Almost every Forex and Futures trader that we have spoken to has admitted to, at some point, taking a trade outside their method and/or outside their risk tolerance. We were curious to see what makes people take those types of trades and whether we can find ways to eliminate this negative behavior.
We engage in situations where we have to deal and assess the level of risk on a daily basis. Whether it’s crossing the street, getting in your car or making investment decisions and placing trades, your brain always analyzes the potential risk and reward tradeoff – but not always in the most rational ways. There are instances where you will be prone to taking higher risks than necessary. In trading, this rarely ends well. In fact, the professionals want you to take these unnecessary risks.
You must also keep in mind that risk/reward evaluations also take place on a psychological level and include a “combat” of the Amygdala (processing of memory, decision-making and emotional reactions) and the Neocortex (sensory perception, conscious thought, etc.) Essentially, your brain is always battling between what is an acceptable amount of risk and what is not.
We believe that a major factor in successful traders is their emotional intelligence. Simply put, when they experience a set of emotions, they understand the source and relevance of their feeling. This higher level of emotional knowledge and analysis is where you need to strive and get to. This may prevent from you taking unnecessary trades and possibly making better decisions. This is where you understand how your emotions affect your thoughts.
Let’s jump into the variables that cause futures and forex traders to take unnecessary risks:
Boredom
Being bored has a “dark side” which often leads to compulsive over trading and rarely leads to good results. The fast pace of the markets and the sudden volatilities while sitting on our hands waiting for the right opportunity is not an easy task. As a consequence, this leads most traders to take decisions which inevitably end up being wrong under most circumstances.
FOMO
The Fear of Missing Out is sparked by ongoing breakouts in the day-trading charts. This causes impulsive behavior which leads to increased risk and taking trades which may lead you to believe will be “the one”.
Stress
There is healthy market volatility that presents traders with good risk and reward opportunities, and then there are times when the market is highly volatile with extreme swings, both up and down. This causes high stress, but oddly enough, traders take more risk than they should when under stress. This may be reflected in trying to catch tops, and bottoms, over leveraging contracts or number of pairs, etc.
Social Peer Pressure
Trading today is very different than it was only 5 or 10 years ago. We are exposed to trading news outlets, forums, Twitter, Facebook, etc. Traders always have an opinion and listening to the wrong people can be costly. However, traders rarely do a thorough background check and often just hope that someone knows more than they do about a potential trade. Acting on someone else’s opinion has to be avoided in trading because it increases your risk significantly.
How to overcome unnecessary risk taking?
There are a number of things that you can do in order to reduce your level of unnecessary risk taking:
- Keep a daily record of your trades. In the end of a 90-Day period you may be surprised to find out the direct correlation between your results and your decision making. A Trading Journal can reveal a lot.
- Start assessing your risk tolerance as a reflection of your risk capital. Start thinking how much you can afford to lose as opposed to how much you can gain. No amount of reward is worth it if you are going to take yourself out of the trading game. Keep in mind that the reward part of trading is often in our head, and at times may not have a base in reality (more wishful thinking than actual facts!)
- Be conscious of your decision making. When you place a trade ask yourself why you want to enter and where you will exit. Your past experience may play a role in trying to make decisions compensating for past losses, etc.
- Have a daily risk limit. Set yourself a limit on how much you are willing to lose per trading session of week. Most traders do this the wrong way and they have weekly performance goals. Don’t do that.
There is a substantial risk of loss in futures trading. Past performance is not necessarily indicative of trading results.
