Last Updated on June 19, 2022 by Quantified Trading
Is fear good or bad in trading? The markets are a battle and you need to have detachment to money to succeed. The balance between fear and greed is a thin one.
We believe fear in trading in moderate doses is very healthy. How do you overcome excessive fear in trading? Trade smaller than you like is a very wise strategy in trading. Not only does it help you remove fear, but it also helps you to limit behavioral mistakes. Mechanical trading strategies are a great tool for removing fear.
In a previous post, I wrote about a trader’s mindset. You have to battle the markets, of which you have no influence and control, but more importantly, you have to battle yourself (and obviously you can control that). There are so many ways to lose, but so few ways to win, as Victor Niederhoffer wrote in The Education of A Speculator. One of the most common obstacles for many traders is fear. Fear of losing or fear of missing out (FOMO) are two examples of that.
However, fear in small doses is healthy as long as it doesn’t interfere with your trading decisions. As soon as it limits your trading, you need to address the problem. Too much fear makes you hesitate, and too little most likely leads to severe losses sooner or later. At the end of the article, I address an easy trick to help you deal with fear.
Is fear good or bad in trading?
I like to call myself a fearful trader. I have a constant fear of losing money. This has cost me a lot of opportunities, but highly likely saved me a lot of losses. It has made me survive and evolve for two decades.
But is fear good or bad in trading? It all depends.
Personally, I believe a certain level of fear is crucial for surviving as a trader. All the surviving traders I know are more or less like me, but perhaps not as fearful and “paranoid”. Fearful traders protect their capital and “fear” losing it. That should be any trader’s primary goal. You must protect your capital to survive and get experience. By getting experience it’s also much easier to survive in the future.
What is the definition of fear?
The Oxford Languages defines fear as:
An unpleasant emotion caused by the threat of danger, pain, or harm.
What triggers fear is the threat of harm. Harm can both be physical, for example by being beaten up by a brute, or psychological in the form of threats. The threat can both be for real or illusionary. In trading, the threat is normally about money.
Is trading stressful? Does this create fear?
Trading is for the majority of traders quite stressful. Why is that? It’s because of losses but also gains. The fear of missing out can be just as detrimental as the fear of losing. Trading is about money and it’s very hard to detach from money.
What kind of fears are typical in trading?
There are many types of fears, here are some:
The fear of losing
The fear of losing is most likely the most typical obstacle for most traders. When you are facing an unknown future, you have no idea if your actions will lead to losses or gains. If the focus is on how much you can lose, you might hesitate and don’t take the trade.
The fear of being wrong
Most people like to be right. However, in trading, you can be wrong 50% of the time and still make good money. Warren Buffett is among the planet’s richest men, but he is surprisingly wrong very often. What makes him successful is his rational mindset and patience (he is long-term).
The fear of missing out
Social media make you fear missing out: You see a lot of activities that you would like to participate in. The same happens in the stock market when the market goes up. The fear of missing the bull ride makes many you giving in at the end of the bull market. The fear of missing out is a very powerful force.
What is a good trader?
A good trader is someone who acts rationally under all circumstances. He or she can tolerate stress and filter out all external pressures. A good trader can manage stress in a good way, but more importantly, he or she has a plan on how to deal with fear.
Trading is about managing risk
At the end of the day, trading is about managing risk. Thus, you need to find the right balance between the potential gains and losses. Having a healthy dose of fear is good as it limits excessive risk-taking. However, it needs to be balanced.
No fear often leads to overconfidence
Having too much confidence, overconfidence, is traders’ worst enemy. Victor Niederhoffer keeps a picture of the “unsinkable” Titanic in his office to keep him humble (he still managed to “blow up” twice). The bottom line is that a fearful trader will always protect his capital. A fearful trader might not make the most money, but he will be around for a long time. Trading is about surviving and removing errors and behavioral mistakes.
However, too much fear has its downsides: one is, as mentioned, missed opportunities. Perhaps a bigger drawback might be getting shaken out of positions that eventually turn into big winners. Trading involves finding the balance between fear and guts. It’s not easy.
My own personal experience: How does my fear affect my trading?
I consider myself a pretty fearful trader:
- I double-check all that can go wrong. I believe in Murphy’s law (all that can go wrong will sooner or later go wrong -it’s just a question of time). I do make errors, but this has saved me a lot of money over the years. Unfortunately, trading involves risks that you only learn by trial and error. You possibly can’t understand all the risks before it’s too late. Black swans are inevitable.
- I try to have as low living costs as possible. One of the reasons why I own real estate is because I want to have a “passive” income if my trading goes nowhere.
- I’m not making as much money as I could. That is fine. My aim is survival.
- I diversify a lot. I invest for the long term in stocks, commodities, and real estate. Among all these, I diversify my trading strategies.
- My fear has put me out of great opportunities. Usually, after a bad day or bad period, things turn around. The best days “always” come after a bad period. To avoid changing exposure due to behavioral biases, I make sure I control my losses and know my limits. It’s easy to give up trading or a strategy at the exact wrong time. That happened in 2007 when I had my biggest loss ever. The very next day was the best trading day ever, but unfortunately, my fear made me scale back as much as I possibly could because of the losses from the previous day.
- I always have a plan B. Any day regulation (or market change) can put me out of business.
How to overcome trading fears
Fear is normal, as long as you can control it. However, as soon as you notice it interferes with your trading, you should address it.
How do you address fear?
I suggest writing down your fears. What are you afraid of? Is the fear rational or is it illusionary?
When you have clearly addressed your fear(s), write down how you can deal with it. Writing is a very powerful tool and forces you to think. If you’re serious about trading, you will most likely be rewarded for taking the time for doing it.
Here are some additional notes that might be helpful:
- Employ mechanical trading strategies to avoid human interference.
- Experience is a good teacher. You will always learn something new every day.
- Never be too confident. You have never seen it all, and you never will. Overconfidence and ego have been the downfall of many traders.
- Being right often doesn’t necessarily lead to more profits.
- If your fear is about losing, write down what you believe is the worst scenario. How much can you lose?
- Be sure you have a lifeline in the form of savings.
- Trade many uncorrelated strategies.
One last piece of advice to overcome fear in trading: Trade small (and trade mechanically)
To overcome fear in trading the best advice is to trade small via automated software. If you trade bigger than your comfort zone, you are less likely to follow your strategies.
Thus, always trade a little smaller than what you believe is the optimal size. By trading small you are much more likely to do what your systems tell you to do.
In order to keep detachment to money, don’t follow every tick or move in the market. Turn off the screen and do other things while the market is open.