Are you an emotional trader? It can be impossible to say until you’ve started seriously investing in the forex market. Many people find that their usual temperament isn’t a good way to determine how they will trade; those who are usually “cool as a cucumber” under pressure may find themselves a wreck when they are confronted with a losing investment.
Emotional trading doesn’t have to be a bad thing — especially when you are in control of it. But you do need to be in control and aware of your emotions. Here’s the good, the bad, and the ugly of emotional trading.
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The Good: Managing Your Emotional Trading
What are emotions? Sometimes they are purely illogical, but other times they’re something more important — intuition and gut instinct.
There are some people who just naturally seem to be right about everything they do; these people are natural traders. They may be able to see and understand patterns without being able to logically interpret them; they may know that a trade is going to perform while not being entirely sure why. This is different from the harmful emotional type of trading, which usually amounts to not trusting your intuition.
It’s easy to understand. It’s the difference between seeing a good trade come up and convincing yourself that a bad trade is going to turn around. If you have an instinct that isn’t rooted in fear or hope, then it may be that you’re identifying a potentially good trade. If you have an instinct that is simply what you want to believe, then you’re just being an emotional trader. Good traders spend years trying to separate their intuition from their fears – and traders who cannot are usually better off ignoring both.
Emotional trading doesn’t need to take control of your investment account. There are ways to mitigate the damage while still taking advantage of your own personal intuition and knowledge.
Forex signals give you all of the information you need to manage your trading account without having to make emotional decisions; you just follow the signals and profit. Otherwise, you need to conform to your trading strategies all the time. If you become inconsistent in your trading, you will quickly find yourself losing money unpredictably, and you won’t be able to determine whether your trading strategies are actually working.
The Bad: The Risks & Disadvantages of Emotional Trading
Why is emotional trading such a bad thing?
Emotional trading manifests itself in two ways: you either let a trade go longer than you should or you end a trade faster than you should. Either way, it generally leads to an entirely unpredictable strategy that will ultimately lose money. Here are a few examples of emotional trading:
- Stopping a trade early when it’s losing money. If you have a “sure thing trade” and it begins losing money, you may be tempted to immediately stop that trade. However, this is a bad move in the forex market. The market fluctuates — some currency pairs more than others. You will often find that a trade will lose money initially but will turn itself around. You shouldn’t be closing a trade until it hits either the take profit amount or stop loss amount because those are the price points that you’ve set. If you stop trades too early too often, you will never give them the chance to turn around. Stopping a trade too early is something that a timid investor tends to do; it generally comes with inexperience in such an intense, fast-paced market. It takes discipline to counter this.
- Stopping a trade early to capture the profit you have. You may be tempted to quickly snag some profit by closing a trade early. But that’s a bad idea. A trading strategy is meant to work as a whole. Your trading strategy may be based on an average of 10 pip losses and 20 pip gains. If you start grabbing profit at 10 pips instead, your strategy will quickly revert to something that will only break even. Essentially, you need to capture a certain amount of profit to make up for the losses that everyone will experience while trading forex. It’s always tempting to grab profit when it occurs, but unless you’re scalping, it’s usually not a good idea.
- Letting a trade ride to capture more profit. If a trade is doing very well a trader may remove their take profit and start waiting for it to do even better. Here’s the problem: it’s not possible to know when the trade is going to stop rising and start abruptly losing again. Many times, a trade may be going upwards sharply because it is significantly beyond its resistance point; after all, you already had anticipated that it would only reach its take profit, so this must be abnormal. In these situations, the trade will often “collapse” and lose a significant amount of money all at once. If you take profit at your scheduled point, you’ll make money; otherwise you may actually find your winning trade converting into a losing trade.
- Letting a trade ride to mitigate losses. This is by far the most common type of emotional trading. It’s easy to assume that a trade must turn around. You may start holding on to losing trades in the hopes that they will recover. Slowly your account will slide closer and closer to margin. Letting a trade ride to mitigate losses really means two things: not only are you accumulating losses the entire time, but you’re also losing out on any winning trades. Your capital is tied up and you can’t initiate the trades that could actually be making a profit. This is one area in which a stop loss is so absolutely critical; stop losses prevent you from letting trades ride. Your loss has occurred already whether or not you close the trade and closing your trade is not an emotional acknowledgment of such.
The most important thing that you should know about emotional trading is that it can happen to anyone. You may feel very confident and secure about your trading strategy but that doesn’t necessarily mean that you won’t get stressed out when you’re on your third losing trade of the day.
Every trader goes through bursts of bad luck and every trader will run into failed trades, but that doesn’t mean that everyone can successfully manage them without worry. The worry may always be there, but you’ll need to be able to fight it off.
The Ugly: The Potential Impact of Trading Emotionally
It isn’t just that trading emotionally can hurt your profits. Emotional trading can completely wipe out your account.
Emotional trading will often lead to issues such as letting trades ride even though they’re losing a significant amount. This will lead to a margin call and a progressively smaller account size until it becomes impossible for you to dig yourself out of your hole.
Essentially, the ugly of emotional trading is that it will eventually run your account down. While it may be a death of a thousand cuts — losing just a little at a time — it will eventually happen. There’s no way to maintain consistent returns without consistency and, unfortunately, emotions will never be consistent.
The Solution: Force Emotional Trading Out of The Picture
The good thing is that it can be countered through the use of careful strategies and tools such as trading signals. By using signals, setting take profits, and sticking with your stop losses, you’ll be able to initiate trades in a reliable way even if your emotions may be telling you to alter them.
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While your emotions can lead to intuitive leaps and wins on the market, you still need to be acutely aware of your emotions either way, and you should never be tempted to “save” a losing trade or capture more profit from a winning trade than you initially intended.