How many times have you hit a big winning trade or a series of winners and shortly thereafter given all the profits back and probably even more? I don’t know about you, but this scenario was one I found myself in more than once early on in my trading career, so I know just how frustrating it can be.
Continue reading to find out what I discovered about why traders give back profits and how to put an end to it once and for all…
The psychology of why you are giving back profits…
Whilst there is probably a number of reasons you are giving back your trading profits again and again, there is one thing they all have in common: Recency Effect.
Recency Effect is a psychological phenomenon that describes how people are more likely to remember and act in accordance with events that happened more recently, compared to those that came before. It sounds like it’s just human nature, and it is, but as traders, we need to understand the profound implications the recency effect has on us, if we let.
When a trader focuses too heavily on his or her most recent trading results, it causes them to lose focus and perspective. In trading, it is EXTREMELY easy to become overly-influenced by our most recent trade(s), and this can cause us to do all kinds of stupid things.
Recency Effect is the root cause of why traders give back their profits again and again. The main reason it causes traders to give back profits, is by giving them a false sense of confidence about their trading abilities…
False-confidence: An enemy in disguise
When we become overly-affected by our most recent trades (recency effect), it typically manifests itself by feeling a false sense of confidence.
For example, a beginning trader might get lucky and start out doing very well, hitting a string of three straight winners, which is entirely possible even if they don’t know what they’re doing. Now, let’s say the market conditions at the time of the winners were “easy” conditions; very strongly trending, easy to quickly profit in. Next, let’s say the market conditions change suddenly but that trader just keeps trading because they are feeling very confident following the ‘easy money’ they’ve just made. A lack of education, understanding and trading skill, combined with this false-confidence cause the trader to keep trading, but now the trader loses all the money they made on their three winners.
This type of situation is very common and nearly every trader experiences it at some point. False-confidence will make you feel like you’re smarter than you are, like you have some trading ‘gift’ that ‘other people just don’t have’. Well, you probably do not have such a gift (it’s rare), and when you are feeling like you do, it’s a warning sign you’re about to lose some money to the market.
The key to overcoming Recency Effect and false-confidence, is by remembering that thinking in probabilities is the key to lasting trading success. In other words, we are trading probabilities, not certainties in the market, and every trade is unique and independent from the previous one; so, your previous trade result has no influence on your next trade’s. This is how you have to think if you want to get in the proper trading mindset. It is when you start assigning too much importance to your more recent trades that you lose sight of your trading plan and long-term trading goals and start losing money regularly.
Cold, hard, cash.
There is nothing more real than cold, hard, cash in your hands. The feel and smell is something that creates a sensory connection and as a result, an emotional and psychological one as well. This is quite a bit different than what happens when you are simply staring at digits on a computer screen
