You turn on the news and see the following headline: Apple tangled in $2 billion lawsuit. You open your computer to see that APPL has fallen to $115/share. You get nervous that this is the beginning of a slippery slope and it will continue to go down today; you sell. One week later, the lawsuit is old news and APPL is back to $133/share. If this sounds familiar, it can be a sign that you are an emotional trader. You get fearful when other traders are fearful, and greedy when other traders are greedy.
Emotional trading is something we have all given into at one point– even though we know emotions should be separated from stocks. When a trader gets emotionally invested, the data, quantitative analysis, and technical indicators become secondary in our decision-making. This can be detrimental to our financial future, as the data must drive our decisions, not the other way around. In today’s blog post, we are going to give 5 ways that you can eliminate emotional trading.
Tip 1: Dollar Cost Averaging Strategy
Dollar-Cost Averaging (DCA) refers to a trading strategy in which a trader divides up the amount of stock he will buy evenly over a certain period of time, regardless of stock price. A common analogy for DCA is a 401k account. In this type of retirement account, you select a certain amount of money to be taken out of your paycheck automatically every month (or every two months, but the interval is consistent). Let’s look at an example of a DCA in stocks: say you want to buy $10,000 of APPL. Rather than waiting for the share price to drop dramatically and making one purchase of $10,000 worth of APPL, you would buy $2,000 of APPL every week for five weeks, no matter what the price of a share is. This allows you to stay consistent and not play drastic fluctuations. Similar to the 401k account, a certain amount of money is automatically used regardless of external factors such as price, volatility, news, etc.
Tip 2: diversify, diversify, diversify
Often, traders read news or know a company very well and put all of their eggs in one basket. This increases your risk, especially if the companies you have invested in are in the same sector. This causes traders to become more emotionally involved, as their perceived risk is high. In turn, they are more cautious and sensitive to news and external factors that may affect their stock. To combat this, diversification is essential. Buy mutual or index funds, vary the sectors you invest in, and seek sound financial advice. By minimizing your risk as you are more diversified, you are less likely to act impulsively. This will save you time, energy, stress, and most importantly, money.
Tip 3: Take a break
Sometimes, the best way to calm yourself is to stand up, take a lap around your office, and sit back down. The reason is based on general scientific literature that suggests that simply by looking at something besides what you have been looking at for the past hour allows your brain to retarget your focus. Before making an impulsive decision, stand up and grab an apple (literally). You may just reconsider a trade based on random news and other traders’ actions.
Tip 4: Set trading goals– and be specific!
This is no secret. Set quantifiable goals to best maximize your trading strategy. The goal must be more specific than “make as much money as quickly as possible.” Write your goals down. I want to have 15% of my portfolio in crypto by the end of the year. I want to accumulate 500 shares of APPL averaging $125/share by the end of January. Specific and numerical goals allow you to stay on track and reduce impulsiveness. It helps you stay consistent, and thus more controlled.
Tip 5: Don’t be afraid to lose
Every action has an equal and opposite reaction. Newton’s law of physics also applies to trading. What goes up, must come down. And what falls down bounces back up. So don’t be afraid to lose. Don’t be taunted by short-term falls; and don’t get greedy by short-term hikes. Stay balanced, commit to your long-term trading strategy, and stay level-headed. By disregarding short-term swings, as a trader, you put yourself in a winning position for the long term.
There are concrete strategies to eliminating emotional trading; all it takes is discipline, consistency, and psychological organization. Sometimes you need to go on a walk, eat something, or anything that calms you down. Other times you need to take a more concrete financial strategy, such as diversifying your portfolio or using a DCA strategy. In both scenarios, you can measure your success as you make less impulsive decisions. Only through these tips can you set yourself up in a long-term position conducive to financial success.