By Don Dawson, Online Trading Academy Commodity Futures Instructor
Ever notice how your trading is going along very nicely and then, like somebody threw a switch, you start having equity draw downs for no obvious reason? What I am about to discuss will most likely answer some of your questions. By being aware of the three barriers I will discuss in this article, I believe you can understand why we seem to hit the wall in our trading sometimes.
Every trader, at some point in their career, has experienced one or all of these barriers. Even after we have identified these problems, we have to deal with them throughout our trading careers. These are human emotions and there is just no way to totally eliminate them. By being aware of their traps, we can be more conscious of when they are affecting our trading. This does not mean you have to fall prey to these barriers. The objective is to train your mind to work around them rather than become their victim. These three barriers can be interrelated but we will break them down and address each one.
The three barriers are:
Fear
In the trading community, the word Fear conjures up a couple of situations. The first one is the act of losing money and sometimes much more than we had anticipated. This situation can easily happen when we don't have stops in the market. Traders who use mental stops realize when it is time to pull the trigger that they cannot stomach the loss and decide to hold on until the market comes back. As these positions continue against the trader, they eventually are forced to liquidate these losing positions, either by a margin call or by actually becoming physically sick due to the large losses adding up. Now these same traders who have just liquidated their positions very near a market top or bottom see the market reverse and go the other way. Once all of their panic orders are absorbed by the market, there are no more orders left to sustain the move. These types of traders are what cause "V" reversal chart patterns on charts (see Figure 1).
Figure 1
These same traders now see the market going the other way and now must decide if they want to chase the market. When traders trade with this kind of Fear, they most likely do not have a trading plan and trade by pure emotion. The odds are pretty good that these same traders will watch this market go the other way until they just cannot stand it and jump back into the market right near the other extreme of the move. This leads to the other type of Fear - missing a move.
How many times have you been waiting for a setup and the market takes off in your direction without you? You start seeing these large green candles that do not offer any pullbacks. If you are an emotional type of trader, you will most likely chase this market thinking it will keep going in the current direction. The problem with this type of trading is that most of these moves do eventually retrace and when they do, there are even more "emotional" type of traders in this type of move that have to get out of their now losing trades. So the market ends up correcting even faster and farther than it actually rallied simply because of people who "had" to be in that trade regardless of their trading rules, if they even had any.
These two types of Fear can have long term negative effects on a trader if one loses a lot of money. We all work hard for our money that we trade with. So when the next trade comes along, we could have trouble pulling the trigger in a timely fashion to enter the trade simply because we remember that large loss we had. This could cause you to get in late and end up chasing the market yet again. The other problem is you could take profits too early the next time, thinking about your big loss from the past. You will see your equity back to "even" or a small profit and then exit. This is called "letting your losses run and cutting your profits short" style of trading. Taking smaller profits can lead to a feeling of not making enough money, which could lead to feeling you need more money and result in the next barrier - Greed.
Greed
Have you ever been in those trades that you know will just keep going to the moon? Your target objective was met a long time ago but your "Greed" monster is telling you this thing will never stop. This is a good case of over-staying your welcome. In the Commodities markets, you could become a victim of "Locked Limit" moves against you for days with no way of you getting out of your position. Ask anybody who has traded the Grain markets during a weather related market if you want to hear how fast a profit can disappear. Once the market starts to go against you, there are going to be many other traders with the same idea as you, getting out of their positions. Keep in mind there are only so many buyers and sellers in any market and when everybody heads for the same exit getting out without losing a lot of profit can be very difficult. This is why our trading plans "should" have logical profit-taking strategies in effect. This will help reduce the Greed factor.
Another side of Greed is the trader who just lost a lot of money. For some, the logical thing to do would be to leave our trade desk until we have regained our rational thinking again. For others, they will continue to "revenge" trade. They will ignore their trading plan all together, take large risk trades that do not fit their risk/reward ratio of when they are trading well, will take several small profits thinking they can stair-step their profits back, and since they are not following their trading plans anymore, will be trading on pure emotion which leads to Fear and bad irrational decision making.
Then we have the traders who "just know" that the market is going to the moon and they mortgage the house to place their bets. I am sorry, but nobody and I mean NOBODY knows exactly where the markets are going. These traders are risking everything on one trade and we know what usually happens then. The next thing out of their mouths is something like "do you want fries with that?" With that said, there are times when the trade has good odds stacked heavily in your favor. A rational trader will calculate his maximum contract size he can trade with the amount of funds in his account and place the trade accordingly. This could be a percentage of his account size (already identified in his trading plan) or the amount he can comfortably sleep with at night if he loses. The point is, he is not a gambler and will not risk his entire account on any one trade.
Each of us has a personal pain threshold of monetary loss we can live with. If you don't have one yet, trust me, you will before your trading career is through. Once we exceed this threshold, we start trading in Fear and this vicious cycle starts all over again.
Ego
Usually when we talk to traders about markets and human nature, Fear and Greed come up all the time. There is also another barrier that can be just as devastating if not more - Ego. Some refer to this as "Egoitis" - this comes from the Fear our Egos have of losing their relevancy in our decision making process. Your Ego will resist you and probably win in more ways than you can imagine.
One way that Ego can affect your profit potential is to cut them short. We all know the rules about allowing profits to run and cut our losses. For most traders they do just the opposite. Our Ego can be like a little child seeking instant gratification. By taking our profits early it gives this quick little reward. On the other hand, our Ego can be so fragile that it hates to lose. So when a position goes against us it tells us to stay with it and wait for it to come back. Or maybe it might try to get you to double-down telling you that this way, the market only has to come back halfway. Either way, the Ego will continue to ruin your trading. There is no place in the markets for Ego. The Ego can generate opinions on its own desires. If your Ego has already made up its mind, there is no way you can see what the market is really doing in a clear manner.
Let's face it, we as traders like to talk about our successes, but not our failures. Since Ego wants to be right all the time this can lead to very costly mistakes. Just as a trader who suffers from Greed, our Ego can cause us to stay in a trade longer than we should while making a profit just as well as cut our profits short. When it comes to losses, our trading plan should help override our Ego by forcing us to take our loss at the pre-defined location.
As I was saying earlier, we are all humans and cannot totally eliminate these barriers. I know people who have traded for a long time (myself included) and they still battle with episodes of each of these barriers. What is important is to have a written trading plan to help us be as mechanical as possible with our actions. This helps to reduce the emotion in our trading and therefore, the Fear, also. Keep in mind, too, that trading is all about probabilities! Successful traders did not make just one big win. They consistently take small amounts out of the market over a long period of time.
So remember that we will always have these little setbacks along the way, but if we follow our rules they will be just that, "little" setbacks. With that I leave you with a quote from Mike Ditka:
"Success isn't permanent, and failure isn't fatal."
Wishing all of you the best with the battle of our "little barriers,"
- Don Dawson
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