis. A more heterogeneous portfolio of real-time time series from a wider source for a longer period would provide further statistically grounded insights. Furthermore, information on the amount of effort and thinking time that every subject spends trading a given market would help reduce potential biases linked to the subject’s reflexivity on the endogenized implementation of revenge trading. An exploration, as explained in Section 4, on how subject behavior differs if the overall point led to a profit would be interesting and would mirror real-world situations, whereby inflated self-worth and overconfidence can spur increases in risk appetite, and conversely, when one’s core trading account feels it, the trader might start trading to “break even sooner rather than later”. We hypothesize that traders may engage in retroactive trading to recapture potential lost profits, just as they might try to break even. Furthermore, we hypothesize that the desire to break even is greater than the concern with operating costs and lower signal thresholds given clear psychological evidence that traders operate with internal rather than external utilities. In other words, traders will not avoid trading at sub-optimal times just to “save costs”. As a consequence, the correct application of signal thresholds will understate the potential impacts.

Analysis and Prevention of Revenge Trading in Forex

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Analysis and Prevention of Revenge Trading in Forex