Chapter 18. Dealing with the Emotions
Making money is highly satisfying; by doing so, you gain a sense of accomplishment, and pride can take center stage.
Trading stocks is often portrayed as a high adrenaline, win-lose game in which only the strongest survive. Emotions run wild in a world where money is on the line, and those who can process news the fastest will prevail. Fortunes can be made and lives can be changed, but it takes a no-lose attitude, a fierce drive, and the ability to attack aggressively.
This perception attracts many investors, but it is far from realistic. If you want to pursue this craft longer than a few passionate days, removing more money than you put in, you must be willing to accept the fact that success does not come from mirroring the hyperactive, emotional style I just shared. If you desire to wear a business suit while talking into three phones, that’s fine. However, make sure that suit is for taking your spouse out to a fine dinner and you are talking with friends on the phone, because following this appearance-only method won’t move you any closer to success in the markets. (It’ll just run up the dry-cleaning and phone bill.)
Over the years, I have learned that success in the financial markets actually comes as a result of pursuing just the opposite of what is perceived by the general public. In fact, most successful stock operators spend years attempting to remove emotions (the ups and downs) from their trading. The best traders give absolutely no hint as to how they are doing at the time you interact with them and never allow their performance to alter their lifestyle. In fact, successful trading is often rather boring, and if you find yourself facing consistent emotional swings, odds are you are doing something wrong.
What most traders don’t realize when they first set out trading is that they are actually playing the market with two different accounts. The first is tangible, in the form of financial capital and is what most believe to be the only real asset on the line. Another account, however, is even more important than that one. It is your emotional capital, which directly correlates with how you allocate your financial capital and perform on any given day. This emotional capital is what drives you each and every day and allows you to make the appropriate decisions with your financial capital. If this is low or even depleted, you can’t possibly make up ground on the financial side (because it takes a full emotional account to start making progress at all).
Whenever I come across a new trader or someone who is ready to adopt a new style, I usually try my best to assess the person’s emotional capital to see where he or she stands. I can never just come out and ask, “How’s your emotional capital?” If I were to, they’d have no clue what I was talking about. I generally gauge this through subtle clues in the discussion we’re having at the time. Most people seek help only when their emotional capital has been depleted and they are ready for a change. I first must help them to rebuild this emotional account before working on any financial gain.
When your emotional capital is low or depleted you may think or say the following:
I can’t do this, I need to just give up and turn my money over to someone else.
Every move I make is wrong. Just trade the opposite of me and you’ll make money.
The moment I sell, it goes up. The moment I buy, it goes down.
No one can make money trading stocks over the long haul; it is not possible.
Your emotional capital becomes depleted because you are trading with no set plan. You have not yet adopted rules that govern your trading, and you are just guessing about what to do or how to trade.
When you are right, you feel as if you did something superior and won, which boosts your emotions and gives you a feeling of success. When you make a mistake and lose money, you feel like you did something wrong and have lost. Over time, the financial market will remove money from those guessing.
A trader trading on emotions has absolutely no edge and is therefore fighting a losing battle. You might win sometimes, and sometimes you might lose, but in the long run you will ultimately put more money in than you take out of the stock market.
The flip side is when you resolve to learn the craft and hone in on rules that govern your trading. Your confidence is not found in your ability, but derives from your strategy that has been tested and refined. You must at first trust that your edge works. Over time and through various market cycles, you will soon see this play out and translate into profits. Only then can you start to rebuild your emotional capital that has probably been depleted over the years. When this is done, you can then confidently face the markets without fear or trepidation.
As you pursue this craft, you will inevitably find yourself becoming emotionally drained occasionally. Whether it is through poor execution or Mr. Market dishing out a bit of humility, you are bound to take emotional hits. To deal with this, the first step is to simply recognize this has happened. Articulating to yourself or a trusted friend that you feel your emotional capital running low will immediately bring light to the issue at hand and opportunity to start working on the problem.
It is challenging to begin rebuilding your emotional capital while you are still financially committed to the markets. Fortunately for you, no rule written anywhere says that you must remain in the market at all times. In fact, this flexibility, when embraced, can give you enormous power. Whenever I face a low emotional tank, I immediately move to cash. Many times, I follow up this move by taking at least one day away from the markets. I find it extremely refreshing and helpful to clear my mind, far away from the screens.
After I have regrouped, I then begin to peruse my trading records and journal to identify the root of the problem. Odds are that somewhere along the way my discipline started to falter and I was no longer following my strategy. I ask myself questions such as these:
Am I imposing my belief on the tape?
Am I not pursuing my original trading plan?
Am I forcing something that isn’t there?
If I am honest with myself, I typically already know the answers. Throughout my history in trading, there have been times that, for whatever reason, I believed the market should advance or decline. Unfortunately, this belief was not rooted in what the market was doing or what the charts were saying; rather, it was my own opinion. This is natural for most traders. However, acting on these beliefs is where the problems start to occur.
After I have identified the root of the issue—that is, the aspect of my behavior getting in the way of my following a sound strategy—I can then begin to rebuild my emotional tank. I do this very slowly and with a reduced level of risk as I begin to pursue my trading strategy. I start from the very beginning, going through charts with a fresh eye and unbiased view. If a trade emerges that fits my criteria, regardless of whether it correlates with my personal view, I act on what I read, place the trade, and execute my strategy.
Once I get back to the basics, it usually does not take long for me to rebuild my emotional tank. As my emotional capital begins to be restored, I can slowly increase my risk. Before I know it, I am back to account highs and trading better than ever.
Does this cycle ever end? Not to my knowledge. However, the time between emotional account draws does lengthen considerably.
Your goal as a trader should be to execute your strategy and keep your emotions in check at all times. Keeping your emotional account at highs will enable you to increase your financial account. You cannot have one without the other.