The Rehabilitation of an Emotional Trader

Written By Alex Koyfman

Posted September 15, 2014

When my friend Brian Hicks asked me to join the Wealth Daily editorial team, he made one specific request: He wanted his readers to get a perspective on trading itself.

You’ve already got a winning pick. You’ve done your due diligence and are ready to make the play. Now it’s time to pull the trigger and make things real.

It seems academic: You buy a stock, and you wait. But the fact of the matter is that the majority of mistakes — very costly ones, at that — happen between the first buy order and the last sell order.

Over the next couple weeks, I’ll be sharing some of my own experiences with irrational trading; the costs associated; the rules of avoiding these instinctive pitfalls; and, most fun of all, the potential benefits of staying cool and calm when things are anything but.

The overarching theme here will be maintaining emotional discipline… and the key to doing that is recognizing the exact moment when adrenaline starts to take over.

Feel the Rush… But Don’t Act on it

A couple years ago, a close friend of mine took a sizable position in a pretty small biopharmaceutical firm that was then trading in the $0.60 range.

I remember it quite well because he texted me repeatedly about it. His texts usually consisted of links to headlines about this company and, in the weeks after he’d finished building the position, updated stock quotes.

Of course, I was already following the stock and didn’t need his updates, but the fact that he was sending them to me as his position gained 3% to 5% on a daily basis told me something about him that was troubling, to say the least…

He was in a manic state — a common occurrence among amateur traders who get their first taste of fast, substantial gains.

trading

That feeling of warm comfort coupled with unnatural optimism opens the endorphin floodgates like the best designer drugs in existence.

And like the effects of any drug, it cannot be trusted.

After that initial euphoria wears off, the next step — as is the case with many addictive chemicals — is paranoia.

His six-figure position was up about 40% when I got the first of many questions that exhibited this next stage of “trader’s drunk.”

“Dude, do you think I should start selling?” he asked one fine day.

He’d made about $50,000 in the space of a couple weeks, so I gave him the best advice I could without actually giving him any advice…

“You’ve done pretty well. If you do now, there will be nothing to regret.”

Don’t Give into Your Feelings

Of course, I knew there would be potential regret. Selling early is sometimes worse than selling late. Money not made can be worse than money lost.

But as a trader, you cannot think that way. There is no such thing as a perfect trade. There is no such thing as nailing the exact bottom for the buy and the exact peak for the sell.

In the rare event that those two events line up for a single investor, it’s usually more to do with luck than with skill.

The only way to stack the odds in your favor and make money on a long-term basis is to avoid trying to hammer it out of the park on every swing. Instead, go for the respectable gains and get out.

Let everyone else lose their hair trying to squeeze out those last few percentage points.

My advice to him was honest in that regard. But he didn’t listen.

He held onto it, and his emotional state degraded on a daily basis. Just hearing his voice or reading his words, I could tell he was swooning — his mind in a constant tug-of-war trying to decide between realizing his gains and gaining a little bit more.

He opted to gain more and held on, and sure enough, the stock kept it up. Every day another 3%, another 5%.

nervous chart

The volume built. There was an announcement of some contracts with a handful of Big Pharma firms…

Big news that made the stock even bigger and garnered increased coverage from mainstream media analysts.

Within two months of this ride beginning, he’d doubled his money.

Again came the question: “Dude, do I sell?”

My answer was the same. “You just made more in eight weeks than most people make in a year. That’s not bad by any standards.”

But that response led to a barrage of new questions… questions he’d pose and then answer himself in the next text alongside another question.

He maintained a conversation with himself, with me as an inactive participant, for hours.

The mania was strong with this one — and probably not good for him either. Sleepless nights. A million clicks of the refresh button on Yahoo! Finance between the hours of 9:30 a.m. and 4:00 p.m.

A breath of relief every time the stock closed in the green.

I got together with him for some drinks in D.C.’s Dupont Circle on the last Friday he held his stock. I hardly recognized the guy.

He was tired, disheveled, a bit more inattentive than usual, and, from the moment I joined him at the bar, apparently dead set on drinking himself to sleep.

We skirted the subject of the stock for about two drinks, and then he went into it, describing how his waking thoughts, as well as his dreams, orbited the image of that stock ticker like a hapless planet orbiting a black hole.

He went from discussing the car he was going to get to what he was going to do if the stock crashed the following Monday and then back again in the space of 10 seconds.

The guy was obsessed, and not in a good way. And it was strange to see it coming from a software engineer whose thought processes were usually bone-dry, scientific, balanced, and in a constant state of logical analysis.

He now more resembled a hamster spinning around in its wheel.

Time for an Intervention?

“Look man,” I finally said to him as he proposed the third shot of vodka in 15 minutes. “Maybe it’s time you let this one go. You’re not going to retire off it. Just learn to live with that. It’s done well for you and set you up for the next one. Slow and steady wins the race.”

Yes, I quoted that old adage. I quoted it because it’s true. In this, just as in anything, you only succeed by planning for the long game.

And it was only then, once he’d heard those words, that I saw the tension begin to leave him.

His shoulders slackened. His speech slowed down. His drinking calmed. He needed to hear it from somebody he trusted.

The following week, he started to liquidate his position. I watched his stock as he sold his shares, and with each passing day, I was more and more assured that my advice was on point.

The stock wasn’t making the same gains it had in the previous weeks, and volume was tapering off. Whatever had caused the increased activity had clearly run its course.

A week after we met at the bar, he sold his last share. Total gains were somewhere in the 110% range. In other words, it was a great run, and over a very brief hold period.

We got together again that weekend, and, sure enough, he was back to his old self. My friend had kicked the habit and completely detoxed from his two-month adrenaline binge.

The Punch Line

The following week, the stock gained 25%. The week after, it ran up another 30%.

By month’s end, it had doubled from where he’d sold.

Now, many of you may be wondering whether this guy is still my friend given that my advice cost him enough money to buy a one-bedroom beachfront condo in Miami (with a view).

The answer is yes. Although I’m sure he thinks about the lost potential every now and then — as we all do — he also thinks about what could have happened had it gone the other way.

He understands that on a long enough time line, relying on long-shot risks becomes progressively more dangerous.

Do it long enough, and your chances of emerging with even your principle investment intact shrink to miniscule levels.

He’s been trading on a regular basis since those fateful months over two years ago, but nowadays, it’s a different guy who gets in touch with me during those tense moments.

No more obsession. No more manic thought patterns. He recognized the absolute impossibility of maintaining control over the situation and resolved to take a passive approach.

Step one, he told me, was forcing himself to check the stock quote no more than one time per day — unless there’s buying or selling to be done.

Step two was learning to perceive the money invested as money spent. It’s gone. It’s not coming back. Don’t stress over it.

Step three, and probably the hardest step of all, was abstaining from mentally spending money before the gains are realized.

Doing this won’t guarantee bigger gains or smaller losses, but it will mentally prepare you to make only measured, calm decisions.

There will be no such things as surprise windfalls when the stock shoots up or debilitating disappointments if it happens to crash. There will only be stop-losses and optimal exit points.

Add this to your behavioral profile, and you will absolutely gain an advantage over the kind of emotionally driven trader who lets his adrenaline guide him into unwise decisions such as buying into a run-up and selling into a dip.

And keep this in mind:

Anybody whose ever risked his hard-earned cash on shares of a company run by somebody else personally knows the impulse to storm into trading decisions like Rambo.

Those who meet these instinctive reflexes with the calmness of Yoda, however, will always win in the long run.

Fortune favors the bold,

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Alex Koyfman

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