Formulas for Managing Trading Emotions

I  truly believe the hardest thing about real trading has not been the math, the method, or picking the right stock, currency, commodity, or futures contract.  The most difficult thing about trading is dealing with the emotions that arise with trading itself. From the stress of actually entering a trade or the fear of loss as a trade goes against you. Even winning trades can be stressful as the fear of losing the paper profits that you are holding with a winner can even effect a trader. Then most importantly the ability of dealing with the emotional lows of a string of losses or the highs of many consecutive wins  can cause a trader to lose their confidence or discipline. The bottom line is how you deal with those emotions will determine your long term success in trading more than any other one thing.

To manage your emotions first of all you must trade a robust trading methodology after you have confirmed that it will be a winner in the long term with your edge if you stay disciplined. You also must trade your method with proper position sizing and risk management to keep the volume down on your emotions and ego. If you have that the next step is the management of your emotions.

We must understand that every trade is not going to be a winner and not blame our self for equity drawdowns if we are trading with discipline.

Do not bet your entire account on any one trade, in fact risking only 1% of your total capital on any one trade is the best thing you can do for your stress levels and to bring your risk of ruin to virtually zero. (This is based on your stop loss placement, not 1% position sizing).

With that said here are some examples of emotional equations to better understand why you feel certain emotions strongly in your trading: (The ‘=’ sign should be read as ‘equals’ and the ‘-‘ symbol read as ‘minus’ to understand the formulas here).

Losing Money – Trading Better = Despair

Do not despair look at your losses as part of doing business and as paying tuition fees to the markets.

Expectations – Reality= Disappointment 

Enter trading with realistic expectations. You can realistically expect 15% -20% annual returns on capital with great trading after you have experience and have done the necessary homework. More than that is possible but you will have take on more risk and be one of the very best traders or investors to achieve greater returns than this.

Disappointment in a loss+ Caused by lack of Discipline = Regret

If you followed your trading plan and lose money because the market did not move in your direction so be it, but if you went off your plan and traded based on your feelings and opinions then you should feel regret and stop being undisciplined.

Winning Trades – Fear of Ruin = Enjoying your Trading

Trading is much more enjoyable when you are risking 1% of your capital in the hopes of making 3% on your capital with a zero chance of ruin or have a very high winning percentage with very small losses when wrong. It is not enjoyable when you are putting a huge percentage of your capital on the line in each trade and are only a few bad trades away from your account going to zero or a big draw down.

 Understanding what makes money + Years of successful trading = Trading Wisdom

To get good at trading you have to trade real money. Wisdom comes from putting real money on the line for years and proving to yourself that you can come out a winner in the long term.

Belief through back testing + Experience of winning with it for years = Faith in your system

Whether  any individual trade is a winner or loser should not influence your faith in your system and trading method. You should trade in a way that each trade is just one trade out of the next 100. Much of emotional trading can be overcome when you do not have doubts about your method. When you believe in your method, system, risk management, and your own discipline, you will overcome many of the emotional problems that arise in the heat of trading during a live market.

Most new traders will be very surprised at the emotions that rise up during active trading when real money is at risk, I hope this blog post gives many a heads up on this factor and how to overcome it.