It is a fact that investing online when emotions are high or simply in tact can have devastating consequences. Last week I covered 50 Ways You Know You Are an Emotional Investor, and this week I want to start by offering a way to combat it.
The best way to combat emotions while trading is to have a list of rules. Your rule list isn't "take deep breaths" and "play soothing music", no. This list is of rules you have for different situations you come across each and every day.
To create your own rule list, first take a few minutes to write down whatever situations that most often make you emotionally driven. I made a list for me personally, titling it "I become emotionally driven..." and writing whatever came to mind,
- "I become emotionally driven when my stock gaps up or down without me knowing about it."
- "I become emotionally driven just before and when my stock reports earnings after hours."
- "I become emotionally driven when my stock falls below key support and I don't know if I should sell or hold"
Your list can go beyond simple situations too, for example I have, "I become emotionally driven when a stock becomes initially oversold intraday according to its Relative Strength Index and I am looking to buy a position."
Once you have your list down, spend a few minutes and write down a rule for each one that would prevent you from making a possible mistake. The rules can be extremely basic, in fact the simpler the better.
- If my stock gaps up or down without me knowing, I will immediately sell half my position regardless of direction, perform research, then make an educated decision to re-add or sell the rest of my position later.
- When my stock reports earnings after hours if it drops more than 3% I will sell immediately using a limit order after hours, and if it remains even or moves up I will hold my full position.
- I will always place stop orders 5 - 8% below my purchase price, so unless my stop triggers I will hold my position.
Post the rules somewhere on your wall, desk, monitor, whatever so that you see them every day. When you run into that situation next time simply refer to rules and you will be amazed at how calm you remain. Why? Because you have a plan of attack.
Worry is most often caused by the unknown, psychologically the mind is stimulated when it faces a situation where you ask "crap, what should I do now?". The whole point of rules is to remove those situations, as a result staying calm and disciplined.
Test out your rules and see how they work, and make sure to tweak them as you go. You may decide that a 4- 6% stop is more effective long term than a 5 - 8% one, or you may find that checking all of your stocks vital signs before selling, "just because" is a lot safer. If you come across a situation where you find yourself emotionally driven to do something potentially dumb, add it to your list and create a new rule to combat it.
Overtime you will begin to see a change in how you handle yourself in clutch situations. The best part is that the more disciplined you become with handling these situations, the more money you are going to save and make long term.