Have you ever initiated a “revenge” trade? Most traders are well aware of this issue; but some of you may need an explanation.
What is Revenge Trading?
A revenge trade is a reaction to one or more losses. Let’s say that you had a good profit run of a couple of months. Your gains were in the 30% category and you were riding high and frequently breaking out into the trader “happy dance”. Then one morning you were feeling quite full of yourself with an illusion of infallibility. In other words, you felt that due to your string of wins you couldn’t lose. Your confidence had exceeded your competence. This irrational exuberance or trader’s euphoria clouded your vision and diffused your focus. Just then the price action inched toward your stop and you gave into an overwhelming urge to move the stop. This behavior is due to a common bias that virtually every human being on the planet succumbs to at one time or another… loss aversion.
Loss aversion is the tendency for individuals to prefer avoiding losses rather than accruing gains. The theory was first introduced in 1979 by Kahneman and Tversky under the assumption that losses have a larger impact on preferences than that of the advantages of gains. In fact, you may have moved the stop several times. Because you loathed the thought of losing so much all semblance of perspective left you and in that attempt to keep from losing money in the trade you inordinately and inappropriately increased your risk, in effect wiping out all of the last two month’s gains.
Make sure you are in the right state of mind when trading, revenge trading can cause significant losses.
In addition to the empty pit that replaced your stomach you felt depressed and self-loathing for violating your rule, while also huffing and puffing at the market for taking your money. Now, whether you were aware of it or not, you also felt anger. You wanted desperately to get your money back. So, you identified another entry, doubled or tripled your size and entered a revenge trade to get back what was rightfully yours and what, according to you, the market unceremoniously snatched from your portfolio. You don’t need me to spell out what the next outcome entailed…another loss, larger than the first one which more or less wiped out a large portion of your account. This very bleak picture is played out over and over again across the trading planet; and traders just like you are losing most if not all of their portfolio funds while caught in this psychological epidemic.
How to NOT Revenge Trading
First, you must aim to be fully present, fully available and in the NOW of the trade. Trading is a zero sum game and it is arguably the single most challenging venture on the planet because you are trading your hard earned money and, more importantly, when you are in a trade, with every tick of the market you are gaining money or losing it. Due to this difficulty, at the drop of a hat you could find yourself in a position similar to the one above where one or two trades could wipe out scores of gains.
Secondly, you’ll want to ensure that you are not trading in mental states where you are frustrated, frazzled and fragmented; meaning that you are immersed in negative emotions like fear, anxiety, greed, doubt, worry or anger that can severely diminish your ability to maintain a fierce focus on what matters most. This is accomplished by taking your emotional temperature early and often. If you detect that you are distracted in any way, take a moment to reset and regroup your mental state.
Thirdly, you’ll want to discover your trading macro purpose and when you have done so, place it prominently in your trading plan, preferably directly under your title. This purpose is where you take the “what matters most in your life” and connect it to the “what matters most in the trade”. It becomes your “compelling reason” for trading. The passion of your life is then put in the service of ensuring that you stay the course in your trading. It lays the foundation for supporting you in planning your trades, trading your plans, following all of your rules and keeping all of your commitments.
Revenge trading is just one of many mental/emotional pitfalls that can derange your trading results. Revenge trading is one mental pitfalls that can derange your trading. It is imperative that you trade deliberately in a methodical step-by-step fashion and by design; that is, taking the time to be intentional about your mental/emotional state to ensure that your A-Game is working…all the time. You want to trade with your highest and best trader trading in your highest and best interests. It is much too expensive to do otherwise. It’s like walking a tightrope high above the ground…without a net. One false step could have you careering toward a very bad end.
Dr Woody Johnson can be contacted on this link: Dr Woody Johnson