Fear and greed are among the key concepts in the financial markets. When not managed well, the two concepts have led to the destruction of many traders. In this article, we will look at the best strategies to manage fear and greed in day trading.
What is the fear?
Fear comes in many ways for day traders. First, there is the popular concept of fear of missing out (FOMO). This happens when a trader jumps to the most popular trade in the market. There are many examples of these in recent times.
The most popular was Bitcoin in 2017, when it reached an all-time high of close to $20,000. At the time, this rally was because most traders wanted to take advantage of the rally. Another popular example of FOMO was investments in Nikola, the embattled electric car start-up.
Second, many forex traders fear opening accounts, moving from demos, and even executing trades. In this type of fear, their biggest concern is that of losing money.
What is greed?
Like fear, greed is seen in several ways in the forex market. First, many new traders want to make a lot of money without doing the hard work. As such, they open an account and start trading without having any experience.
Second, we see greed in the size of leverage many traders use. Instead of opening an account with small leverage, say 1:15, they go big with a 1:500. While big leverage can make you more money, it also exposes your account to bigger risks.
Third, greed is also seen in the number of trades many traders open. In most cases, many traders open less than ten trades per day. This helps ensure that each trade is well-thought. However, many traders exhibit greed by opening tens of trades each day.
So, how do you deal with fear and greed in day trading?
Having a well-defined trading strategy
The best approach to deal with fear and greed is to have a well-defined and well-tested day trading strategy or plan and stick with it.
There are many trading strategies in day trading. Among the most popular of these strategies are:
- Swing trading – this strategy revolves around buying or shorting an asset and holding the trade for a few days.
- Scalping – scalpers buy and short assets and close their trades within a few minutes. Their goal is to make a few dollars per trade.
- Algorithmic trading – these traders use algorithms or robots to get signals and even execute trades.
- Copy traders – these traders use copy trading tools to emulate the trades of other experienced traders.
- Arbitrageurs – this strategy involves opening two trades of correlated or uncorrelated assets to take advantage of the spread.
In other words, before you move from a demo to a live account, we recommend that you spend time identifying your strengths and weaknesses. As you do this, you will be able to identify your most preferred strategy to use as a professional trader.
Having a strategy is not enough. Indeed, most successful traders who find themselves captive to fear and greed usually have a strategy or a trading approach. Therefore, you should ensure that you follow your strategy to all trades you execute.
Having a trading journal
One way of enforcing your trading approach/strategy is to have a trading journal. For starters, a trading journal is a document, often in soft-copy format, where you write down all of your trades. There are several approaches to journaling your trades. The layout most popular with the traders has the following sections:
- The asset being traded – this could be a currency pair, stock, or exchange-traded fund (ETF).
- Time of execution – in this, you should indicate the time of the day you have executed the trade.
- Reason for execution – here, you should note why you open the trade. This could be because of new data or political events or because of technical indicators.
- Time of closure and profit/loss – here, you should record the time you closed the trade and the profit/loss.
- Reason for closure – In this section, you should write down why you decided to close the trade.
A trading journal will help you avoid fear and greed in several ways. First, it will help you keep track of all your trades. Second, when used well, a journal can help you improve your trading discipline. Third, taking the time to write these details will help you avoid making decisions in haste.
Having a risk/reward ratio and using stop loss and take-profit
Another way of avoiding fear and greed is to have a good risk/reward ratio. This is a simple approach that ensures that you know the maximum loss and profit you are willing to take per trade. For most people, the ideal risk per trade is usually 3%. This simply means that if you have a $10,000 account, the maximum amount you are willing to lose is $300.
You can achieve this using several approaches:
- Position sizing – this means that you should always open relatively small trades. While the profits won’t be much, your potential loss will equally be manageable.
- Stop loss and trailing stop – you should always use a stop that will automatically halt your trades when a certain threshold is reached. A common mistake among traders is to adjust their stop losses when the trade is running.
- Take profit – always use a take profit that automatically stops your trade once a certain profit level is reached.
Don’t open trades in haste
A common fear and greed mistake people make is to open trades in haste. For example, a trader can enter a buy trade because a certain currency pair is rising. In other periods, a trader can open trades shortly after losing money with the goal of recovering their money. Similarly, a trader can initiate trades without doing any analysis. All this is wrong.
You can prevent this by always ensuring that your trades are well-thought. This means that all the trades you initiate meet the criteria of your already-defined strategy.
Fear and greed have pushed many traders to make serious mistakes. Indeed, failure to have quality approaches to prevent the two has pushed many traders into significant losses. Using these four approaches will help protect you from these risks.