If you are wondering how developing your emotional awareness when you aren’t trading can be important, consider the blackjack player who, in an effort to make back his losses, doubles down every time he loses a hand.

From an objective outsider’s perspective, it is clear that the gambler is playing with fire. His insistence on quickly making his money back is only exposing him to even larger losses, significantly increasing the probability that he will walk away from the table with nothing.

This same emotional reflex, driven by the desire to quickly exit traumatic emotional states, affects traders as well.

This should sound familiar to you if you have even a little experience trading – just think of the times you exited a trade at a loss and felt the impulsive need to immediately get back in the market again.

The feeling is even worse if you have been on a losing streak.

The feelings of failure and anger, probably mixed with a little sadness, form a combustible emotional cocktail that can drag you into a negative spiral of knee-jerk trading, which will only compound your losses.

Needless to say, this is a spiral that you will want to avoid falling into.

The best way to avoid it is to, again, have a predefined process in place. One that has specific criteria setting out conditions which must be met before entering a position.

If for whatever reason you don’t have such a process in place, then you must, at the very least, be aware that your emotions can and will affect your decision to re-enter the markets after taking a loss.

This awareness will allow you to take the time to reassess market conditions and logically think of what to do next, instead of knee-jerking back into the market trying to recoup your losses immediately.

However, even having a process in place does not preclude you from making trading decisions which are fueled by emotion.

While a process can, to some extent, mitigate the disposition effect and knee-jerk trading, it can’t shield you from impatience and the feeling that you must always be doing something.

This feeling, and the discomfort it brings, either out of FOMO or the uncertainty of waiting, is particularly acute when you have just exited a position at a loss and are waiting for the next trading opportunity to present itself.

While acting out of impatience and putting on a trade in the absence of an optimal setup may not lead to a loss, it will have a reduced probability of success.

Considering that we have precious little control over the outcomes of our trades to begin with, we must do everything we can prior to entering a position to ensure the highest probability of their success.

This means waiting for the right time to trade, and not succumbing to impatience.    

Ultimately, developing emotional self awareness only comes with experience, and experience in markets means losing money.

We all need to lose money in order to gain insight into ourselves, pinpoint areas in which we need to improve, and then not repeat the same mistakes in the future.

Think of the money lost in this endeavor as tuition, although paying this tuition does not come with a guarantee of future returns.

After all, most people don’t even make back the amount that they initially lose; they either give up and don’t participate in the markets again, or fail to learn their lessons and keep throwing money away in the markets.

The lack of consistency means that after a trade is complete (entered into and exited, regardless of profitability), the result cannot be evaluated in a way that provides insight into how to improve.

This is because there wasn’t an underlying process to the trades that were made, and as such, no areas of improvement which can be identified.

In other words, if we were to continue to allow our emotions to influence how we trade, we cannot improve as traders, and if we cannot improve as traders, we will end up being part of the 95% who lose money. 

All of which begs the question, how do we keep our emotions from influencing our decisions?

Firstly, it is important to understand that we are only human and our emotional responses are natural. This means that, for the sake of your own mental health, don’t try to avoid feeling the emotions or suppressing them in some way.

Doing so presupposes that we can be robots, which we obviously aren’t, and hence will not help us to achieve our objectives.

What you need to do is to become very aware of how you respond to different situations when trading.

How do you feel when a trade moves against you and causes you to lose money?

How do you feel when a trade is profitable?

Of course, everyone’s answers to these questions will differ slightly. But, in general, the response to losing money will be fear tinged with hope and anger.

The fear stems from the uncertainty that more money may be lost, the anger from the fact that circumstances did not work out in a way favorable to you; and hope from wishing that you can recoup the losses quickly – if only the market turns.

The danger here lies in allowing the loss to grow larger by not exiting the position because of this hope, potentially resulting in an ultimate loss of catastrophic proportions.

On the other hand, the response to making money will be fear mixed with greed.

Fear in this case arises from the reluctance to lose those gains, and greed from the desire to see those gains grow larger. In this case, should you give in to fear and exit the position, you are giving up potential gains (cutting winners too early).

Conversely, if you were to hold on for too long, the market might turn against you and leave you with less profits, or possibly even a loss.

As such, the objective is to not allow small losses to snowball into large ones, while keeping positions open in the market for as long as possible in order to make the most amount of money possible.

Since your emotions will change as your profits and losses fluctuate with the market, the only way to accomplish this is to have a predefined process. 

To be concluded…