Updated from its original posting on 14-01-2011
In trading, fear comes from the increased possibility of price hitting your stop loss. I say increased because the possibility of losing is always there, so fear usually kicks in when the probability of losing suddenly rises.
Experiencing fear is normal. In fact, fear is considered a basic survival mechanism. Without fear, we won’t be able to recognize danger and respond appropriately. The problem with fear comes when we let the perceived danger of stopping out or losing money scare us into making a decision that goes against good trading habits and our pre-determined trading plan.
Let’s say you are holding a long EUR/USD position. You bought it at 1.1220, and price is currently at 1.1205, so you are down 15 pips.
Your stop is at 1.1190, just below the support at 1.1200. At this point you are very nervous, and very afraid, especially since your last trade was a loss.
Simply put, you are experiencing fear.
You think to yourself that you cannot handle it anymore, and do not want to lose more than you already have.
You close early.
Can you guess what happens next?
Support holds, and price shoots up a few hours after. Your fear caused you to irrationally close a valid, high-probability trade! D’oh!
Once you identify the reasons behind your fear, you can use them to make better trading decisions. If you’re able to analyze the root of your fear, you can look back at your trading plan which should help you decide what to do in that scenario.
Let’s go back to that long EUR/USD trade that I mentioned earlier. For instance, you heard news that Greece might default on its debt (not an unlikely scenario, if you ask Forex Gump!) while your trade was open. This makes you feel uncomfortable with your long euro position, so you experience fear.
Now, there is a change in the fundamental landscape and an increased probability of a losing trade, so it may be better to exit your trade even before it hits your stop. Once price breaks below support at 1.1200 and plummets, you’ll be patting yourself on the back for acknowledging a valid change in the environment instead of closing your trade purely on fear alone.
For those of you who need your very own checklist, here’s the TL;DR (too long; didn’t read) version:
1. Embrace fear
Fear is part of human nature and everybody experiences it, so embrace fear and focus on dealing with it. You have to find a way to use this negative emotion to your advantage or as Brett Steenbarger, author of The Daily Trading Coach, puts it – make fear your friend.
2. Identify the source of your fear
Did the funny tingling in your tummy come from valid reasons like a break in support and change in market sentiment, or was it just because you had a nightmare about your trade the night before? Learn to identify the good kind of fear from irrational fear so you can focus on acting on it.
Because fear warns you that something doesn’t feel right about a trade, you should try to figure out what exactly is going wrong. Ask yourself these questions:
- Why am I feeling uneasy?
- Is it simply because I’m afraid to lose?
- Or are there fundamental or technical factors telling me to exit this trade?
3. Use fear to make better trading decisions
Once you pinpoint the source of your fear, make the necessary changes in your trades. This way you have turned your fear into an area of growth and improvement.
As super trading coach Brett Steenbarger says, “Confidence isn’t the absence of fear; it’s the knowledge that you can perform your best in the face of stress and uncertainty.”