The Art of Being A Disciplined Trader
Trading is often described as an art, leading us to treat it as a subjective process where we can exercise a large degree of discretion.
However, with great discretion comes great anxiety. When we have so much freedom to decide when to take profits and when to cut losses, we begin to fall prey to emotional biases, in particular loss aversion and regret aversion.
With loss aversion, we feel more pain from a loss compared to pleasure from an equal gain. For example, if we bought a stock for $10, we experience more sadness when it dips to $8 compared to happiness when it rises to $12. As a result, we will tend to hold on to losing positions for too long, hoping they will recover. We may also sell winning positions too early as we fear we will lose out on the opportunity to make profit if the stock reverts to its initial price.
With regret aversion, we end up being “paralysed” and do not take action as we are scared our actions could be wrong. Classic examples are thinking “oh no, the stock price has reached my cut loss threshold but maybe I should not sell it yet because I could be wrong and the stock price may go up” or “wow, this stock is flying! although it has reached my take profit price, maybe I should hold it longer because it may rise even higher and I will make less money if I sell it now”.
So how do we tackle these biases and improve our trading mindset?
We should practise a DISCIPLINED trading/investment approach.
Tips:
1. Determine a suitable risk-to-return ratio.
Note: A decent starting ratio to consider is 1:3
2. Establish strict stop loss (SL) and target profit (TP) prices.
Note: you can update these prices from time to time based on fundamental analysis (based on news articles and quarterly/annual reports) or technical indicators (based on signals from the stock price and volume).
Example: You buy a stock at $10. If your risk-to-return ratio is 1:3, you can set your SL at $8 and TP at $16.
3. Take action based on your rules and you will become a more consistent trader/investor.
Hope this sharing will help my fellow Mooers in their investment journey 😉
However, with great discretion comes great anxiety. When we have so much freedom to decide when to take profits and when to cut losses, we begin to fall prey to emotional biases, in particular loss aversion and regret aversion.
With loss aversion, we feel more pain from a loss compared to pleasure from an equal gain. For example, if we bought a stock for $10, we experience more sadness when it dips to $8 compared to happiness when it rises to $12. As a result, we will tend to hold on to losing positions for too long, hoping they will recover. We may also sell winning positions too early as we fear we will lose out on the opportunity to make profit if the stock reverts to its initial price.
With regret aversion, we end up being “paralysed” and do not take action as we are scared our actions could be wrong. Classic examples are thinking “oh no, the stock price has reached my cut loss threshold but maybe I should not sell it yet because I could be wrong and the stock price may go up” or “wow, this stock is flying! although it has reached my take profit price, maybe I should hold it longer because it may rise even higher and I will make less money if I sell it now”.
So how do we tackle these biases and improve our trading mindset?
We should practise a DISCIPLINED trading/investment approach.
Tips:
1. Determine a suitable risk-to-return ratio.
Note: A decent starting ratio to consider is 1:3
2. Establish strict stop loss (SL) and target profit (TP) prices.
Note: you can update these prices from time to time based on fundamental analysis (based on news articles and quarterly/annual reports) or technical indicators (based on signals from the stock price and volume).
Example: You buy a stock at $10. If your risk-to-return ratio is 1:3, you can set your SL at $8 and TP at $16.
3. Take action based on your rules and you will become a more consistent trader/investor.
Hope this sharing will help my fellow Mooers in their investment journey 😉
Disclaimer: Community is offered by Moomoo Technologies Inc. and is for educational purposes only.
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