Wednesday, June 3, 2009

Fear of losing money

Anonymous commented to one of my previous posts which treated the subject of what is that makes good trader and that comment inspired made me to write something about fear of losing money – together with greed, this fear of losing money is one of two most influential emotions which run one’s trading and/or investing.

Through our life, we all were, mostly, taught to go into the world and be always right about everything: To get good marks in school; to be good kids; to get into university, etc. All in all - we were never taught what to do when we are not right and how to handle situations when something, that opposes our beliefs/wishes, is happening. Unfortunately, current schooling system is still not designed to teach our offspring what to do in such situations, so they are going to, probably, follow our path.

Let’s assume the following: One day you start to trade, as your colleague told you about one guy, whom he knows and who made some money. Inspired, you’ve purchased and read books that are supposed to show you how to make money. Brokerage account is there and you are buying your first shares, based on hot tip by friend’s friend. Market starts ticking in your favor for first few minutes and then, suddenly, some bad news hit the market. Selling is coming in and your recent acquisition, in a blink of an eye, turns against you. Fear of losing money just kicks in and you don’t know what to do, as nobody ever told you what to do in this kind of situations. You decide to play it safe and in deed you phone your friend and he tells you to hold position, as this is just correction after good run. Next day comes and your position is deeper under water. Of course, you decide not to close your holdings now, because you are afraid of losing money and you stay in, with belief that this is just a temporarily pullback in price and all of this is just a “paper-loss” to you. Time goes by and one morning you face the fact that your capital is down by, let’s assume, massive 20 or 30%. 

I believe that fear of losing money is the most influential emotion you will experience during your trading career and it is very difficult to explain how one should handle it. As I see it: 

- You should have trading system (mechanical, semi-mechanical or discretional) that makes money in the long run;  

- There must be defined entry and exit signals for every trade; 

- Your trading discipline should be in charge, allowing you to follow your system without asking too many questions.

By having all three in place, you will know in advance how much money you are going to lose if trade goes against you: Stop loss will be pre-defined and if that price level is touched you will close your position. For me, trading is getting easier when I know why and how much money I am risking on each trade. 

This is one simple recipe that should help you eliminate fear of losing money. Of course, do not expect that it is going to work first time, as it takes time to get there: Someone gets it sooner, someone later and someone never!

If you are beginner, work on processes of becoming good trader and forget about money for now, as it will come later. One of the first steps is to eliminate greed and fear from your trading and I wish you all the best in that crutial process.

Trade well.


Liquid Trader said...

Discipline Discipline Disclipine...

If you wake up in a cold sweat worrying about your trade then you shouldn't be trading it in the first place.

Alsi Trader said...

Liquid Trader

Very true and thanks for the link.

At the end of the day, in this game, discipline is what differentiates winners from losers.

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