Psychology and Risk Management
• What to expect
• Risks
• Position sizing
• illusion of control
• Accepting critisism
• Paralyzed by fear
• Loss is a feedback, not a failure
• The flexible trader
• Focusing on the positive
• Short straddle
• The dynamics of greed
• The herd mentality
• Notes
For two months, rohan had been holding a long position in a stock. He anticipated a product announcement would result in a slight price increase, but nothing happened. The stock didn’t sell like hotcakes despite the product receiving excellent reviews and being in high demand. Although there was substantial support, the price had barely altered. Rohan made the decision to just give up, sell, and move on rather than wait another day. But the price rose four points the following day. Rohan is currently irritated. He is enraged at both himself for losing patience and selling too soon and at the markets for defying his trading strategy. Ever have Rohan’s feelings?
Even if you had a good trading strategy, the markets weren’t on your side. Your viewpoint may play a big part in how you handle irritation. It’s critical to make sure you have cognitive techniques that will enable you to deal with setbacks gracefully.
Some traders make the markets their own. They automatically perceive the markets as people, as opposed to seeing them as impersonal entities. They begin to believe that they are personally connected to the markets. They generally think they have a hostile relationship with the markets because the markets typically don’t cooperate with their trading strategies. Due to their frustration bias, some people are more prone to feeling frustrated than others. People who have a frustration bias sometimes believe that others are trying to harm them in real-life interpersonal interactions. They make the assumption that people are trying to harm them, as though they are experiencing a paranoid episode. They also apply this bias to markets.
It’s crucial to neutralise your frustration bias if you have one. Recognizing that you frequently perceive personal slights when none exist is the first step. Although there are different types of individuals at the marketplaces, they don’t know you. For instance, they aren’t doing maliciously when they refuse to purchase when you ask them to. It’s critical to keep in mind that it’s not personal. The second crucial action to take is to prepare for unfavourable circumstances and setbacks. When caught off surprise, people are very angry. Because Tom, for instance, didn’t anticipate the stock price to rise the day after he sold his position, he was extremely upset.
Allowing yourself to make errors is another tactic. Tom was frustrated because he put too much pressure on himself to trade flawlessly. But he would have felt lot better if he had acknowledged that both he and everyone else made errors. The distinction is between thinking, “I was stupid to sell too early,” and “I sold too early, but I fairly thought that I had waited long enough.” You are sometimes correct. Sometimes you are mistaken. I was mistaken. It was neither the first nor the last instance. I’ll simply put it behind me and go on.
You are human. The markets aren’t. Don’t personalize the markets. Look at them objectively. The market action won’t always match your expectations. That’s all right. Take setbacks in stride. If you dwell on them, view them as mistakes, and mull them over, you’ll feel frustrated. But if you expect them, and accept that no one is perfect, you’ll feel relaxed, free and creative. And trading in a cool and logical state of mind will help you trade profitably.