SK Biswal Chief Engineer at ONGC. Interested in Stock option trading ,Technical Analysis of Stocks & Commodities

Emotional Trading Vs Rational Method Of Trading.

4 min read

The worst thing ,an individual investor can do is to follow the market too closely.

Paul Bolster

Surely a sign of a good trader is that they don’t jump every time the market says ‘Boo’, but take a longer term perspective, ignoring short-term noise.

What is emotional investment?

Most of us invest based on our gut feeling or intuition also called instinctive impulses.Psychological factors such as greed ,fear ,hope and pride or Ego dominate our investing decisions.We sometimes go by tips or advice of some body or jump with news on TV or news papers.Our assumption of certainty of outcome is based on knowledge gained from various sources which we tend to believe or just give a try.This is irrational investing process as certainty of outcome is based on our belief of information where outcome is always binary and not predictable.

 
How emotional investing happens?

We have been hearing this gloom and doom stories or bubble themes since we are child. Good traders prefer to Turn off the TV and radio and study higher time frame charts. News is nothing but brainwashing to separate you from your hard earned cash by putting you in emotional freight train.

We all track news and information from various sources for investment purposes.Following very closely market news means tapping into short term developments which is deeply impacting price and consumer and investment sentiments.These short term moves emotionally involves us and influence our decision making.This is invariably true for most of us except professional experts or technical experts.When I say closely watching ,it means watching in 5 or 10 or 15 minutes time frame.You not only miss big picture ,but something happens in your head.It becomes subjective ,psychological called emotional trip.There you are in pressure of excitement or tension .

If you play chess ,imagine playing against an expert.You are not calm and relaxed.Your rational brain stops working completely.Time is pain then and you have no patience.Without patience ,you are in hurry like in greed or fear of missing out and you make mistakes. Similar mindset prevails when you are in trade.You don’t know when to buy or when to sell or when to book profit and loss. But Patience is slowing down in the face of pressure .It gives strength and maturity .It gives tremendous confidence to deal with any problems and provides solutions.Patience gives courage and confidence which opens the gates of solutions.This is true both in chess or trading or for that matter in any sports.

Emotional investing happens due to lack of patience resulting from addiction or obsession with market on 24X7 basis.You are just reacting to something which may or may not have certainty impact on price or expected outcomes.Your emotions or beliefs have nothing to do with market outcome whether present or future where mass beliefs are constantly changing.No predictability there, only probability or higher odds of certainty.Your emotional impulses or reactions affords none of these except the comfort of risk aversion.You eventually lose because emotions have nothing to do with certainty of outcome.We want to hit home run and don’t wish to be shaken out like suckers.Sound funny if someone tries to trade millisecond breakouts .Emotions lead you to be out of control and do silly thing in your attempt to control the uncontrollable.Give yourself and your mind some room to see big picture ,to observe from vantage point like a general instead of fighting like a foot soldier in direct combat.

What is Rational Investing Method?

Rationality is about probability ,odds and edge or superior chance of winning. In contrast ,Emotional investing is reacting to current market move by looking at smaller time frames which is most of times are not durable however terrible it may appear.It is called irrationality.On the other hand Rationality involves analyzing longer term or medium term trend and ignoring short term noise called volatility.Seeing big picture in randomness or chaos or deciphering high degree of certainty in sea of uncertainty .Trading is like crossing super highway where the danger getting crushed forever looms large.

However Rationality or objective method of trading does not afford 100% certainty per se.But trading safety is enhanced and Risk is greatly mitigated.Rational method demands high level of certainty of expected outcome and tolerable downside which is also kept in domain of possibility.This process protects downside and eliminates surprise elements from equation.

High level certainty of expected outcomes requires identification of long term or medium term trends or ranging behavior, historical volatility which determines both return and risk inbuilt in stock, or by building up higher odds with optimized and back tested Moving Average filters /MA cross over filter and ADX based filters like in trend following systems for examples. In addition ,odds are made favorable with Price action analysis by Japanese candlesticks ,trend lines and patterns or Fib tools and support/resistance study or price by volume study.Basically trading from long term chart is about objective trading.

Further ,we can reinforce our odds and edge to have greater certainty of expected outcome with higher safety and protection,using momentum indicator filters like RSI,STO,MACD, ATR, ADX and so on to know oversold/overbought conditions ,support/resistance ,filter noise or to know VAR and statistical significance of expected move.Your method should have formidable edge like that of casino and positive expectancy.Besides Using fundamental based filters like quarterly results or macro results like inflation.IIP or RBI policy announcements may serve same purpose. This is rational and objective filtering method for certainty and optimal outcomes.

Breakout traders ,momentum trading ,swing trading or trend following are some examples of rational method of trading.Rationality is about maths(quantitative methods like accumulation distribution or sentiment metric) ,charts ,probability. fundamental based study .positive expectancy or Edge which completely disconnects emotions from trading equation.

CROWD AND IRRATIONALITY

We tend to invest as herd and make our ivesting decision based on psychological factors such as fear,greed,hope and pride.We react and jump at every piece of news or every short term move of market which may not have decisive role to bring about certainty of the directon.Noise are misleading and to be ignored.In stead we ignore long term message of market about future.We tend to miss big picture over and over again.We are fooled by tips ,piece of inside information , media hype ,interesting news or noise and believe them.This happens we look at market too close in short timeframes which mistakenly gives us perception of certainty and we get trapped instead.

Ignore Noise and see big picture.Dont fall in Love and Keep distance from Market.

“The thing to do is to watch the market, read the tape to determine the limits of the get-nowhere prices, and make up your mind that you will not take interest until the price breaks through the limit in either direction.”

Jesse Livermore

SK Biswal Chief Engineer at ONGC. Interested in Stock option trading ,Technical Analysis of Stocks & Commodities

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