Today we’ll quickly have a look at some of the problems with revenge trading and reasons why it occurs.
Revenge trading occurs when we’ve made a lost that has changed our emotional state, making us trade without any disregard of anything in the hope of recovering back our losses.
When you trade based on emotions, it becomes more like gambling. A lot of the time you’ll start to overtrade, which usually more often than not increases the amount of losses that occur. And then this creates further revenge trade to try to recoup losses putting deep into the hole.
When you’re revenge trading you could start to overleverage positions. Trading with no risk management is a big trading NO NO and because you’re trading with such large volume, any movement in price can create big swings in your profit and losses, usually on the losing side because you’re probably trading against your trading plan. This can destroy months of hard work within a few short hours because it will take twice as long to recover when your account is 50% down.
The reason why revenge trading occurs is because of a psychological effect in human behaviour called loss aversion. This means that people will prefer to avoid losses compared to gains of the equivalent amount. And the reason for this is because if we lost the same amount, research has shown it has at least 2 to 3 times the negative psychological effect than if we were to win the same amount. For example, if you lost $1000 bucks, you would feel so much more pain than if you had won $1000. Because of the pain of losing and as being a human being, we have a natural tendency to want to win and unable to accept losses. Our trades are clouded by judgement and as our account starts to get in the red, we start to do things that are not part of the plan and usually when things that aren’t a part of the plan, they fail.
A few ways I combat this problem is by having a max loss amount per day that if it gets hit, I’ll stop trading for the day or at least a few hours to clear my head.
Another way is if I’m in a losing position and I’m about to add on more, I’ll ask myself first where my next stop loss target is and also if this is another possible entry point. If the answers are no or the stop target is far away I’ll hold off from adding altogether and wait until my next entry if I’m holding the trade still. If the price still continues to go against me, I’ll ask myself would I possibly have an entry in the opposite direction. And if the answer is yes I’ll exit all my trades.
Just make sure you traded correctly and that means following the plan. And if you loss, accept it, as trading is a game of probabilities. We can’t win every day and that’s alright. We’ll save our account and live to fight another day. Capital preservation is the key to lasting in the trading game. So next time when you start to feel emotional in trading, I suggest exit your trades altogether and walk away until you’ve cool down.