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Emotional vs rational trading

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    Emotional vs rational trading

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    First off, when making your trading decisions, stay away from your emotions. Decisions based on your emotions are hardly every right.

    If you have a strong gut feeling that a certain stock will go up or down then, unless it’s based on your analysis, forget about it. And even if you have made your decision based on what you saw on the chart or based on what the fundamental analysis told you, at all times it’s your responsibility to keep yourself emotion-free.

    Why? I guess it’s the most simple to explane it via poker. A good poker player might know exactly what to do, when to do and how to do and he may have decided also to act on only depending on his knowledge. However, if some other player starts to piss him off or if he needs money fast he might start to make decisions that are affected by his emotions and thus are not clear and right ones anymore. He might have started based on his knowledge and analysis of other players but after the flop he is starting to feel lucky and does a wrong move. It’s the same with trading stocks or forex. You might have made a right decisions when buying the stock and you might have set the right stop loss and take profit limits. However, due to emotional hopes that do not stem from any exact analysis anymore, you decide to move the stop loss lower for example. Just because you THINK this stock WILL go up very very soon.

    Until long you notice the stock is still falling, you keep adjusting your stop loss limits to even lower and lower levels where eventually you are starting to think – wtf have I done? Everything was great, I would have taken a minor loss, so what...but instead I took a huge loss. And all that due to the adrenalin in my brain.

    So, even though I am very well aware that keeping your emotions locked when playing poker or when trading is not a simple task, it IS a very important task in order to become a successful and profitable trader.

    Price changes ARE emotional
    While you yourself should not act on your emotions, you do need to keep in mind that the major crowd on the markets do act on emotions and this means that the price changes are caused by emotions. Trading for most people is emotional not rational. And because of that, when making our trading decisions, we must take rational approach to conquer emotionalism.

    The main emotions that are causing price changes on the markets are fear and greed. And that’s also one reason why technical analysis works. Prices are somewhat predictable due to the market players, the people, their emotions, their fear and greed.

    Imagine a bad news about a stock or a company that is published in Financial Times. You now make your analysis and get to the conclusion that actually there is nothing wrong with the stock and the news shouldn’t really affect the stock price. At least logically thinking. However, very many traders are searching for a reason to buy or sell a stock, many traders are counting on news on their trading decisions and if they see a bad news, they are starting to feel fear and they act on it. And because they are doing it and there’s lots of them you can’t anymore think that your analysis is correct and the stock price will not go down. Your analysis was correct from the rational perspective. However, if masses are starting to sell the stock then the price will go down – so your rational decision, especially if you’re a day trader, should be to rationally analyse what will people’s emotions do to the market.

    Thanks to technical analysis you often do not even have to take a look at the news to see what’s happening. If you’re a good chart reader and interpretator you can see it all from the charts – the news, the fear, the greed.

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