3 Fears in Stock Trading That Can Cost You.

According to new research, there is an excellent possibility that fear, if left unchecked, could be the destructive aspect of your trading. A recent study completed by Boston University and MIT professors labeled emotional responses within traders as “a significant factor” in the outcome of their trade. (1) This should be a wake-up call for retail traders because studies are suggesting fear could be the silent threat sabotaging your trades and one you might not have considered.

The Hidden Danger of Fear.

The truth is, fear guides our focus. We tend to fixate on the very thing we are afraid of. The real problem, however, is that what we focus on tends to become reality more often than not, even if it is the very thing we are trying to avoid.

Consider this true story. I once had a friend share with me his two-day experience as a NASCAR driver. It was a weekend school he enrolled in to learn how to drive stock cars. The very first lesson that he learned was how to crash—or maybe more accurately titled, “how not to smash into the wall”! The outcome was simple: if you lose control, there are maneuvers you can do to end up in the grass and not smashed into the wall.

Rule #1 was do not look at the wall. Instead, focus on where you want to go.

With his classroom education completed, he headed out to the track with his instructor, who then placed the car into a spin. My friend forgot Rule #1 and found himself focused on the wall. Had the instructor not intervened, he would have driven right into the wall. Having recovered from the spin, he practiced the maneuver again. The second time yielded the same result.

My buddy stared at the wall, and the instructor had to intervene to preserve the paint job on the car. The third time around the track, when the instructor put him into a spin, he simultaneously used his hands to force my buddy’s head to look at the infield instead of the wall. My friend recovered perfectly, and the lesson was complete.

The larger lesson is simple: our outcome is largely predicated on our focus, and our focus can easily be hijacked by that which we fear. The same is true in trading. How many traders do you know who consistently make a profitable return yet are scared to death of losing money?

Really, How Many?

In my experience as one of the main instructors at TradeSmart University, I can tell you that I have never met a single one. Or how about this one—how many successful traders do you know who are perpetually afraid of knowing when to get in or out of trades at exactly the right time? What should be alarming is that this fear is so prevalent among retail traders that someone coined a cute term for it “Analysis Paralysis.” The result is the same, though fear leading to a loss of potential profitability and increased frustration with trading.

During a recent survey of over two hundred active traders, TradeSmart University identified the three most prevalent fears as:

  • Not knowing when to get in or out of trades (40%)
  • Losing money (29%)
  • Being wrong (14%)

It is likely that as a trader, you have also faced some of these fears, and maybe even “hit the wall” a couple times before you learned to maneuver out of your situation. Or perhaps you are remaining fixated on the very thing that left unchecked will take you out of the game. There is good news, however! A well-rounded approach to trading education can help train you to stop looking at “the wall,” much like my friend’s instructor did as they were spinning around the racetrack.

Destroying Fear: 3 Key Components of Trader Education.

There are three critical components that every trader should be looking to incorporate into their trading education. While the elements of Dow Theory and Technical Trading have changed very little in the last seventy-five years, exceptional advances have been made in the area of managing emotional responses within traders. Successful traders will consistently:

  • Execute a process of constant conditioning.
  • Disassociate their emotional ties and personal esteem from losing trades.
  • Control the conversation with themselves and others.

Executing a Process of Trader Conditioning.

Conditioning is the mechanism by which we move analysis and trade execution from the active portion of our thinking to the place in our brain where our habitual memory resides. Research has shown that over 40% of the decisions you make in a given day are out of this habitual portion of your brain. (2) An example of how we use our habitual mind occurs as you drive home from work. Daily, millions of people make this journey without incident. If you stop and consider the nearly limitless possibilities of events that could occur, yet the relatively small cognitive energy needed to accomplish the outcome, you now understand the power of our habitual mind. This level of brain activity is executed from a special place in the brain near its stem called the basal ganglia, a place reserved for our habits. (3)

TradeSmart University has done extensive training with students in this area and has created a four-step process called the Trader Conditioning System. This system helps expedite the time required to take a beginner trader with little experience and a lot of active, present mind focus to operating in a nearly habitual state. It is through this process of conditioning that a trader will stop fearing losing money or not knowing where to get into the trade because the execution becomes as natural as driving home from work. While we would think it was foolish to sit at an intersection we have encountered hundreds of times and wonder which direction we should turn; it would be equally foolish to see a trade setup we have conditioned and wonder when we should enter or exit the trade. That is the power of conditioning.

Disassociating emotional ties and personal esteem from the Win-Loss ratio.

This is a big one. Do you “judge” your performance based on your win-loss ratio? Stated differently, how do you feel when a trade goes against you? Most novice traders love to toss around the words “right” and “wrong” as they recount their most recent trades. “Oh man, I got that one ​right!” or perhaps, “Boy, did I get that one ​wrong!” There are two inherent problems with this way of thinking.

First, how many people enjoy being wrong? Does anybody come to mind? Probably not. We all endeavor to be right, and we avoid situations where we might be wrong. The challenge with trading is that even the greatest analysts will have trades that go against them. Does that make them wrong? Most would be slow to suggest that they were wrong. So what is the disconnect here? One solution is to remove the ability to be wrong by remaining constantly neutral in your trading. At TradeSmart University, this would be accomplished through bracket trading.

Bracket trading is a great start, but there is still a deeper issue here with being right or wrong. In working with students, TradeSmart University has discovered that most retail traders have an inappropriate paring of measurements and outcomes. Consider this. A professional trader can see an excellent trade setup, execute flawlessly, and still lose money, right? Conversely, a reckless trader can misread a trade setup, execute poorly, and still make cash on a trade, correct? Unfortunately, most traders tie the quality of their trade to the ROI at the end.

A positive number means I was “right,” and a negative number means I was “wrong”, true? No, the problem with this line of thinking is that the above example would imply that the trader who poorly analyzed and executed his or her trade was superior. That is not true because we all know how that story ends. The professional will experience a long trading career while the reckless trader will wash out quickly.

At TradeSmart University, we have identified this as a dysfunctional trading loop, and it is an extremely dangerous situation for amateur traders. It is imperative that a trader wishing to experience consistent profitability adopt an Empowering Trading Loop that accurately measures their processes and disciplines as a trader. Once this shift has been made, two things happen. First, the consistency of your trading will stabilize and optimize. Second, it will eliminate the fear of being wrong. When you trade with an Empowering Trading Loop, you have complete control over each step of the process. Even if the trade is not profitable, you can still be “right” in your discipline of analysis and execution.

Controlling the conversation with themselves and others.

Language has meaning. Having worked with so many traders over the last several years, it is always amazing to me the types of words we use to describe our profession. For example, if I said.

The market is driven by two emotions, fear, and _________. What would you say? 

Usually, when this question is asked in one of our classes, nearly the entire room responds with fear and greed. They say it as though it’s almost a silly question. But is it? My followup question is always: Which are you, fearful or greedy?

Then I usually get crickets. I have met very few people who are truly fearful or greedy in their core. Yet they enter the market, subconsciously believing that they must adopt one of these personas. Is it no wonder people are fearful within the market! Let’s ask a better question. Are fear and greed appropriately paired emotions? The answer is absolutely NO. Fear is a state of mind, and greed is a state of the soul. The opposite of fear is optimism or courage, or confidence. The opposite of greed is generosity, abundance, love, etc.

Do you see the point? So often, beginning traders set themselves up for failure by failing to control the conversation, both within their mind and with others. Our students are the best around period. When they have that moment in class and realize they can release the burden of fear or greed and adopt a spirit of confidence, it is one of my happiest moments as an instructor. Once we have that foundation laid, I can walk them through the educational process to profitable trading. It is truly a game-changer.

Would you like to build this level of confidence in your trades?

TradeSmart University has a program for beginning to intermediate traders called Foundations of Stocks and Options. It is a series of twenty-four classes that are designed to teach the principles of Technical Analysis, Trade Management, and Disciplined Execution. Your fears of trading will be replaced with confidence in yourself and confidence in your trading plan because we believe there is no place for fear in a profitable trading plan.

List of references:
(1) Lo, Andrew W. and Dmitry V. Repin (2002), “The Psychophysiology of Real-Time Financial Risk Processing,” Journal of Cognitive Neuroscience, 14 (3), 323–39.
(2) prl. 3 One paper published Bas Verplanken and Wendy Wood, “Interventions to Break and Create Consumer Habits,” Journal of Public Policy and Marketing 25, no. 1 (2006 ): 90– 103; David T. Neal, Wendy Wood, and Jeffrey M. Quinn, “Habits— A Repeat Performance,” Current Directions in Psychological Science 15, no. 4 (2006): 198– 202.
(3) Duhigg, Charles (2012-02-28). The Power of Habit: Why We Do What We Do in Life and Business (p. 15). Random House Publishing Group.