Managing Fear and Greed when Trading in the Markets
Fear is a powerful emotion. It can increase your adrenaline and make you feel very uncomfortable. Managing your fear comes from experience. For example, when you are young, there are many unknowns, and you may be afraid of people in disguise, such as clowns. As you age, you will learn to control these fears. Investing in the capital market can be frightening because returns cannot be guaranteed and you may suffer losses. As a result, you may not be able to get back all the funds you have invested, so the risk is very high.
Managing Your Emotions
Investors often consider strategy and risk management, but few people consider the feeling of making or losing money. Although copying these emotions is challenging for you, there are several ways to practice emotion management, by trading small amounts of funds or even using a demo account. Fear has a close relative, called greed. Although fear of losing money may be the strongest emotion you experience when investing, greed is almost as powerful and must be managed to achieve investment success.
Unfortunately, when greed becomes unstoppable, it will cause trouble. Balance and chaos. Greed may be related to stress and despair; behaviors such as gambling addiction may manifest as greed. Greed uses FOMO in trading, which is the fear of missing something. Greed and fear play an important role in the capital market. As market participants become fearful or greedy, the exchange rate of the currency pair will exceed the value level, thereby pushing the currency pair to an unsustainable value in the short term. Greedy traders can push stocks into the realm of a bullish market, or they can plunge them into a desperate bearish market.
How Do Your Emotions Play a Role in Trading?
When your emotions try to change your business thinking, your emotions play a key role. One of the most complicated parts of being a successful trader is learning to control your emotions and avoid fear-based trading. Humans are not machines, so managing risks and losses can create business fears. When fear or greed overwhelms your feelings, a common problem is to change your business plan. Here are two examples, one is based on greedy trading, and the other is to show you how fear affects your trading decisions.
The figure below is a candlestick chart for EUR/USD that shows the trading strategy of moving average crossover for this example. On the bullish side, when the 20-day moving average (simple) crosses the 50-day moving average (simple), it enters EURUSD. It stops when the EUR/USD closes below the 20-day moving average. When the 20-day moving average is lower than the 50-day moving average, you reverse your position or go short the EUR/USD. A typical mistake of novice traders is to exit a position early when you start to lose money. When you start to see losses, fear may cause you to withdraw trading positions early without waiting for the market to reach your risk management stop loss level.
Greed will also play a key role in your trading mentality because FOMO in the market can lead to dire situations. In this example, suppose you are trading using a moving crossover strategy, similar to the strategy used in the figure above with repeated entry and exit criteria. This moving average crossover trading strategy aims to capture the trend created by the USD/JPY exchange rate. The first exit criterion occurred when the exchange rate broke through the 20-day moving average. Greedy investors can bypass risk management standards by seeking higher exchange rates. If you do not react quickly, you can easily see that the exchange rate falls long before reaching the next support level. This kind of greed-driven scenario may cost you part of the expected gains.
Developing a Winning Mindset
One of the keys to successful trading is to manage the ups and downs of the market, which can generate fear and greed. To achieve a successful mentality, you need to learn to manage your emotions. You want to make sure you understand the market noise. Daily changes in price behavior occur naturally. You want to avoid making divergent decisions that might undermine your business plan. Your goal is to control fear and greed so that you stick to a business plan that can succeed over time.
Sticking To Your Trading Plan
The most effective way to manage fear and greed is to develop a business plan to persevere during turbulent times. A business plan is a business plan. It describes how much you plan to earn through your trading strategy and how much risk you are willing to take to generate these returns. Investment is a process that allows you to generate higher returns with a higher level of risk. If you don’t want to take risks, the rewards you will get will be minimal and commensurate with your risks. For example, the general stock index risk associated with the Standard & Poor’s 500 Index has produced an annualized return of approximately 8% in the past 20 years. year. During these periods, there have been several reductions of 20% or more. This situation means that you are likely to face downgrades unless you buy at the right time, which means you are taking risks. Alternatively, you can deposit money in short-term government treasury bills, which provide a very nominal return.
When you make a business plan, you must determine in advance how much risk you are willing to take to generate returns. Buying Treasury bills will not lose money, but buying the S&P 500 Index may lose money. risk. For example, if you want to invest in the S&P 500 index to generate 8% annualized profits, if you enter the market at the wrong time, you may initially lose 20% or more. If you understand that you will lose money in certain currency trades, you will avoid becoming a fearful trader.
How to Manage Loss Aversion
You can also train yourself to avoid the fear of losing money. If you are afraid of losing money, your trading will be blocked by your aversion to loss. All traders will experience loss aversion at some time or other. In your first trade, you may experience consecutive losses or face losses, and unknowingly, you are afraid to trade. To properly manage loss aversion, you need to treat transactions like business and understand that loss is part of your business plan. This situation means that you must have a good grasp of your trading psychology and the conditions required to correctly deal with the capital market.
Understanding Loss Aversion Theory
Loss abhorrence is a psychological fact. He said that people hate loss more than love gain. For the same loss, such as $100, many investors would rather avoid the loss than accept the same gain. This principle is widely used in economics. Loss aversion is different from risk aversion. Loss aversion is based on past experience. Some economic theories say that people hate losses twice as much as gains. Before focusing on investment behavior, this theory was originally used for consumer behavior.
For example, consumers are more willing to accept price increases than price drops. If the price goes up, you are more likely to stop buying products instead of buying more products when the price goes down. Loss aversion is usually accompanied by loss of attention. This theory refers to the tendency of consumers to pay more attention to situations involving losses than situations not involving losses. This situation means that you will pay more attention to price increases that cause wealth to shrink than price drops that cause wealth to increase.
Loss Aversion in Trading
Investment theory loss aversion says that traders are more likely to become neurotic after a loss, rather than becoming aggressive when making a profit. This scenario tells investors that losing $100 is more valuable than gaining $100. Since this is part of the psychological makeup of most people, you need to retrain your brain to understand that the two are the same. This also means that traders will pay more attention to previous losses or losing positions rather than profitable trades. This characteristic also means that you are more likely to succumb to fear rather than excessive greed.
How Does Loss Aversion Occur?
Since most people are programmed to avoid losses rather than accept gains, loss aversion occurs naturally. Of course, you have to experience some kind of loss to understand the feeling of losing money. Most novice investors only see some gains; for example, when you start working, you will only experience getting paid. Your employer may pay you a flat rate or an hourly rate, but you can only experience making money. Few people go to work. If they do a bad job on a certain day, they won’t get paid, or worse, they owe money to their employer.
Since loss is not a deeply ingrained concept in your behavior, your first investment experience may be the first time you experience a loss. Now that you know how hard it is to make money and how long you have to work to make money, the fear of trading losses far exceeds the concept of income generation. There are many reasons for loss aversion. You may be a novice trader and will not expect losses. You may suffer greater losses than expected. You may experience a losing streak that you did not expect.
How Do You Handle the Fear of Losses
The first step in managing loss aversion is to understand and accept that loss is part of your investment plan. You should anticipate losses and accurately treat them as gains. The loss will be a certain percentage of your trade. If the percentage of loss is greater than you expected, you should spend more time and attention dealing with your loss. The next step is to develop a specific business plan. If your trading strategy is discretionary, you should have a risk management plan with strong risk-reward characteristics. If you have never considered how much risk you plan to take in each transaction and what your potential loss might be, then it is best not to trade. If you operate intuitively and do not have a risk management plan, then you are preparing for loss aversion.
Experience is the best way to overcome loss aversion. If you see that you quickly accept losses to avoid major losses or quickly make profits to avoid losses, you should take a step back and check your trading plan and investment psychology. You can consider two different ways to practice coping with fear. Related to loss. One is to open an account, and the risk is small. Although loss does not cause financial pain, you may feel the same about loss. It’s a bit like vaccination. You are training your brain and body to experience the leaked virus and become immune to the fears associated with failure.
Another option is simulated trading, you do not need to bear any actual capital risk, nor do you need to use a broker’s simulated account. Demo accounts usually provide you with simulated funds that are not real assets. You can still see your profit and loss, but the principal will be false. Although it is different from taking risks with real money, a demo account will help you experience some emotions related to real gains and losses.
The Bottom Line
Fear and greed are convincing emotions. They play an important role in driving the trend of the capital market. When prices climb the “wall of worry,” bull markets tend to over-expand due to greed and fear. When fear leads to uncontrollable selling, the bear market may spread too far. When investors start trading, the emotional aspect of trading is often overlooked. Managing sentiment is a basic part of capital market transactions. It helps to understand this concept early in your business career. The sooner you understand how fear and greed affect your investment, the sooner you can solve the problems that arise from greed or fear trading. Although both fear and desire can lead to negative behavior, fear can lead to loss of aversion.
Loss aversion is the fear of failure, it is greater than the joy of victory. Continuous losses can lead to loss aversion. In order to properly manage loss aversion, you need to treat transactions like business and understand that loss is part of your business plan. This situation means that you must have a good grasp of trading psychology and the correct way to deal with the capital market. The most effective way to deal with the emotional aspects of investment is to develop a business plan. A business plan is similar to a business plan in which you can describe the risks you are willing to take to achieve your financial goals. You can do this at the portfolio level and commercial level. Your goal is to eliminate the excitement in business activities by determining what to expect in advance.
Since you do not expect all transactions to be profitable, when the position is not good for you, you understand that the change is only part of the transaction. A trading plan will help you avoid becoming greedy when the trading position is in your favor and will allow you to avoid being afraid when the trading position is not good for you. You should consider using a small amount of money to gain experience. You can also consider setting up a demo account. Together with the trading plan, these two techniques will help you avoid many common mistakes that traders make when fear and greed invade their trading psychology.