Trading Psychology

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SOURCE: http://www.insightsquared.com/wp-content/uploads/bfi_thumb/why-people-buy-buyer-psychology-of-purchase-decisions-mx6ltneguhv45z0z7drrz7974r0mukjfbr11oxlh28.png

How many situations have you been in where you bought a stock that you truly believed in and knew that it was going to go up no matter what?  Now how many times have you done that, watched the stock hit a resistance level as you begin to panic, selling for a loss at a near low of day only to watch it rebound that afternoon?  Where I often see new traders falter is their trading psychology.  Too often a new trader will panic sell positions that they knew were good buys and would reach higher share prices than their buying price, but feel the short-term risk is too great.  This is what leads to 90% of retail traders to fail at investing their own accounts.  Letting emotion dictate when you buy a stock, when you sell a stock, and the stock you buy almost always leads to a poor outcome.  The best advice I have really is, keep your cool and stick to your game plan

No trader should enter a position on a trade without a real plan set in stone. That is a sure-fire way to guarantee failure.  Always have a strategy that fits your personality, risk preference, and is one that you will be able to follow for all your trades.  This will set up consistent patterns in your trading behavior, allowing you to analyze your efficiency in the strategy and adjust based on you results.  I trade almost purely off technical analysis, this allows me to follow indicators and pick which stocks currently fit my entry and strategy for both entry, exit, and risk tolerance.  While I prefer more risky investments and am willing to take a loss or average down, not many investors are capable of the stress.  I will lay out a few tips for you to follow to beat out pull backs or handle them with a better mentality than previously.

·        Never enter a trade without a set goal of entry, profit taking point, stop loss point, position size, and a clear set reason/indicator for which you are entering the trade
It is a fool’s choice to buy a stock for a trade (unless long term investing in an excellent product) that you believe in blindly.  I will follow technical indicators and let those dictate my trades, not “AMD to the MOON! $16 by the end of the week” because it is the current hype.

·        If you use a stop loss in your strategy, it is effective to set it tight, you do not want to expose yourself to higher risk than necessary. 
I personally rarely use a stop loss because I prefer volatile stocks that will likely give greater returns.  Having a stop loss a fair distance from your purchase price will cause panic to set in if there is a pullback and can lead to you being down 3-5% on your position taking a loss rather than down .5-1% if you keep your stops tight.

·        Take several entry points on a stock. 
Great traders do not buy and sell all their shares in single blocks.  They will often “position in” a stock, buying at a key entry zone they specify, watching the price action.  They will also do the same, selling a portion at their price target and letting the remaining shares run up with momentum to sell for greater profit.  If you purchase shares equaling 30% of your planned position size, it gives you more flexibility with averaging down or cutting losses.  Let’s say you have $1000 for a certain stock worth $10.00 and you decide you want to buy in so you purchase 30% of your position.  That leaves you with 30 shares and spending only $300.  If that stock then drops 10% after purchasing it and crashes through the stop losses you had planned, you are down only $30 rather than $100 if you had bought the full position.  It also leaves you $700 to average down your cost basis if it pulls back or allows you to keep buying into momentum up safely. 

·        Do not chase a stock. 
I have had followers see my purchases and notifications later in the day and try to jump into the momentum after a stock has already run 5%+.  They often get the short end of the stick as people begin taking profits and the share price starts to dip.  If a stock is running up big, it is usually best to sit the side lines as you are most likely too late.  The risk to reward ratio is not feasible to be worth putting your money into.

·        Take on risk that you know you can handle. 
Don’t purchase a leveraged ETF with 80% of your portfolio when you have no ability to day trade and get nervous easily, selling when you see bad price action.  The greater positions you take with the higher risk, the more likely you are to burn through an account.  Stay away from leveraged ETF’s or stocks that generally move 4%+ a day unless you have a clear set strategy you are implementing.

·        DIVERSIFY. 
While diversification might limit your potential profits, it also mitigates your potential losses.  I personally do not like to purchase any amount of a single stock that is more than 30% of my portfolio.  While I have in recent months, it is rare and usually when I am still bullish on technical and am averaging down.  A 10% loss on 30% of your portfolio is much better than 10% loss on 90% of your portfolio.

·        Lastly, Do not doubt your system. 
If your strategy is to purchase tech stocks based off Fibonacci Levels and keep $0.10 stop losses and hold for no longer than 2 hours, STICK TO THAT.  Do not try to trade 3x leveraged Oil ETF’s because you see them reach 52-week lows and that’s all you know. 

 

Every trader must know that they will have losing trades.  The key is learning to minimize your losses on your losing trades while allowing your winning trades to run past your price target, positioning out and taking profits as the price moves upwards.  Even if you have a winning trade only 50% of the time, if your winners make you 4% and your losers only cost .5%, then you will become successful in your strategy. 

My upcoming articles will lay out many different strategies and how to use them so that you can develop your own trading systems and not have to rely on my notifications or posts to find stocks to purchase.