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Do you recall my example on Trader A and Trader B in my article last week? Apart from bringing home the point of trade discipline, I would also like to use the same example to talk about emotion as part of your trading psychology.

Some aspiring traders told me that they found trading an exciting business because it is fun, especially when their trades became a home run. Recently, I was in a local workshop as a coach. During the session on value investing, the participants were required to play a stock simulation game. Basically, the participants have to make certain investment decisions on a stock, which would be traded for approximately ten minutes. They were allowed to buy and sell the stock, and even short-sell the stock if they wish.

I have played this game before as a participant. I can tell you that when I played this game in the past, I was very emotional. I pretended to be calm and applied my technical analysis including support and resistance, and candlestick patterns. So what? In the end, I only broke even. When I was a coach, I helped out in this game as a market maker. When I saw the participants approach me to “buy … buy … buy and sell … sell … sell,” I realized the importance of staying away from emotion when we are trading or investing. Other coaches were asked to create noises and some were acting as analysts. So, with the noise around us, our emotion will drive us crazy.

You may ask what exactly I refer to when it comes to emotion. Well, two words can sum it up very well. One starts with Alpha “F” and another starts with Alpha “G." The answer can be found at the end of this article.

When your mind is boggled with emotion, chances are you will make a lot of irrational decisions. When you are supposed to buy low and sell high, you may end up buying high and selling low. This is precisely what emotion can do on your trade. So, you may then ask how to overcome the emotion. The answer lies with the need of having a trading plan.

An ideal trading plan should consist of the following elements:

1. Entry Rationale
2. Entry Price
3. Stop Loss(es)
4. Profit Target
5. End Result
6. Self-assessment
7. Evaluation / Post Mortem Analysis/ What lessons did you learn from the trade?

Very often you will hear people saying that forex trading is risky. Why? It is because the word “margin” in forex trading is different from the same word in options trading. One can lose the whole farm in forex trading due to the misunderstanding of the word ‘margin.’ No doubt this statement is true. However, you should not be scared by the margin issue in forex trading because you may never have the nerve to try forex. One important lesson I learnt in forex is that in every trade, we must establish three points before placing the trade, which in turn helps us to determine the risk involved in that trade. They are:

• EP (Entry Point)
• SL  (Stop Loss)
• PT (Profit Target)

Once we establish the difference between EP and SL, we will be in the position to decide how many lots we can trade as part of the proper money management. With this number, we can also establish the risk/reward ratio and assess whether it suits our trading personality.

In my view, putting an SL in forex trading is a must, because without an SL, one can really lose the whole farm in forex trading. Many losers in forex trading properly may not know the importance of the SL, and that is why they tell the others that forex trading is risky.  

Answer to the Quiz – F(ear) and G(reed)

To access previous articles written by Jack Wong, please click here.

Jack Wong 
Staff Writer and Instructor
Optionetics.com ~ Your Options Education Site

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Recent Articles by Jack Wong, Optionetics.com

• November 17, 2008
  Lessons from My Grandmother, Part III: Taking Charge of Your Life
• November 10, 2008
  Lessons from My Grandmother, Part II: Dealing With Loss
• November 5, 2008
  Lessons from My Grandmother, Part I: Never Give Up
• October 27, 2008
  Essential Elements in Trading Psychology, Part V
• October 20, 2008
  Essential Elements in Trading Psychology, Part IV