One of the hardest things for a trader to identify and admit is overtrading. Overtrading is almost always associated with the emotion of desperation. Like panicking, desperation has the same effect on the brain, stifling the ability to make clear, sound and calculated judgements.
Over trading is no different to a gambler who is desperate to win back their losses and makes repeated visits to the ATM. Or the winning gambler on a hot streak who doesn’t know when to quit and ends up walking away with nothing. We have all experienced this form of desperation in some form.
Essential to longevity in trading is the ability to identify when this happens and stop.
One of the main forms overtrading comes in, is the need to win back a loss or series of them quickly, if not sooner. This need is often driven by stubbornness to admit that the trade was perhaps wrong, so this trade is repeatedly entered even though it’s been stopped out a dozen times before. Sounds ridiculous when no emotion is involved, but makes perfect sense when you believe a trade is a “sure thing”. This desire to be ‘proven’ right is all based around ego and allowing it take control of the mind. Even if it’s not re-entering the same trade, it can be executing a separate trade for the pure purpose of winning back what was lost on the last one. This desire is purely driven by emotion and almost nothing to do with the merits of the trade. And that’s why almost all such trades are loss making ones.
I recall one particular trader when I worked at an investment bank who was convinced the then Pacific Dunlop (now Ansell) was a buy. From 1994 through to its low in 2001 the stock fell almost 90% as it went from an industrial powerhouse to an indebted frail company. Over the period of about three months the stock virtually halved but this trader was determined to pick the low (and a bargain) if it was the last thing he did. Each day without fail he would come into my office and ask me whether I thought Pacific Dunlop was a buy and after each time I failed to give him the confirmation he was looking for the next visit was slightly more animated. This animation quickly grew to high levels of frustration and anger, and his justifications for buying more and more and again and again while the stock skidded south grew more and more absurd.
One morning when I saw him walking my way from across the other side of the dealing room, I quickly brought up a chart of Pacific Dunlop, changed the name, the scale and inverted it – so it was unrecognisable as still being the same stock. Rather than the chart heading south it was now heading north and I told him I thought this was the next great “short” – effectively doing the same thing as he was trying to do – pick the reversal point. His response still rings clear in my head today “you would have to be an idiot to try and pick a top on that, that’s going to the moon!” Because this trader had no emotional attachment to this particular trade being presented to him, he gave his clear and unbiased judgement. The only thing clearer to me today than his response was the look on his face when I revealed it was his very own Pacific Dunlop, just presented differently. He had just in full confidence declared his long trade, a “short”.
His desire to win back his loss and be right prevented him from seeing the real developments in the trade. His repeated trades over and over were leading him down a path of ruining his career.
It’s ok to make a loss. It’s even ok to admit you are wrong. Most traders are, but what sets the professionals apart from the herd, is the understanding that trading has nothing to do with being right or wrong but everything to do with how much you make when are right versus how much you lose when you are wrong. It’s no good being right 9 out of 10 times if your 10th trade loses more than you made in your last 9 trades.
Poker players are a perfect example of playing winning hands only. If the cards dealt are poor, they fold. Live to fight another hand. Bluffing never works in the world of professional poker – it’s a game of odds, and unless the odds are in your favour, the sideline is the place to be.
Likewise in trading, unless the trade suits your set criteria it’s better to do nothing, than do something that is purely driven by the emotion of making a win. The pain of losing money is greater than the joy of making it.
The ability to identify yourself overtrading is a difficult task and often comes with experience but here are some tell-tale signals:
1) Your goal for profit on the next trade is exactly what your loss was on the last one.
2) You are trading twice as often as you usually do
3) You have entered the same trade three times without a win
4) Your focus is turning to being right and not focused on what the basic merits of the trade are
5) You are feeling that you have “no luck”
When you come across any of these – stop – and ask yourself two questions:
– what would I do if I was just in cash? and;
– how does this trade meet all my trade setting criteria?
If you do suspect you are over trading, it’s always better to take a break, move to the sideline and wait for the emotions to pass until you can make your next trade purely on the merits of your analysis. Your broker might not be happy with it, but then again, he doesn’t subsidise your losses.
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