Thoughts, Trading

Irrational Trade Actions and Psychological Pitfalls in Trading

I wanted to review the mistakes that I have been making in my intraday futures trading. The difficulty for me in intraday futures trading is not in reading the market action, but in not succumbing to taking irrational trade actions due to emotional impulses generated while watching every tick of the action. I think it has a little to do with the trading style as well. If you are watching every tick in order to scalp 1-3 ticks, or to do spreads for 3-5 ticks, then reacting to emotional impulses (that are honed through experience) may be reasonable. However if you are watching every tick and taking trades for a 2-hour trend, then the below problems may arise.

I have categorized the irrational trade actions below, and listed down psychological reasons that resulted in those actions and possible solutions. I’ll add more to the list as I encounter more of such issues =)

Not Taking Trade Setups

  • Reasons
    • Freshly burned by attempts to the catch the turning point of the trend.
    • Reluctant to take the trade because recent trade experience has been associated with losses, and did not want to make the losses even worse.
    • Avoidance of the market due most likely to pain avoidance.  You don’t dare to pull the trigger because you have associated the intense negative emotions of losing or the possibility of losing with being in a trade, so you escape from experiencing those feelings by not entering into a trade.
    • You might have decided to stop trading for the day because the market was in a tight range, however you are still looking at the market while working on other matters. When you are not paying attention, you are slow in reacting because there is a conflict between your mind telling you not to play further, but you noticing a valid trade setup.
    • Justifying to yourself that you shouldn’t be taking the trade because the market is “not good”, especially when you have a number of losses earlier.
  • Solutions
    • Reduce failure attempts by not taking “trend change” trades prematurely, only take trades showing decent probability of the trend turning, i.e. for an uptrend, when a support level is broken, and a lower high is formed, then you take a trade betting that the uptrend has changed.
    • Take every valid trade setup, especially when you are trying to catch the turn because every failure brings you closer to the actual turn.
    • Recognize that it is possible to have around 8 losing trades in a row, even for a profitable system. If you try to catch tops and bottoms, you are going to have many more losing trades in a row.

Entering Counter-Trend Trades

  • Reasons
    • Missed the start of a trend, and have the fear of missing out, so you want to get into the market quickly. Felt that missing the start of the trend meant that it is too late to enter in the direction of the trend, so defaulted to looking for a counter-trend trade.
    • Usually the price will be at a high point of a trend, if its an uptrend, you don’t think you can enter long because you are entering in the middle of nowhere, so the quickest way to get into the action is to short, and once price just fluctuates down a little, you grab hold of that as justification that this is it, this is the turn, and you enter short to get into the action.
    • As the market is moving higher and higher, you feel more and more emotional pain, and you would naturally justify to yourself that the market is going to come down (probably a defense mechanism in an attempt to alleviate the emotional pain), that the market is going up too much.
    • It is like a hammer looking for a nail, and you end up prematurely trying to hit imaginary nails.
    • That leads to repeated revenge trades and eventually missing the actual entry when the trend indeed changed.
    • On the revenge trading, it can also stem from a need to be right. For example, for whatever reason you shorted and lost money, then as the market keeps trending up, you look for opportunities to re-instate your short position again, because you cannot accept that you lost money shorting, so you keep using the exact same method (i.e. shorting) to make your money back, in an attempt to prove that you did not fail in your original endeavor of “making money from shorting”.
  • Solutions
    • Recognize that you are ‘suffering’ under the urge to simply get into the market.
    • Actually the more probably action is for trend continuation, so it is not too late. You should be looking to enter on pullbacks rather than looking for counter-trend trades.
    • Counter-trend trades should only be taken when a real nail appears, which is when there is a breakdown and a retracement. When that happens, you are actually entering in-line with the trend, and is no longer making a counter-trend trade.

Hesitating on Entry and Ending Up Chasing the Market

  • Reasons
    • You just had a string of losses and you don’t dare to enter the next trade.
    • You are not sure whether to take the entry signal, you do not trust your system completely.
    • You were not paying full attention to the market, so your mind was not prepared to play, so you got stuck in indecision.
    • You take too long to weigh all the arguments for the bull and bear sides.
    • Chased market for fear of missing out. End up entering trades with stops being too far away.
    • Might be the case where you detected hesitation, and you know hesitation is bad, and you simply brush hesitation aside without thinking and just enter the position.
  • Solutions
    • If you hesitated and missed the proper entry, wait for a retracement.
    • If no retracement occurs, no choice but to miss the trade.
    • It is better to take trades with limited risk rather than trades with bad risk:reward ratios.
    • If the bull / bear case is 50-50, stay out.

Selling Out at a Good Price and Re-Entering at a Worse Price

  • Reasons
    • You think that the price is going down, so you sell at $X. Price drops below $X, you feel good that you sold out earlier, then you shift your attention to other things. Now and then you check the price again, and saw that it kept going lower, so you still feel good. Then after a while you start to notice that the price is inching back to $X, so you start to think ‘hmm.. look’s like it’s going back up, maybe I shouldn’t have sold. Let’s monitor this for a while, see what happens’. Your ‘Fear of Missing Out’ and your ‘Fear of Future Regret’ is starting to grow.
    • All the while, you had no concrete action plan on how you would handle this, you have not decided at what price or point you would go back in, or would you cut this position out entirely. Without a trading plan decided beforehand, you are bound to react to your emotions.
    • Soon, the price moves above $X, and keeps moving up. Finally, you can’t take it anymore, you re-enter your position at a price higher than $X. That helped to ‘quieten’ your ‘Fear of Missing Out’.
    • Then as it usually happens, price goes back down again, drops below $X and goes down further. Either your fear of taking a loss kicks in and you stick with a losing position, or you sell out at a loss.
  • Solutions
    • You have to decide beforehand, even before you exit the position, how you would handle the position.  To do that,  you need to be clear on the reason why you are selling in the first place.
    • If you are selling because you think that the uptrend has changed to a downtrend, or the uptrend is broken, you would need to have specific criteria that you look for to know whether the uptrend has resumed. If the criteria has not been met, even if the price goes above $X, you will not re-enter your position.
    • If you are selling because you think the uptrend is still intact but there will be a short momentum reversal, you need to get out and get back in very quickly, usually just catching 1-2 ticks more. This type of play where you react to momentum is highly discouraged. The risk-reward is bad, the skill level, reaction speed, concentration required are extremely high, and it makes you susceptible to falling into the trap of ignoring the bigger market structure.
    • You have to realize that you are playing into the hands of the usual fighting that goes between bulls and bears when you keep reacting to the swings, which will naturally make you buy high and sell low.
    • In conclusion, you need to be very clear of reason that you are selling. In that way, you would be clear of when, if ever, you would re-enter the position.

Exiting Position Prior to Being Stopped Out and Not Re-Entering When Market Goes Your Way

  • Reasons
    • Firstly, the action of exiting your position via active orders is on the basis of making accurate predictions on the immediate short-term movement of the price. When you sell because you think that it has gone far enough, or the opposing forces are becoming stronger, you are essentially predicting the short-term movement of the price and acting based on that prediction. Nobody can do that successfully. You have to let the fighting take place and resolve itself.
    • Secondly, it is very difficult to get back in after you jump off the train.
      1. If you just jumped off and the train carries on going in the direction of the trend, you have this natural inertia to get back on, because
        • You have just got off, so it doesn’t gel internally to get back on again immediately. You will be doubting yourself, thinking why you would get in at the same price when you just got out; and
        • Most likely you would need to get in at a slightly worse off price compared to the price you just sold, so you don’t like that and will wait to get a better price hence resulting in you missing the boat all together.
      2. Your entry price to get back on the train might be too far off from your stop, so it is more risky and if it exceeds the threshold in your trading plan, you can’t take the trade.
      3. You have to be contrarian, when there is a sudden vertical drop move towards your support level, but does not exceed your support, you have to buy when your instincts tell you to sell. The logical action is to buy because you have a good risk-reward, but your natural tendency is to extrapolate the down move to urge you to sell.
      4. It gives you more chances to question your entry, for example, even if you have higher lows, you might see a lower high and say hmm maybe the uptrend is going to end, and when price breaks out, invalidating your caution, you might say that price is too far away from the support to take the trade, you might think chasing is bad.
    • Basically getting off the train brings with it so much issues in terms of getting back on: (i) internal dissonance with recent sell action taken, (ii) creation of a price reference point to judge current price, which is illogical, (iii) could result in situations where your trading plan does not allow you to enter, (iv) need to reverse your natural tendency to extrapolate recent price action, and (v) introduces an avenue to question your re-entry.
  • Solutions
    • Don’t do it. Don’t enter active orders to get out of positions.
    • Get into the habit of entering your trade, placing your stop, and manage your position by only moving your stops.

Trading When the Market is Not Conducive

  • Reasons
    • Usually you have decided not to trade the market for the day, or to stop trading because of hitting a day stop.
    • However, the market starts to trend, and you are not in it. You try to calm yourself and rationalize that you are not trading for the day, however the market continues to give good opportunities one after another, and you finally cannot take it anymore (fear of missing out), and you start to enter the market without proper analysis because you just want to play. And that is the precise time when it is no longer conducive to play in the market, because the market starts to consolidate, or you are in a trend transition period.
  • Solutions
    • If you have decided to stop trading, don’t look at the market, switch it off.
    • If you look at the market, you are trading it and you have to focus.

Overtrading / Being Led Around By Very Short-Term Momentum / Chasing the Market

  • Reasons
    • The frequent reason is that you keep reacting to very short-term momentum. Price moves by 2 ticks, you react, you buy and sell, so you keep churning.
    • One symptom of this is if you find that you have large losses, made lots of trades, and the average purchase and average sale prices are very close (within just a few ticks).
    • And there are two reasons why you react to short-term momentum. One, when price jerks up or down, it is natural instinct to expect it to continue in that direction, so you buy when price jerks up, and sell when price jerks down. Buy high sell low, sure way to ruin.
    • Thinking that price will go further when it jerks up, and price will go down further when it jerks down, is the more ‘logical’ aspect. Mixed into the fray is the more ‘psychological’ aspect where the fear of loss intensifies the situation. If you are long, price jerks down, you are afraid of the loss, you sell. Price goes up again, you think you were right, you buy. Vice versa for shorts. Repeat this multiple times and you will be wiped out.
    • The other reason is because you don’t have an anchor to know when you should buy or sell. You have not put in a stop order at a logical spot to control your exit. Without an anchor to manage your exit, you  end up letting go of control over yourself and simply reacting to price jerks. This is especially common when you “chase” prices, because that will exactly make you end up in a spot where any anchor is too far away and you have no choice but to react to price jerks.
    • How much of a jerk is reasonable, or allowable? Too tight a leash and you end up churning or getting out just before it spurts in your direction. Too loose a leash and you end up taking bigger losses, and worse still, it gives you a very tempting opportunity to convince yourself not to cut losses swiftly (especially when you don’t have any level to rely on prior to trade entry to cut your loss!) and try to queue at a ‘better’ price to get out, which often leads to staggering losses.
    • You may find yourself naturally adopting a tight leash because of the market is moving extremely quickly (which is what you are chasing). So it is ironic that the market moves in a way that pulls you in to join the party, yet makes you adopt a tight leash so that you will be shaken out so that you won’t stay for the party.
    • The only good scenario is if you catch it right at the moment where price continues to spurt in your direction. What are the chances of that? Bear in mind especially that you are by definition chasing the market, i.e. price has already spurted, the odds favor the price pausing, or even turning (because the big boys like to torture late comers for profit), more than continuation. If price pauses, you get shaken out by a tight leash. If price turns, you lose your shirt by not cutting your losses swiftly. Of course if price continues to spurt, you are happy, for a moment, until the fighting returns to your entry price, then you’ll be faced with the same issues all over again.
    • What about if you do a chase entry, and place your stop in a logical spot? Then you will in effect be taking a bad risk-reward trade. What is the chance that if your stop is 12 ticks away, that the market will move in your direction for at least another 12 ticks, especially when it has already spurted a distance? Your upside is limited, your downside is huge. Doesn’t sound like a good tradeoff. This is no about whether you have the psychological capital to weather this kind of trade, but it is by logic, a bad trade.
  • Solutions
    • Don’t chase the market. It is a lose-lose-lose-lose-‘win-if-i-can-strike-the-lottery’ situation.
    • Trade based on the price structure made by the price action, and based on key levels, not based on short-term momentum. Price action TRUMPS short-term momentum.
    • Gun for good risk-reward trades, but don’t be too stingy on the risk you take.
    • There is one way to handle chasing, but its not a very good method. That is to place a stop, say 1-2 ticks below the lowest low of the last 1-3 bars if you went long, vice versa for shorts. In that way, you have defined the length of your leash, so it alleviates the issue of short leash vs. no leash. However, the stop location is not a good location in that it is not a level defended by one party, so is no good logical basis for it. The only slight logic is that you are chasing momentum, and if price cuts below your stop, it shows that the momentum is gone, not that the trend has potentially ended.

Cutting Winners Short

  • Reasons
    • Pre-occupied by losses, especially losses accumulated in the day.
    • Want to turn the running losses to break-even or positive first, before doing trades to make money, which is illogical.
    • Afraid that whatever small profits will go away.
  • Solutions
    • Don’t look at the running P&L during the day.
    • Exit only when stopped out.
    • When you feel like getting out, ask yourself, if your original reason for taking the trade still valid? is the trend still valid? If yes, stay in the trade.

Holding Losers and/or Averaging Down

  • Reasons
    • Did not place a stop upon entry.
    • Removed your stop when the price goes near because you don’t want to take the loss.
    • Frozen in indecision because you hope that the trade will turn around, and yet you know you should have cut long ago.
  • Solutions
    • Always place your stop immediately upon position entry.
    • Never ever remove your stop.
    • NEVER average down!

Removing Stop Orders

  • Reasons
    • Hoped to exit at a better price, however more often than not, you exit at a much worse price because the price blows through your original stop and you get frozen in indecision.
    • You might think that fast moves that blow through your stop is usually met by a quick rebound back, so you cancel and stop and wait to see if you can get a better exit price. However the risk of the price blowing through and stop and never looking back can be very devastating. Why take the risk?
  • Solutions
    • Don’t do it. More often that not, you will end up with a much worst price. Stick with the stop, never ever remove it or move it to a worse off level.
    • If you couldn’t resist the temptation, and have taken out your stop as the price approached, remember this: get out immediately once your original stop price becomes unattainable (i.e. you are trying to sell to exit a long and your original stop has become the Ask, or you are trying to buy to cover and your original stop has become the Bid)

Moving Stop Orders to Break-Even Too Quickly

  • Reasons
    • Afraid that the gains turn into losses
  • Solutions
    • Stop orders must be placed at key levels, where the violation of those levels would invalidate the trade hypothesis.
    • Do not hastily move the stop to breakeven when there is only a small gain.

Entering Orders Away from the Bid-Ask and Removing It When Price Approaches

  • Reasons
    • Want to get a bargain, but most times when the bargain comes, it is actually due to a reversal compared to the direction that you wanted price to go in the first place.
    • So when you are about to get your bargain, you end up removing your entry order because you think that it is a reversal, which defeats the original purpose of putting in the order in the first place. This is totally ridiculous and illogical.
    • Also, if you think about it, there are the following scenarios: (1) the market reverses which means you don’t want your order to be filled, (2) the market moves in the direction you thought and you end up trailing your order without getting filled and finally hitting it at a horrible price, (3) the market fluctuates, gives you your bargain and then moves in your favor, and (4) the market fluctuates, gives you your bargain and reverses. Three out of the four scenarios, its bad for you.
  • Solutions
    • Always enter orders at the bid-ask, unless you are playing a valuation counter-trend game.
    • That will also eliminate the problem of removing entry orders because you don’t have such orders in the first place.

Not Noticing Key Levels

  • Reasons
    • Checklist not yet ingrained in the mind, playing an intraday game where there is no time to check off checklists before entering a trade.
    • Was narrowly focused on the DOM.
    • Too many things to pay attention to (e.g. support, resistance, previous day’s high, previous day’s low, vwap, indicators, price action, etc.)
    • You were tired, which makes you less alert.
  • Solutions
    • Automation, program trade signals.

Trading Excessive Size / Not Adhering to Day Stop

  • Reasons
    • Revenge trading to make up for earlier losses, thinking that you can quickly make back your losses if you just double the size.
    • Did not want the day to end with big losses, justify it by thinking that all trades should be taken, but already not in a good psychological frame of mind due to the losses.
  • Solutions
    • Adhere to your day stop, turn off your trading platform, go do something else.
    • Set a maximum size limit in your software to alert you that you are trading excessive size. Stick to your size based on your trading plan.

Forcing a Trade to Shoot for a P&L Target

  • Reasons
    • Your P&L is having a slight loss, or slightly below a nice number (e.g. $1,000), so you force a trade when the market is not ready or take a trade where your setup rules are relaxed.
  • Solutions
    • Follow your trading plan and adhere to your setups.
    • You have to catch yourself thinking things such as “It would be nice if I can end the day positive, it’s just a little bit more”, “It would be nice if I can end the day above $1,000, it’s just a little bit more”. Once you catch that, stop! Walk away! Calm yourself down. Tell yourself that you will not force a trade, you will only take a trade when the proper setup occurs. Then go back to looking for proper setups.



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