June 20, 2009 - Tricks of the Trade! - part 2

In the last "Tricks of the Trade" post on June 18th, I wrote about how to not get into positions where emotions can become strong enough to affect your decisions. And today's topic also serves to keep you out of emotional trades.

Have a Complete Trade Plan Before You Get In
When you pick a trade with high-probability for profits, pick your entry and exit points at the same time. Remember that you have to pick two exit points. I assume that you would like the trade to be profitable, so first (based on analysis) pick the exit point where you would close the trade and take profits. Secondly, but maybe more importantly, pick your stop-loss point. Pick a point where you imagine the trend you are following to be broken if it is hit. This may be based on support lines, trending lines, or other evidence of a broken trend.

Even if you have determined a zone to execute the exit, pick a price point before you enter the trade. Write it down. If price hits X, I will do Y. This is an important part of your trade plan, and perhaps an overlooked part of trading as a whole. The difficult part after that is actually sticking to your plan once you are in the trade as emotions will run high.

Picking the exact prices before you enter into the trade may not be the greatest idea to an experienced trader as markets are continuously evolving and our trades need to evolve with them, but it will help a newer trader keep out of highly emotional situations, which is the hardest part of trading.

If you don't pick a profit-taking exit, once in the trade, the feelings of GREED will compel you to hold on to the shares in hopes of bigger profits. But as the market turns around and cuts into your profits a new feeling will emerge and take over. This (often very strong) feeling is hope. Hope that "it will go back up!"

If you don't pick a stop-loss exit, once in a bad trade, the feelings of FEAR will dominate. Fear that once you get out of the trade your losses are "real", while if you're still in the trade, the market can come back and make you whole again - financially and emotionally. Here too, feelings of hope have taken over.

I guess it's ironic that hope, a feeling that can be very positive in life, can be disastrous to a trader's account!

Happy Trading.......