From The Mental Edge NewsLetter:

Monday, February 11, 2008

Conquer Your Fears When your money is on the line, it’s natural to feel afraid of losing it. You want to do well, and when market conditions are not cooperative, there is extreme pressure to perform. When people feel pressure to do well, they may hesitate or make errors. Learning to over come fear is a necessary step to trading with the proper mental edge. Only completely naïve traders don’t experience fear occasionally. When we first started trading, we were not aware of how much we could lose and how long it might take to make back what we had lost. We were fearless, but as we gained experience,we learned that a little caution pays off. There are times when fear protects us from making huge mistakes. When we see danger, we instinctively react, and flee to safety. But fear can interfere with trading with a calm, rational mindset. Rather than react instinctively, the astute trader assesses the situation logically, thinks ahead of the crowd, and turns any circumstance into an opportunity to take home profits. If you are more fearful than most people, it may not be your fault. The tendency to experience fear has a biological and genetic basis. Fear is related to the fight-or-flee response. Fear is a very basic response that animals use to survive inthe wilderness and it's controlled by very primitive parts of the brain. The fight-or-flee instinct can be very adaptive. When harm is perceived, a wild animal must mobilize resources and make a quick decision to either fight the opponent or flee to safety. When trading the markets, however, the fear instinct can throw you off course. You don't want to panic and sell off positions impulsively because you irrationally fear that a temporary downturn is the sign of impending doom. Instead,you want to evaluate your options calmly and rationally and make a prudent decision. People differ in terms of their ability to handle fear. Some people can't trade at all because fear paralyzes them. All they can think about is the money they could lose and how terrible it would be to lose it. Other people may be able to execute a trade, but while their money is in play, they are on edge. They are overly worried about losing their stake. Other traders, however, are rarely fearful. For still others, the extent they experience fear depends on the situation. When a great deal of money is on the line, and they have just experienced a string of losers, they are likely to experience fear. If on the other hand, they are risking a large amount ofcapital after a winning streak, they have little difficulty trading even a large stake. What can you do if you are a fearful trader? How can you manage fear? Sometimes it is difficult. If you are a seasoned trader, you have experienced losses and know that there are times when your fears are quite real. So fear may not always be irrational. It may be a true reflection of reality. But you still can take steps to control your fears.In his book, Trading to Win, Ari Kiev offers a quick and effective way of controlling fear: Acknowledge you are afraid and the feeling will pass through your consciousness and lose all power. Refusal to acknowledge fear allows the feeling to perpetuate, while admitting that you are afraid will allow the feeling to diminish. The first step in conquering fear is to merely admit that you are afraid. But not everyone can manage their fear so easily. Some people have a nervous personality.They are easily frightened and once they become afraid, they have difficulty calming down. For these individuals, their biological disposition gets in the way of staying calm. If you are prone to experience fear, it's vital that you acknowledge this tendency and work around it.How do you work around a tendency to experience fear? Some people may need professional help. They may need to work with a professional counselor to learn relaxation training, or how to use biofeedback methods to control their fear. An effective procedure psychologists have used to combat excessive fear is called"systematic desensitization" or "counter-conditioning." In essence, this procedure capitalizes on the fact that it is impossible to experience both the fear responseand the relaxation response simultaneously. By preventing the fear response from occurring by feeling relaxed, a previously fearful event will lose its potency and no longer elicit fear. You can try the following exercise to get an idea of how this process works. Pretend that you are putting on a risky trade. Since you are not risking any money, you will feel relatively little fear. But if you do feel fear, try to calm down and relax. Now, you can up the ante by executing a real trade. Put on a small trade with minimal risk. Again, try to relax and prevent the fear response from occurring. Ifyou become fearful, go back to imagining that you are trading until you can prevent the fear response from occurring by using a relaxation procedure. Gradually execute trades that require greater risk and work your way up until you can put on are latively risky trade without experiencing fear. The idea is to avoid doing too much, too quickly. Gradually increase risk and potential feelings of fear, and fully relax in between each step you take. Another effective way to control fear is to change your thinking. When we are intensely afraid, all we can think about is the worst-case scenario and how much pain we will experience: "I'm going to dig a financial hole so deep that it will take months to get out of it." One of the obvious ways to feel better is to think positively: "I may lose a little capital, but it won't be so bad." If you could just change your thinking, you would immediately feel a sense of relief. That said, ifyou lose too much, it's hard to fool yourself into thinking you can survive. For instance, if you tend to make only $20,000 on your trading account a year, and you lose $40,000 in a week, it will take you two years or longer to make up the loss. Thinking positively is not going to change that fact. It's also necessary to take obvious safeguards. An obviously effective way to manage fear is to trade small positions. The less money on the line, the less risk you are taking, and the less fear you are likely to experience. Similarly, managing risk can minimize theworst-case scenario, and allow you to trade more calmly. By using protective stops and by risking only a small percentage of capital on a single trade, for example,you will feel more at ease and can more easily manage fear. It's impossible to find stocks that are guaranteed to increase in price, so when wetrade, we always carry with us a feeling of uneasiness. It's hard not to be afraid at times, but we don't have to let fear overwhelm us. By taking precautions, we can feel a little safer, a little surer, and trade a little calmer. And, in the end, the fearless trader is the winning trader.