The key takeaway point from last week’s article ‘the trading experiment‘ was the level of comfort associated with risk and being exposed to it. The key to your success as a trader is your ability to become extremely comfortable with exposing your trading account to risk – managed risk, that is! The more comfortable you are, the more likely you are to succeed. Sounds pretty simple and it is!
Motivations, when it comes to investment and trading decisions, are often governed by two primary emotions – fear and greed. These can be equally as damaging to your trading account, state of mind and of course, stress level.
So as a trader, how can these be addressed, in a practical way that enables smoother sailing?
Firstly understanding your trading personality can go a long way to identifying the driving forces behind how and why you make the decisions that you do. At AIE we have pioneered the trading personality profile, to help our client get the best fit, when it comes to trading strategy and the approach they should take. If you have yet to take the test, click here and see what you can learn about yourself!
Getting into the nitty gritty, what exactly are fear and greed?
In short, these are emotions which can and do impact on our ability to make decisions in the way that we would like.
Taking fear, first and foremost, this can come in an assortment of concerns including;
- Fear of missing out on an opportunity for profit
- Fear of the risk on the trade.
While these are opposite sides of the same coin, they both have the potential to be very damaging.
For example in the first instance, missing opportunity, traders with this kind of fear tend to over trade or have too many positions running at a given time, based on the size of their account. As a result, there is potential for a lack of focus, or by spreading too thin, fees such as brokerage may be eating into returns or exacerbating losses.
Alternatively, not taking the trade through fear of risk – is really a paralysed with fear syndrome. This may be brought on by a whole raft of things. Previous experience, attitudes toward money, lack of desire to get out of the comfort zone, lack of knowledge and beyond.
According to Gordon Gheko, greed is good!
But is it? In reality and beyond socially acceptable behaviour, greed is really not that appealing and, in a trading context is outright dangerous. Typically, greed see’s a trader exposing his account to unnecessary levels of risk, in order to “squeeze” the last drops of profit from a trade.
While this can be a great ego massage – “hey I got in at the low and sold at the high” in reality it simply doesn’t work as the decision making is being made for entirely the wrong reason.
Greed can also influence areas such as asset allocation
For example, a trader may find a strategy that has the potential for higher returns (wrong focus) and plough too much funding into this strategy. What they may have overlooked are things like volatility of return and probability of return. Caught like a rabbit in the headlights, drawn in by the allure of return only, an account can take quite an un-necessary bashing, when instead, it may have been better suited to a lower potential return with higher probability and lower volatility of return.
Working with private clients, 1-1 or at our live Mindset Mastery events, it can all too often come down to one or two very specific belief systems, held by the person, particularly in relation to money. The great news is, that it is fixable, afterall, most things are!
And think about it, this is all before even being in the trade, let alone the psychological variables that can then kick in. These include things like the endowment effect, which we will look at next week.
Simple experiments can often lead to dramatic results – that simple coin toss has really lifted the bonnet!
Any advice included in this article is general advice only and is based solely on consideration of the investment or trading merits of the financial products alone, without taking into account the investment objectives, financial situation and particular needs (i.e. financial circumstances) of any particular person. Whilst this tool may assist you in determining your trading personality, the result will not be taken into account by us. The results are for your information and consideration only. Before making an investment or trading decision based on the result of the trading personality tool, you should carefully consider the appropriateness of results in light of all factors of your financial circumstances and you should carefully review the Product Disclosure Statement and financial services guide regarding the relevant financial product as provided by your investment advisor.