Understanding your fears
When you are involved in trading and stocks are down, it’s understandable that you will be a little scared. Unfortunately, this fear might cause you to overreact and liquidate your holdings, go to cash, and refrain from taking any more risks of losing money. This action might prevent you from some losses, but you also risk missing out on potential gains.
One way to help deal with fear is to understand what the fear is. By definition, fear is a natural reaction to what is perceived as a threat. In trading, that fear could be a reaction to a posed threat to your profit or potential to make money. You will better deal with fear if you consider what exactly you are afraid of and why you are afraid of it.
If you ponder the issues of your fear at a time when you are not emotionally charged, you are better able to determine how you might react in a given situation. For example, if you think things out ahead of time, you might be able to identify your feelings of fear during a trading session. By acknowledging your fears you can focus your efforts on moving past the emotions that might distract you from completing a successful trade. This exercise takes practice, but it is necessary to preserve the health of your portfolio.
Greed is your worst enemy
A common statement cited on Wall Street is pigs get slaughtered. When investors are winning, many of them hang on to their winning positions much longer than they should in the hopes of getting every possible tick. This is risky and can result in a devastating blow to your position.
Despite being aware of the greed factor in trading, it is a difficult emotion to overcome. Many traders have an inherent desire to keep doing better so they push the boundaries of their trades. It is important that you recognize this emotional trait and develop your trade plan on rational business decisions, not emotions.
The importance of following trading rules
To avoid the risk of emotions undermining your trading efforts, it’s a good idea to establish guidelines based on your risk-to-reward relationship before you enter a trade. These trading rules can function as a safety net that can prevent you from a catastrophic loss. For example, if a particular stock is trading at $15 per share, you might consider getting out at $15.25 or even at just below $15 to put in a stop loss limit and get out.