Controlling Emotions in Stock Trading
Whenever you see the words 'short term' or 'stock trading', there's always an aura of scepticism that follows.
This is possibly due to the predatory behaviour of fake gurus that pray on people looking for 'get rich quick’ solutions, or more probably because the trading scene is usually filled with unemployed males in their mid 20's convincing their family and friends that they have a viable 'career'.
It's these kind of negative associations with stock trading that kept me away from it for a long, long time. However, it wasn't until the last 18 months that I found myself investing in activities that were technically classified as stock trading. I was buying stocks without a plan to on hold over the long term (over 10 years). I got lucky on this occasion and was able to turn a profit, but the emotional rollercoaster that came with that was one I didn't enjoy and won't look to repeat again.
This is not a knock on stock trading, as with anything, I know there are always winners in any investing strategy. However, I discovered that at least personally, trading brought more anxiety than enjoyment, and I wanted to unpack the psychology behind why.
Trading is a very different game to investing
Trading is essentially any investment activity thats viewed with a short time horizon; days, weeks, months, MAYBE even years. Its on this basis that trading is focused around timing, the difference between a win and a loss is often when you buy and sell, and rarely on the long term intrinsic value of the purchase.
This is what makes it distinct from investing, which is a time insensitive purchase, for which the buyer believes will bring a sustained profit over a very long time period of 5 years or more. An investor is not focused on timing, a trader is.
Because trading is short term, it soaks up mental energy
My first discovery was how incredibly mentally draining trading can be. When your wins and losses are identified by your buy and sell prices over the short term, you're always wondering what the short term prices are, its always on your mind, taking up your mind.
Because trading is often crystal balling (yep, technical analysis is crystal balling), you find yourself regularly checking on prices, bringing in a lot of unnecessary noise, getting overly worked up mentally and losing sight of your initially planed sell prices. The more you look, the greater the fluctuations in price look, every minor thing is magnified, even if it isn't that significant in the long run.
Even if you win a trade, you can still feel like a loser
Compounding the above, is the fact that you will almost never buy at the bottom and sell at the top. It's a guessing game after all, and the odds of you picking the bottom AND then selling at the top consistently, are slim to none.
This leaves you with an ongoing feeling of FOMO. You feeling that you should should have bought on a specific date, and if only you held on for X amount of days then you could have sold and made infinitely more. You know that thinking like this is utterly stupid and unproductive, but you just cant help thinking it, it's very hard to emotionally detach from. So, even if you make a profit, you'll always wonder how much more you could have made. It's a lose, lose scenario, even if you win.
A documented plan limits the emotional swings
What I Learned Losing a Million Dollars is an incredible book documenting Jim Paul's great success as a trader before he blew up and lost it all. He outlines a key principle in the book that underpins this entire mental model. Always have a plan.
A good plan will:
Limit a panic sell when the asset price falls temporarily.
Ensure greed doesn't kick in when you’re in the money, making you sell while you’re still in profit
Provide peace of mind that you stuck to a strategy, eliminating the ‘what ifs’ once you’ve exited your position.
Free up your mind by taking the trade out of mind. The decision has already been made when you plan, so there’s no need to constantly check an assets current status or price.
Key takeouts for how to control emotions in trading:
Make your bed, then sleep in it: The key is to set a clear plan from the beginning of your investment; a preallocated amount to invest and a clear sell price, whether the stock goes up OR down. Have a plan, write it down, and by christ, you better stand by it. If there’s no plan to sell, there is no plan.
Plans limit the influence of emotion: There's a reason why there are more successful investors than traders. With so much emotion floating around to influence decisions, it can lead to far more human error. Sticking to a plan reduces short term stress, and in the long run, sticking to a plan will reduce the influence of greed or doubt when holding a position.
Plans free your mind of noise: A plan allows you to clear short term distractions from your mind, which can often take up much of your mental running power. Once you've documented your approach before you decide to play, your emotions cannot never take over (unless you allow your ego to override your plan). You will never feel the 'what ifs', because your destiny was written out from the start before your emotions take over.