Most traders lose money in the stock market due to two emotions: fear and greed. Fear manifests itself in at least two main ways, fear of losing money and fear of losing profits.
Fear of Losing Money
Fear of losing money happens when a trader first initiates a position and immediately sees the trade go against him/her. At this moment, beginners in the stock market (who normally do not trade according to some predetermined rules) will often second guess their decision. Intense fear of losing can cause the trader to immediately ‘cut loss’ and exit the trade, at a small loss. These losses, though individually small, can quickly add up to a significant amount. Over time, such losses can cause the trader to lose his/her morale and confidence.
To overcome fear of losing, I remind myself that a surgeon spends more than 10k to receive his/her qualification. I treat losing in the stock market as a form of tuition fees, a necessary investment. Investment in education always pay the best return. To make sure I get the highest return from my ‘tuition fees', I make sure I analyze each losing trade to find out what mistakes I made and modify my trading rules accordingly.
Fear of Losing Profits
Another fear is the fear of losing profits of winning trades. When a trader sees his/her position making a profit, the trader starts fearing that any second, the position will turn against him/her. To quote Jesse Livermore (one of the greatest stock traders of all times): “Most people fear when they should hope and hope when they should fear. " Thus, they close out their winning trades, taking a small profit, believing that they can't go broke taking a profit.
Unfortunately, they CAN go broke taking small profits. Unless the trader can achieve 100% accuracy in picking stocks, he/she is bound to have a number of losing trades. In order for traders to make money in the stock market, they need profits from those winning trades to be big, so as to cover for losing trades. If a trader constantly takes small profits, it is unlikely that he/she will have a significant amount of surplus left after covering for these loses. George Soros once said: “It is not about whether you win or lose, it is about how much you win when you are right and lose when you are wrong that matters. "
To overcome fear of losing profits, I use the method mentioned by Jesse Livermore in his book “How to Trade in Stocks". I constantly remind myself: “Why am I afraid of losing profits I did not have the day before?" Instead of focusing my thoughts on the possibility that the position can go against me, I focus on the need to win big when I am right.
In generally, there are three main methods to overcome fear of losing:
- Changing one's perception of losing. To overcome the fear of losing money, treat any money lost as tuition fees. In addition, do not treat unrealized profit as your money; those are merely profits on paper. One can't be afraid of losing money that do not belong to them yet.
- Have clearly defined rules for cutting loss and taking profits. These should be based on empirical research or intensive back-testing. Alternatively, one may choose to adopt the rules of a proven time-tested system (such as the CANSLIM system by Mr Williams O'Neil).
- Use visualization techniques to take one's focus away from the possibility of losing. Visualise the current position becoming a big winner, a grand slam. (Note, this does not mean one should pray and hope and visualise a losing position turning into a grand slam. A good trader should always ensure that they know exactly when to cut loss. As long as the cut loss level is not reach, one should not let the fear of losing overwhelm him/her resulting in the closing of a position prematurely. )
It helps to ask yourself three questions:
Q1) What is the worst that can happen?
[e. g. The worst is that your stop loss is hit and you lose $1000 on the position. ]
Q2) What is the best that can happen?
[e. g. The best is your profit target is hit and you win $4000. ]
Q3) What is most likely to happen?
[e. g. The most likely is you are stopped out of your position by your trailing stop and your profit is less than $4000]
If you cannot accept the worst that can happen, you should not open the position. If you can accept, you should find courage in the fact that even if the worst happens, your world won't fall apart (which means there's nothing to fear). You should then focus your energy on visualizing the best scenario.
About the Author:
Joelle has invested in the stock market for more than 5 years and has successfully used various investment strategies to consistently make money from the stock market. She offers free top quality investment tips at her blog Stock Market Investing for Beginners .