Nov 2, 2004

Trading your emotions

The most important lesson I have learned in trading is that predicting which way the market will move is only about 10% of the game. The odd thing is that it is predictions and opinions that completely dominate the news coverage. Brokerage reports indicate price targets and pundits always declare either a bull or bear market. For me I have found that the day to day volatility overwhelms such insights even if they are correct. After watching the markets for several years, recognizing a trend becomes easy but actually participating in it is always difficult.

If prediction is 10% what is the other 90%? Risk management. How to set stops and take profits to minimize your own emotional reactions. That is where the money is in trading. Taking profits when others are euphoric and having capital to buy when others panic. For me, a large part of this involves keeping position sizes relatively small and if I make a bigger bet I do it in the options market to cap the loss.

I have been reading my own posts and generally realized it fits pretty well into the "predict the markets" mold. While it is important to have a game plan and future expectations the actual position management is really what dominates long run performance. From now on I will try to focus more on that management. It may get cumbersome at times with repeated stops being hit in the same trade before I give up or the trend works out but I believe it will add value by seeing how good risk management actually creates the profits.

I called this post "trading your emotions" because that ultimately is what risk management accomplishes. It is impossible to tell if the market is irrational when you are not rational yourself. To keep my mind clear and open to both sides of the market I manage my positions so that I literally don't care which way the market moves.

No comments:

Post a Comment