When things are going great, greed can get the better of us; perhaps convincing us to add too large a position on that winning move, or coercing us into not taking profits at our pre-determined limit levels.
When things are going badly, well fear rules the day. Perhaps we remove that small winner so quickly that it can’t reverse against us running straight to our stop. Or maybe fear of losing convinces us to ‘hold on’ to that losing trade, even if so it can just get back to break-even so that I don’t have to take a loss.
Greed and fear are two challenging emotions that have been turning traders into ex-traders for years; and this article is about balancing these emotions, arriving at a ‘sweet spot’ of trader psychology in which we might actually be able to use these emotions to our advantage.
Confidence: The Great Equalizer
A common inquiry from new traders, or even experienced traders that have just gotten down the mechanics of trading their strategy, is ‘how do I get rid of/eliminate greed and fear from my trading?’
Unfortunately, this isn’t possible. As long as you are alive, these emotions will be part of what makes you human. So, don’t try to eliminate greed and fear; embrace them. Know that they are there for a reason, and then work towards using these to your advantage.
Then, ask yourself – what is the worst/best thing that can happen from this one trade?
The best way to get a handle on greed and fear is to gain confidence; so that when these emotions are encountered in the future the trader knows more readily how to respond.
For a trader first finding the FX Market, greed will often encourage them to over-leverage their account looking to make a small movement in a currency pair amount to a big change in the trading account. After all, a one-percent move in a currency pair could mean a 50% change in account value to the trader that was levered at 50-to-1.
It’s an unfortunate fact, but it’s often too late that traders learn that 50-to-1 is too much leverage, and that small retracements against the trend may bring a margin call to the trader even if they knew what direction the pair would move.
This is where fear comes into the equation. After a trader sees that first margin call, they can begin to understand that taking on too much leverage can bring disastrous consequences, even if they were right in their analysis.
How to Build Confidence
As a trading educator, I know that simply saying ‘have confidence’ isn’t nearly enough for one to be confident. So what follows are some tips so that you can begin to build this confidence as quickly as possible.
The best way to build confidence is to gain experience.
Just like anything else in life, the more we do something, often, the better we can become. Trading is no different. The more trades we place, the longer we trade, the longer we manage risk and calculate risk-reward ratios, the better we will often be at doing so.
Probably more important, through experience, one often learns that the worst thing that can happen on any one trade is taking a stop. That’s really it, just one stop. And to professional traders, this is something that will be a regular occurrence.
There is no such thing as being a professional trader and avoiding rejection (getting stopped out).
The best way to gain experience trading is quite simple and pretty fun too. And that is to simply trade. The more one trades, the more experience they are gaining.
An important element of note: This experience should be in the manner of trading that you would like to do. By simply taking trades on the daily chart for 2 years, I won’t necessarily become a better scalper. I want to focus this experience on the type of trading that I am going to be doing.
For traders that really want to expedite experience, manual back-testing can be a great way of getting more comfortable (and confident) on charts.
In ‘Just Because Trading is Closed, It Doesn’t Mean You Have to Be’ we looked at a way that traders can ‘simulate’ trading in live environments. This can greatly help expedite the experience quotient that so many traders lacking confidence may need.
Learn from Others’ Experiences
A primary motivation behind the research in the DailyFX Traits of Successful Traders series was to see what had worked for traders in the past, so that others may be able to benefit from those traits in the future.
The Number One Mistake that Forex Traders Make circles directly around emotions, as it was found that in many cases, traders win a majority of the time. Despite that fact, traders, as a whole still end up losing because they take such larger losses when they are wrong against the pips made when right.
Traders can look to tackle the greed-fear conundrum by instituting the thesis from this research, stated by David Rodriguez in the article as:
‘Traders are right more than 50% of the time, but lose more money on losing trades than they win on winning trades. Traders should use stops and limits to enforce risk/reward ratio of 1:1 or higher.’
Lower the Leverage
One of the most striking findings of the Traits of Successful Traders series was the difference in results for traders at high levels of leverage versus traders at lower levels of leverage.
In ‘How Much Capital Should I Trade Forex With,’ Jeremy Wagner analyzed the differences for traders with less than 1,000 in their accounts and those with between 5,000 and 9,999 in their trading accounts.
What was most shocking was the difference in leverage being employed by these traders.
On average, traders with less than 1,000 in their account were utilizing leverage of 26-to-1, and were profitable approximately 20.91% of the time.
By many accounts, 26-to-1 leverage is way too high. Many of the best professional traders in the world are using amounts of 3, 5, or at a max – 10 times effective leverage; and these are the best of the best traders. From our research, we see that many traders with less than 1,000 are taking on much more risk than some of the best of the best.
Those traders with between 5,000 and 9,999 used a far more moderate amount of leverage; around 5-to-1. And correspondingly, these traders saw far greater success, being profitable in 37.37% of instances.
On the face of it, 37% against 21% may not seem like a large difference; but if we mine a little deeper we see that traders with 5,000-9,999 saw success in over 80% more instances than those traders with less than 1,000 – and a big reason for that is the amount of leverage being employed.
Traders can make a giant leap of progress in tackling the greed-fear continuum by lowering their leverage.
And even if you don’t have the capital to fund up to the 5,000-9,999 tier – it doesn’t mean you have to hit a homerun on every single trade to build your account up to that threshold, as you can still look at trading with more moderate levels of leverage.
Even an account with 200 can use a 5-to-1 leverage factor, by trading a 1k lot on the major pairs. (Lot size of 1,000 divided by account equity of 200 = 1000/200= 5).
Remember, increased experience will often help us get to where we want to be; but if we blow up our trading accounts before we get there – then all the experience we gained can be for naught.
--- Written by James B. Stanley
To contact James Stanley, please email Instructor@DailyFX.Com. You can follow James on Twitter @JStanleyFX.
To be added to James’ distribution list, please send an email with the subject line “Notification,” to Instructor@DailyFX.com.
Forex Trader’s Guide to Price Action
Trading the Cable
Trading the Euro
Trading the Dragon
Trading the Aussie
The US Dollar: The World’s ‘Safe-Haven’