Risk Management

What's Emotional Trading, and how can you avoid it?

October 31, 2022
3 min red

Ambition, perseverance, greed, fear.

Human emotions often play a crucial role in charting the course of our existence. Unfortunately, although they can help us overcome our limitations or avoid hazardous steps, they can hinder designing investment strategies.

What Is Emotional Trading?

Emotional trading is when investors let their emotions impact - often compromising - their decision-making.

Successful investing may require years of practice. It takes observational and analytical skills, a thorough knowledge of available tools, costs (and how to avoid them), and assets at your disposal.

However, as in a challenging poker game, a skilled trader can make a winning play out of an unfortunate hand.

Similarly, a novice player may need to gain the ability or timing to take advantage of sound cards.

That's why, along with good training, a firm emotional discipline makes the difference between success and failure.

Non-Professional Traders' Problems:

  1. The — usually emotional — motivations that drive rookie traders to approach the investment world rarely go hand-in-hand with their relatively low-risk tolerance. Experiencing first losses may cause excessive anxiety and push the trader to surrender.
  1. When the Fear and Greed Index pointer gets close to 100, the widespread (and sometimes unjustified) bullish sentiment may be an encouraging sign for market entry. To simplify, when something appears in the news, it's outdated. This also applies to investments: entering when the market is at its peak almost certainly leads to a drop. Once euphoria has worn off, the newcomer trader may end up with a lower capital (and hurt feelings).
  1. In a continuous cycle of cause and effect, money flows into the market when it's at the top and out of it in bearish periods. This is counterintuitive and finds its only possible explanation: passions rule the game. Just as there's a wrong time to enter, panic selling when the market is in the red is usually the wrong time to exit. Don’t abandon your ship in troubled waters.

How to Prevent Emotions from Impacting your Investing Journey

Trading is a risky activity in itself. So it's unwise to further complicate it by letting euphoria or panic lead to regretful decisions.

We can't erase our emotional sphere, but we can take caution so that it doesn't influence our judgment.

  1. Design a well-defined investment strategy:

Realism, rationality, and a broader vision (be it trading or long-term investment) are essential to chart a course without significant deviations.

We can still make potentially risky decisions as long as they’re supported by credible rationale and aren’t the result of panic or euphoria.

Stick to your plan without taking risks beyond your risk capacity or tolerance limits.

  1. Recognize emotional biases:

Daft Punk once sang we’re “Humans After All.” Investing money must be a decision partly motivated by dreams, hopes, or ambitions, and the idea that these won’t be fulfilled can cause anxiety.

If we decide to be our own traders, we must learn to recognize and manage the impulses when market movements prompt us to an emotional response.

  1. Rule out unnecessary influences:

Traditional media, social media, friends, family, a partner, and colleagues. All these factors can influence us directly or indirectly in our decisions.

Regarding investments, we must be deaf to the buzz around us and base our strategies only on reliable sources and tools.

  1. Include technology in the mix:

Technology can come to our rescue in many ways, collecting and analyzing volumes of data humans couldn’t handle, saving time, and allowing us to identify otherwise invisible patterns.

Peccala trading engine works this way. Our proprietary algorithms scan the crypto market, trying to assess the possibility of a movement turning into a trend.

Less experienced investors can not only evaluate this solution to learn financial market fundamentals but also to limit their exposure to stressful situations that might result in logically non-justifiable decisions.

Join our waitlist, and let Peccala be your trading ally!