This blog post isn’t really related to the trades I was in this week (although I’m going to put the chart up) but more to do with dealing with the emotional impact of making a less than stellar trading decision. This began as a sort of investigative experiment but ended up telling me an awful lot about my mental and emotional approach…
First, a bit of background… In my reading I’ve seen a number of people talk about having an ‘edge’ in a trade, along with time stops and of course the all important entry point. What messes up a lot of traders early on is that they place stops way too close to their entry points in choppy markets. There’s no room or the trade to move/breathe/react to market noise. However, trading with the trend does at least give you something like a 10% advantage that the whole scenario will work in your favour.
I’ve also done my own loose monitoring/experiment to validate this belief [here] and it came out with a 25% percent advantage to following the trend over my own decision making… Possibly a shocking indictment of what goes on in my head but hey ho ;)
From what I’ve seen/experienced trading stocks it’s that money (investment capital) moves in and out of stocks roughly in time with market sentiment. So, even if you’re long on a great stock that just keeps going up, when sentiment is negative people will take profits and recover their capital to move it elsewhere. On this basis it’s challenging to make money going long when the market is dropping. This applies even if the sector you’re in is also outperforming the market. It’s just human nature that people feel at risk when things look bad.
Just as an aside here these are all my opinions/perceptions so if anyone does really disagree with me that’s fine. I’m not telling you what to think or putting myself up there as an example at all.
So what I decide to do is find an FX pair with a significantly strong up or down trend and just place a trend following trade with very wide stops at an opportune moment. This was an experiment to see what would happen and whether I could deal with the unfolding situation emotionally. Testing my faith in the idea of trends so to speak.
I’ve broken the experience into three phases.
- Preparing to place a trade – creating a scenario
- Being in the trade – managing fear, doubt and despair
- Exiting the trade – resisting the pressure to cut and run
Following some deliberation I saw that AUDUSD had recently reached new highs and was trending up strongly.
So rather rashly and with a disregard for what was actually happening in the moment I entered the trade long.
I also noticed that USDCHF was in a long term downtrend but had recently risen so I entered that short.
I’ll talk about the AUDUSD trade because that is the best illustration with the widest movement of the two. So no-ones hanging out for the ending to the blog and because it’s not actually the point I ended the AUDUSD trade up about 35points and closed the USDCHF trade at evens. So lets take a look at what happened.
Preparing to place a trade – scenario creation
I’m guessing that experienced traders can probably go through this process in lighting fast time. It may also be that at shorter timescales (15 mintues and below) I’ve consistently lost money because I’ve just not had enough thinking time to step through all the options.
So coherent trades I’ve entered have all worked because I’ve created a scenario around them about what is happening now and what I expect to happen in the future. Here are some quick bullets about the AUDUSD trade
- The aussie dollar has been on an up-trend for ages
- There’s decent amount of support to halt any retracement
- The price has bounced off a level (x) a number of times and headed back up
- I’m going to place really wide stops because I believe eventually the aussie will keep rising
- I’m prepared to let this trade play out over several days if I have to
- I’m going to have a >100 point stop so that I don’t get stopped out by market noise
- I will not fold the trade early because I’m uncomfortable
- I will only move my stop up when it’s really safe to do so i.e. when the trade is up at least 20 points
- I will not spend my time watching the trade or looking at my P&L
So happily the AUDUSD fell like a brick on Wednesday and I decided to go long.
Now, at this point this was actually a bad entry decision (isn’t hindsight amazing!) because I’d not really had any kind of confirmation that a reversal was even close or the downward momentum had ended… Not a good start.
For those interested purely technical point my entry was at point A at about 21:30 on Wednesday. I was looking at the bounce off a new low without taking into account there was still plenty of scope for the price to keep dropping…
Being in the trade – managing fear and despair
Now, the one thing I had in my favour as this trade went south for 36 hours was that I’d already mentally rehearsed my reactions based on my beliefs about this trade. I checked this trade at one point yesterday and it was 81 points down (see point B). At that time I quickly logged out of IG Index and got on with what I was supposed to be doing!
I’ve found that dwelling on a situation is counter-productive and you have to eventually have faith in your own ideas and decision making. The fact that, although I wasn’t ‘happy’ about how this trade was going I also wasn’t beating myself up about it or letting it get to me too much. Now, I’ll of course admit that I wasn’t jumping for joy either ;)
The thing that helped, apart from having already thought through how I was going to react if indeed the trade did go against me, was realising that emotionally ‘I am not my trade‘. The trade that is currently in play is a completely separate thing from me. There’s no reason for me to really credit the emotional reaction to a situation in this trade with any ‘weight’. It’s a separate thing over which (now it’s in the market) really don’t have any control. So if I can’t control it why worry about it?!
Of course this is the conclusion I came to as the roller-coaster went up and down as my emotions went the same way. What I’m pleased about in all this is that I had the patience to hang on and trade the scenario I had laid out mentally in advance. It wasn’t a particularly pleasant experience but by un-linking my ‘self’ from the trade I managed to stay the course…
Exiting the trade – resisting the temptation to cut and run
The most difficult part for me, or the part with the most intense ‘feeling’ component is actually all around exiting the trade. Again, especially for beginners, this is difficult to deal with because we’ve not experienced a lot of winning trades to practice this bit on! ;)
After two days of doooowwwwnnn then slow climb to even (no loss) I felt under huge emotional pressure to walk away and just get out of the trade! How dumb is that? Now, also notice that there are entry and ‘in the trade’ rules in my scenario but I’ve not written any ‘exiting’ scenarios. I found I had to make these up on the spur of the moment!
As I got to +1, +5 and +10 points I was incredibly tempted to just close the trade. A couple of things stopped me… The scenario points I made up on the spot were: -
- I’ve not done all this ‘work’ and been through the 36 hr rollercoaster for nothing (emotional)
- EMA’s were all moving up
- Trying to limit loses but need to let profits run – the great maxim
- I can move my stop up to a sensible point (i.e. open) after 20-30 points and not lose money
- It could always carry on going up further, as it dropped further than I thought it would initially – lol
This temptation to quit out happened twice – at point C and at the second break through my entry where I was 5 or 6 points up and the price was going plus 1 plus 2 then back to entry…
So I managed to hang on till I was about 35-39 points up (point D) when the whole work scenario got in the way and I felt happy to close the trade and not have this going on in the background while I was having to deal with a significant project problem.
The points I had in my favour…
- Having thought my way through the trade (and holding my nerve) in advance
- Understanding that how the trade was going didn’t reflect on ‘me’ and wasn’t linked to me emotionally
- Having wide stops
- Being patient – letting the trade ‘do the work’
Things I didn’t do particularly well
- Should have waited for a better entry point – 10 period EMA not still nosediving would have been a start!
- Hadn’t thought the exit scenario through in enough detail – would have made resisting temptation easier!
This trade also broke the 1% risk rule by a significant margin so although it was a very useful experience I’m not planning to do any more of these soon… Will be adopting a more sensible approach next week.