Trading Psychology, The 14 Stages of Investor Emotions

Efficient markets are based on the assumption that rational people enter transactions with the intent to maximize gains and minimize losses. While this theory is sound, most investors are not the purely rational robots that efficient markets rely upon. Instead, emotions often cloud our decision-making and prevent us from acting in a rational manner.
Knowing we can never conquer our inherent emotional biases, we should seek to understand the range of emotions we may experience as investors and how it affects our interactions with the market. A common market psychology cycle exists that shines light on how emotions evolve and the effect they have on our decisions. By understanding the stages of this cycle, we can tame the emotional roller coaster. The fourteen stages are:

1. Optimism – A positive outlook encourages us about the future, leading us to buy stocks.
2. Excitement – Having seen some of our initial ideas work, we begin considering what our market success could allow us to accomplish.
3. Thrill – At this point we investors cannot believe our success and begin to comment on how smart we are.
4. Euphoria – This marks the point of maximum financial risk. Having seen every decision result in quick, easy profits, we begin to ignore risk and expect every trade to become profitable.
5. Anxiety – For the first time the market moves against us. Having never stared at unrealized losses, we tell ourselves we are long-term investors and that all our ideas will eventually work.
6. Denial – When markets have not rebounded, yet we do not know how to respond, we begin denying either that we made poor choices or that things will not improve shortly.
7. Fear – The market realities become confusing. We believe the stocks we own will never move in our favor.
8. Desperation – Not knowing how to act, we grasp at any idea that will allow us to get back to breakeven.
9. Panic – Having exhausted all ideas, we are at a loss for what to do next.
10. Capitulation – Deciding our portfolio will never increase again, we sell all our stocks to avoid any future losses.
11. Despondency – After exiting the markets we do not want to buy stocks ever again. This often marks the moment of greatest financial opportunity.
12. Depression – Not knowing how we could be so foolish, we are left trying to understand our actions.
13. Hope – Eventually we return to the realization that markets move in cycles, and we begin looking for our next opportunity.
14. Relief – Having bought a stock that turned profitable, we renew our faith that there is a future in investing.

Individuals clearly follow this cycle in their decision making process. Since broad indices like the S&P 500 are comprised of the decision of millions of individuals, we should expect index prices to track this pattern as well. If we are aware of the stage of the cycle we are experiencing at a given point in time we will have a greater grasp of how our emotions are affecting our investment decisions. This knowledge will help us manage our own investment portfolios as well as predict the next step for the broad market.

Sean Hannon, CFA, CFP is a professional fund manager.

Have you ever seen two people in the same situation act differently? With trading futures this is really evident. Only one side gets to make money.

How a person handles sinking (losing money) will help shape what they become as a trader. The second thing that my mentor every told me was learn how to lose. Winning is easy. Here are some key things about losing:

Losing is a result. A loss is a culmination of an action or inaction, own it.

You can’t control when you lose only how much. It is ok to lose, it is not ok to lose big.

In the beginning, it is easier to learn through losing than winning. Understand why you are losing and winning. Losing is what makes you put in the work. Winning is what makes you continue to put in the work. Allow yourself the second opportunity.

Don’t run on a broken leg. The worst day is always the second day. You will get better at healing until then recognize it.

Stick to your limits. If you cannot stick to your loss limits than you should not be trading. It creates a path you do not want to go down and hole that is hard to get out of.

Run it like a business. If you are losing more than you are making, risk less. If you can’t make $200 you should not be risking $800 a day.

You can’t prevent yourself from losing but you can control everything before and after. That is the best that the market has to offer. It has to be enough. Lose with a purpose or it will always be greater than your wins. Don’t epitomize the definition of insanity. Clear your head and come back, however long that takes. Learn how to lose so that your winners count. Exit every trade the same, with confidence.

No trader likes to lose but the best traders know how to swim.

From Trader Habits blog...

The market is on the upward move as shown from this chart, Russell 2000 (the small caps).

Switching my concentration to monitor the small caps which comprises all the small companies as compared with the S&P's and the Dow.

Though they all move almost in the same direction, this time I am preferring to concentrate with the Russell 2000 which is the equivalent of the IWM etf.

Dont Follow Your Passion, Follow Your Effort

Mar 18th 2012 2:47PM

I hear it all the time from people. “I’m passionate about it.” “I’m not going to quit, It’s my passion”. Or I hear it as advice to students and others “Follow your passion”.

What a bunch of BS. ”Follow Your Passion” is easily the worst advice you could ever give or get.
Why ? Because everyone is passionate about something. Usually more than 1 thing. We are born with it. There are always going to be things we love to do. That we dream about doing. That we really really want to do with our lives. Those passions aren’t worth a nickel.

Think about all the things you have been passionate about in your life. Think about all those passions that you considered making a career out of or building a company around. How many were/are there ? Why did you bounce from one to another ? Why were you not able to make a career or business out of any of those passions ? Or if you have been able to have some success, what was the key to the success.? Was it the passion or the effort you put in to your job or company ?

If you really want to know where you destiny lies, look at where you apply your time.

Time is the most valuable asset you don’t own. You may or may not realize it yet, but how you use or don’t use your time is going to be the best indication of where your future is going to take you .
Let me make this as clear as possible

1. When you work hard at something you become good at it.

2. When you become good at doing something, you will enjoy it more.

3. When you enjoy doing something, there is a very good chance you will become passionate or more passionate about it

4. When you are good at something, passionate and work even harder to excel and be the best at it, good things happen.

Don’t follow your passions, follow your effort. It will lead you to your passions and to success, however you define it.

From blog maverick/mark cuban

The market made a nice pretty move last Friday's session.

A surprising move considering a Friday trading is usually a profit taking day.

But that's not quite a surprise since the market is on the downward trend since Monday's trading open.

The Dow made a nice classic pattern to trade, a cup with a handle setup.

It drops further after the open to make a small cup formation opening for the setup at the consolidation when it reach red line.

Every Adversity Contains The Seed Of …

by: Bill Zimmer

Friday, March 23rd, 2012 at 9:58 am

The path to success consists of knowing your outcome; taking action; knowing the results you are getting; and having the flexibility to change until you are successful. You have to find the beliefs that support your outcome, the beliefs that get you where you want to go. If your beliefs don’t do that, you have to throw them out and try something new.

The accumulation of all of our experiences creates the impression that “we know“. When in fact, we “don’t know“, we merely believe “we know“. Confused? Take for example the old cliché “Everything happens for a reason “. As a normal human being we usually invoke this cliché in our minds when something goes wrong, when something bad happens. There must be a reason this happened to me, perhaps someday I will understand. I knew I should have… I knew it, I knew it, I knew it. How will I ever recover? Sound familiar? It’s happened to everyone! Now comes a choice.

There are numerous ways people react to this situation. If we use trading as an example and assume for the moment we’re not doing well, we may; refuse to even open our statements (out of sight out of mind). We can feel hurt and frustrated. We might sit home and mope, or go out and get drunk. We will be mad. Seek blame; the broker, the advisor, a friend who recommended it, the company insiders whose shares we invested in. It doesn’t really matter, it just must be someone else’s fault, it can’t be me!

All of this might allow us to let off some steam, but it doesn’t help. It does not bring us any closer to our desired outcome. It takes a lot of discipline to be able to retrace our steps, learn painful lessons, mend fences, and take a really good look at new possibilities. That is, however, the only way to get a positive outcome from a seemingly negative result.

All successful people have the uncanny ability to focus on what is possible even in a negative situation, what positive results could come from it. They think “everything happens for a reason, and a purpose, and it serves them”. They truly believe that every adversity contains the seed of an equivalent or greater benefit.

The bible says, “you reap what you sow” it does not say you reap what you desire. Could the mistakes you have made, the losses you incurred, sow the seeds of learning? Does it make you think, perhaps all I need is a further education? And then get one? Or does it make you think, you need to be a professional, an insider, a floor trader, to make money in the markets?

You probably paid for your professional education. The market is your new education. Your losses, if any, are the cost of your new education. If you take the positive approach, say this is just the school of hard knocks. I will read, study and learn. Next time I’ll make money. From now on I’ll make money. Now you can say, this happened for a reason and it serves me!

Trade Like A Turtle

Been learning and observing the market for a quite a while and participates daily with its movements even in an "on and off" activities.

The thing that I noticed from all (or most) participants (especially the individual retail traders, the home traders) were all looking for the "kill" in the market.

And also looking for the "short cut" in trading the markets to make easy profit.

But that's not how the market works.

Unless you are working for the sophisticated prop firms, but if not, you need to trade in a slow pace with minimal but consistent expectations.

Making a low profit in the market that is equivalent to a minimum day's work might be enough considering how the markets is tough to trade.

Especially if you are still at the initial stage of your trading endeavor, expecting high returns should first ignore.

Trade like a turtle might be the suitable words to describe in trading the markets.

Trade the market in a slow calculated edge with minimal profit enough for a day's work is the right way to get involved in the market.

In other words, treat trading as a day job, not for the get rich quick scheme.

Otherwise, you will quickly lose your capital and if you are not ready also your sanity.

Trade the market carefully!