Gordon Gekko aka Michael Douglas, in the 1987 movie, Wall Street, famously raved about it when he said - 'Greed, for the lack of a better word, is good." When it comes to the stock market, it is easy to become obsessed with making as much money as possible to 'get rich quick.' Almost always, it is this psychological trading perception of garnering a large amount of wealth within a short period of time- that attracts many to the stock market.
Yes, trading stocks can provide you with the opportunity to make quite a lot of money and possibly, even get rich. But there's a catch – there exists a fine line between trying to extract the best from what the stock market has to offer and becoming 'greedy.
This is a line that you must draw in permanent ink, particularly when trading.
Greed is one of the most common emotions in trading, so much so that some of the most experienced traders tend to have trouble mastering this emotion. And when traders fail to control their greed, the punishment can become rather agonizing.
The dotcom bubble of the 1990s is a perfect example of how greed affects sentiments in trading. During this time, any and every internet or start-up company that had a '.com' label attached to it was being heavily bought by traders. This resulted in extremely inflated stock prices.
As more and more traders began buying these tech stocks, the fine line-mentioned earlier- disappeared from traders' psychology, and pretty soon, they got greedy.
The stock markets ran into a buying frenzy, creating a 'tech bubble' which ultimately burst in 2000, causing stock prices to crash down and burning deep holes in the pockets of many traders and investors alike.
Whether you’re a new or an experienced trader, the ability to control greed and steer clear of the 'get-rich-quick' mentality is key to long term trading success.
In reality, however, most traders are often overwhelmed with their greed for more.
Trading Psychology – How Greed Affects Your Trading
The psychology of stock market trading is such that it rubs on the ego, and in your mind, you get carried away when you make a profitable trade. And when there's a loss, you simply refuse to accept it. Both, of course, are dangerous. Both stem from greed.
How does greed affect you?
Let's look at an example:
You decided that Stock X seems a good buy at $4.00, with a resistance level of $4.35 and expect the price to rise higher. You bought 1000 shares with a target price of $4.25.
The stock moves favorably and rewards you with a profit of $250 on your trade quickly.
Your confidence increases and you think the stock can inch up higher, up to $4.35 a share. The market sentiment once again is positive and Stock X moves up to $4.40 a share, making you another cool $150.
Mr. Ego pats your back and pushes you to make another trade – why, you've found a winner!
As you get more attached to Stock X moving up, breaking its resistance levels, your confidence increases and you think you can perhaps make more money if you buy another 1000 shares of Stock X to capture the breakout.
The market looks positive, and you buy 1000 more shares of Stock X at $4.40.
The above is an example of the thought process that happens to traders across the world.
The above example is a clear manifestation of your 'greed', making you potentially over-buy Stock X, without further consideration.
The key here is: "without further [or much] consideration"
When you allow yourself to get in a state of 'just buying', your better senses goes through the window and you can place yourself in a position to lose money.
Using the example above, let's say after gaining a few hundred on Stock X, you wake up the following morning and realize the stock has lost some ground.
You're now confronted with a situation of either taking the profits you have left or holding on for further gains-or to make up the gains you lost by not booking a profit earlier.
Most traders, operating strictly on the basis of 'greed', will now begin to hope that Stock X will bounce back. More than likely, they will continue to hold on.
Stock X continues to fall.
Greed continues to have a strong hold on you.
Mr. Ego tells you what you want to hear -this is a winning stock pick, and it will inch back up again.
Stock X falls further down.
At this stage, you realize you ultimately managed to lose more money than you would have, if you had just booked your profits the first time around.
The greed factor took a strong hold on you and eventually, won.
It is also common to observe traders over-leveraging themselves, increasing margin payouts in their trading account so that they can hold on to their position for longer. As mentioned earlier, the ego prevents us from accepting that the stock trade might have been the wrong one.
Instead, you would typically look for more information to reinforce your conviction that your trade is the right one- also known as confirmation bias.
In our example, if Stock X continued to fall below $3.95 a share, you may want to 'stay-put' and begin to look for reasons to justify your belief that it is a winning stock, and that the price will rise soon enough. It might have resulted in you buying more shares, doubling down on your bet in the hopes of recouping all your losses in one go. This would have led you to risk over-leveraging yourself, perhaps without noticing the broader market direction, to dangerous consequences.
It is, therefore, vital for you as a trader to manage this psychological impact of greed in trading and try to control this emotion.
It is a lot like ‘ an addiction’ -you can never get enough. Always wanting more.
Only those who master greed can come out a winner in the trading game.
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How Can You Control Greed in Trading?
Here are some of the practices that successful traders follow which you can also adapt to control greed when trading:
1) Have a trading plan or strategy – and stick to it
Successful traders carry out their trades according to a particular trading strategy.
Having defined entry and exit points in your trades will help you stay detached. You don't want your emotions controlling you when trading.
Even if the price of your stock pick is close to your entry point, you must wait for it to reach the precise level and only then buy the stock. When the stock price moves further up, you must hold on to your horses before exiting.
What this does is brings the mountain to Muhammed – you are no longer trying to chase the stock market. You know exactly at what price you will execute the trade, based on all of your extensive research and analysis, and you don't need to bother yourself with outside noise.
Your emotions are kept in check, thanks to your calm, rational mind-set and trading plan.
This is not to say you become like a robot. You must exercise prudent judgment and calm presence of mind when the broader market sentiments take a turn, for instance.
Having a proper trading strategy or a plan will cut out the emotional trading excesses and the harmful effects of greed, helping you carry out your trade successfully.
2) Know when to exit, especially in a loss
Just like you map your entry points in your stock trade, it is crucial to practice discipline and stick to your exit points. One of the biggest obstacles that greed can trigger is to remain hooked on to a profitable trade for just a little longer, hoping to cash in at the peak price point. As you begin to stick to your trading strategy, you must monitor your exit points and get out of a trade even if it means making a little less money.
What this does is re-inforce discipline in your trading practices, so you can make steady gains from multiple trades instead of swaying with your emotions.
Conversely, you must also keep strict stop-loss levels across your trades. This is a practice that no decent trader can let go of. Having stop-losses will prevent you from being overcome by the psychological greed when trading and potentially over-leveraging yourself in a losing trade. It will help you control your ego and accept the risk of losses before they become too dangerous for your trading account.
3) Be patient
This is a trait that cannot be emphasized enough. Successful traders can make money only by practicing patience and discipline.
As you develop a habit of following your set trading strategy, with its defined entry and exit prices, you need to have ample patience to allow the stock market to reward you for your efforts.
This comes with time and over a sustained period of trading.
What this does is protects you from over-trading: running multiple trades based on a pure whim or spur of the moment with no clear rationale in the hopes of making tiny but quick and more profits.
Imagine yourself in a casino, placing too many bets at the same time because of greed – does it reduce or increase your risk? Patience is a virtue that the stock market rewards every time.
You can focus on the process of trading and persist with your trading strategy without getting attached to every trade's outcome. Since you cannot control the outcome in the stock market, being patient, and sticking to what you know best becomes a good idea. It will help you get the best from the stock market, without crossing that fine line of negative emotions in trading.
4) Keep a trading journal
Swing traders, especially in the beginning of their trading journey, tend to maintain a trading journal – a record of the trades you made. You can note down your trading strategy before you start, the actual trades that you make and the reasons for making them, and the outcome of the trades. Feel free to add new ideas, your thoughts on the stock market movements, or even how you felt with a particular trade.
Maintaining a trading journal will help you track your stocks, discover patterns, and figure out what's working for you and what isn't. Many traders get caught up in losing trades without realizing they are making the same mistakes again and again. Having a written record of your trades will identify these problem areas, and you can then decide to remove such stocks from your trading strategy. Conversely, it will also help identify your winning strategies and stocks.
Journaling your trades on a regular basis will help improve your trading strategy itself – by knowing whether you had set the appropriate entry and exit points, or whether you were able to identify the right price triggers, or whether you executed the trades properly. You can monitor your progress and rework your trading strategy when needed.
What this also does is help you monitor your process of trading and cuts out the emotional element of trading, in this case, greed. In the long-term, your ability to successfully follow a good trading strategy, consistently, is what will determine your success.
Thus, understanding greed in trading psychology and overcoming this emotion in swing or day trading is a crucial step towards becoming a successful professional trader – it's not just about research and analysis. Stock market traders, apart from keeping themselves updated on fundamental and technical trading knowledge, also practice self-control and discipline to inculcate the right mind-set for achieving their goals. Remember, no one can accurately predict or control which way the markets will move, but you can control your greed in trading.
Gordon Gekko, too, realized that greed, after all, isn't all that good.
In the 2010 sequel to Wall Street, Gordon Gekko noted, "somebody reminded me the other night that I once said "greed is good. I swear I don't remember it but it sounds like something I would say in the eighties"
Nothing good ever comes from greed.
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