"Our natural human instinct is to fight or flee that which we perceive to be dangerous. Although this mechanism evolved to protect us, it serves as the single greatest limiting process to our growth."
Traders will suffer from bear markets, bad news and bad luck, but ultimately a trader's biggest enemy is himself. Nothing causes more bad trading decisions than our emotions.
That isn't a great revelation. We all have stories of how our emotions have caused us to act in a manner we eventually regret. Our instinctive reactions to stress don't often produce the ultimate outcomes.
In the 1930s, Walter Bradford Cannon identified the fight-or-flight response that occurs in reaction to perceived harmful events. It is an actual physical response triggered by a change in brain chemicals that drives us to act without any thought. It is our instinct and happens automatically.
Traders must constantly battle the fight-or-flight response in their trading. This usually manifests itself by causing us to freeze and do nothing or by selling or buying too quickly.
A classic example is a trader faced with a position that is declining for no apparent reason. Although a stop level may trigger and their position is too big already, they decide to fight the action and they add more shares as the stock declines. This sort of action wipes out more traders than anything else, but it is instinctive and can run wild if you don't battle the inclination.
Even though we know better, there are chemicals in our brain that drive us to do those things when faced with stress. The way to deal with it is to understand what is driving us to train ourselves to respond to stress in a less impulsive way.
The first thing we need to do is simply be aware of this phenomenon. If we are self-aware enough to know that the fight-or-flight response is kicking in, then we can deal with it much better. We need to question our actions rather than act reflexively.
The best way to combat impulsive reactions is to have a trading plan. Knowing in advance what you will do in certain circumstances relieves the stress. Stress is a function of uncertainty and if you anticipate various scenarios you will be more confident in your action.
Nothing drives the fight-or-flight response more than having too much money tied up in one position. Our objectivity becomes impaired when we start watching every tick and are focused on the potential for disaster or euphoria. Smaller positions don't produce stress, but they also don't produce big rewards, so we have to constantly balance these considerations.
I find that my fight-or-flight reaction is most often triggered by news. There will be a market development or an analyst report and I'll react emotionally to the headlines because I'm fearful there is going to be a major move I didn't anticipate. Rather than focus on the price action, I feel like I better move quickly before the rest of the market reacts and ruins my trade. I must force myself to stay patient and not overreact. I try to do that by acting incrementally. A partial buy or sell will help to relieve some of the stress I feel and then I can calmly plot how I will play the action.
Traders who can conquer their emotions have a huge advantage. The problem is that it is much harder to do than it sounds. We are always looking for justifications that allow us to change our plans. We don't have good logical reasons for our actions. We simply are faced with stress and are trying to find a way to deal with it.
Self-awareness is the first step to being a better trader. If you know what drives your impulsive action, then you can address those things.