Have you ever been afraid to place the next trade after losing four trades in a row, despite seeing a fully formed trade setup or entered a trade without a stop loss or removed the stop loss you initially put because you are afraid you will be stopped out at a loss? This is pretty common among new traders, and it is simply a sign of fear. Our fears try to protect us from a seeming danger. But the truth is, we have to overcome fear in trading before we can make any headway in this business.
To overcome this fear, traders have to first acknowledge that it exists and look for ways to address them, but the problem is that the way trading is advertised, newbies often think that it is just about clicking the buy or sell button, and the profits keep rolling in. They come to the market with this mentality, but the reality quickly sets in, and they realize that trading is not as easy as they think. Then, fear takes over.
Fear is a common emotion in the financial market. In fact, fear and greed are the main sentiments that drive the markets. All traders and investors exhibit some levels of fear in the market. But the key to profitable trading is your ability to deal with these emotions and prevent them from affecting the way you implement your strategy, which is why we want to tackle fear in this post.
By the end of this piece, you will learn:
- What fear is
- The different types of fear that can affect a trader
- How to overcome fear in trading
What is fear?
Fear can be defined as a strong distressing emotion caused by the perception of an impending danger or pain —irrespective of whether the threat is real or imagined — which usually leads to anxiety and a loss of courage. It is probably the most powerful emotion experienced by traders, but most often than not, the source of fear in trading is imagined.
The emotion often arises from mental conditioning developed after experiencing adverse price movements in the past. Traders associate the pains experienced by adverse price movement in the past with the current price movement, thereby triggering a state of apprehension. It could be that the trader was always getting knocked out each time he places a trade or often watched the price reverse on a profitable position and erased his profits.
Whatever the case, these situations cause emotional turmoil which the trader can experience again the next time the price behaves in a way that has been associated with the previous events. The resulting apprehension can make the trader unable to place a trade or act in any other way that is against his desired goals in a bid to prevent himself from having that experience again.
But the problem is that in trying to prevent himself from re-experiencing the painful moment, the trader acts in a way that makes no trading sense, such as hesitating to enter a trade because of the fear of losing, jumping on a trade that has already progressed in order not to miss out, widening or removing stop loss to avoid taking a loss, or closing a trade early so as not to give back profits. All these poorly-thought-out actions will make it impossible for the trader to achieve success in trading, or he may even blow up his trading account in no time.
The truth is, you have to overcome fear in trading if you are to have a future in this business. Fortunately, you are not alone. Everyone is fighting the same emotions, but only those who are able to manage theirs well can taste success in the game. But why exactly does this emotion seem so difficult to control?
The legendary Mark Douglas, a renowned trading psychologist, wrote in his famous book, Trading in the Zone, that traders attach too much importance to the outcome of their trades because they do not realize that trading is a game of probability. As a result of this attachment to the outcome of an individual trade, traders tend to get overtaken with fear when they perceive that the outcome will not be in their favor.
Mark Douglas discussed four types of fear a trader can experience in trading, but we added another type. Read on to find out more.
Understanding the different types of fear in trading
You need to understand the various ways fear can manifest in trading so that you can know when you are experiencing it and how to tackle it. In the book, Trading in the Zone, Mark described four types of fear. We will discuss all the four here and also discuss a fifth type of fear that often affects novice traders.
The fear of losing
There are many ways this fear can manifest in your trading. It could be that you are afraid to place a new trade when you see your trade setup. This can happen if you have just lost your many consecutive trades, and you are afraid that the next trade would result in a loss as well. So, you become hesitant to pull the trigger even though the setup meets all your entry criteria.
Another way you can manifest this fear is if you don’t cut your losses because you are afraid of accepting losses. In this case, you either widen your stop loss or take it out when the price is threatening to hit it. It could also be that you pretend to trade with a mental stop loss, but when the price reaches the level where you should close the trade, you find it difficult to close the trade. Worse still, you may even start averaging down by adding more trades any time you think that the price is about to turn to your direction. See the charts below.
One of the main reasons for acting this way is trading with an amount you cannot afford to lose or when you are under pressure to make money.
Your fear of loss may even extend to being afraid of losing the profits on a trade, which can make you to close the trade earlier than planned. In other words, you reject the prospects of making more money because you are afraid of losing the profits you’ve made. This suggests that the fear of loss is actually stronger than greed.
The fear of being wrong
This fear can also manifest in many ways, but most commonly, it manifests as being afraid to place a trade. However, the reason here is different. The primary cause of this fear is that you don’t trust your analysis of the market, so you are afraid that you might be wrong. It could be that you don’t have a reliable trading strategy for the market you are trading, or you don’t have what it takes to implement your strategy, or you have not tested your strategy to be sure that it can make money in the market.
What normally happens here is that you are stuck in your analysis. You keep analyzing the market, bringing so many variables and indicators but still can’t come to a conclusion. This is what they call analysis paralysis. It cripples your ability to take decisive action in the market.
Another reason for this fear is that you are a perfectionist and think that you can get a strategy that can tell you, for sure, what is going to happen next in the market. That is to say that you have not yet understood that trading is a game of probabilities where some of your calls may be correct and others may be incorrect, and that there is no way of knowing which ones would be correct or not.
With your perfectionist attitude, you believe you can get a perfect strategy that can give you correct calls all the time. So, you keep searching for that the Holy Grail — you make use of more and more indicators and patterns, thinking that more data would solve the problem. At the end of the day, you end up confused.
The fear of missing out
You manifest this fear if you jump on a trade midway after you have missed to enter at the right point because you don’t want to lose that opportunity to make money. There can be many reasons for missing to enter at the right time. It could be that you’re initially doubting the setup but got convinced after the price has moved in the anticipated direction, and you don’t want to be left out.
It could also be that you weren’t aware of the setup or were distracted when it was forming. But on noticing the setup when the price has moved, you’re determined to be on board the trade, despite the fact that it has moved from the ideal entry point. In a way, this fear can be seen as greed because it shows an irresistible desire to make money at every opportunity, even when the conditions are not right.
What normally happens in this situation is that you get to place your stop loss order in the wrong place or risk more pips to put it at the right level. Moreover, the profit potential is already diminished, resulting in a poor reward/risk ratio. Most times, the trade ends up a loser, but even if you get to make the small profit from the trader, you will be reinforcing a bad trading habit, which can hurt you sooner or later.
The fear of letting a profit turn into a loss
Here’s how it normally happens: You did your analysis well and spotted the right trade entry level, stop loss level, and profit target. Then, you entered a trade, and the price moved nicely towards your profit target. But before the price could reach your profit target to get you out, it reversed, erased all the profit, and eventually knocked you out at your stop loss with a loss. It is possible that this may happen on more than one occasion.
With this unpleasant experience, you become afraid of losing your profits whenever you are in a profitable trade. You start taking your profits earlier than you should. But the problem that comes with this is that your stop loss size remains the same, while you take small profits in each win. When a bad trade finally comes, you will lose more than all the small profits you’ve been taking from your winning trades.
The fear of the unknown
This kind of fear is unique to newbies who just started trading the market without knowing their left from their right. They were probably deceived by flashy broker’s adverts into thinking that forex trading is easy — just to click the buy or sell button, and the profits start rolling. So, they open a trading account and start trading without knowing jack about trading or bothering to learn first.
This type of traders open trades randomly without a trading strategy and don’t know where to put a stop loss or a profit target. When the trade is moving against them and the red pips keep increasing, they become confused as to what their next line of action should be — do they close the trade or wait for the price to turn around?
If they close the trade, they have lost their money, and the price may still reverse and move in their direction. On the other hand, if they don’t close the trade, their account can blow, and they lose all their money. So, they stay there watching the market, frozen in fear of the unknown and hope for the best.
What you can do to overcome fear in trading
Now that you know what fear is and the different ways it can manifest in trading, let’s take a look at how you can manage each of those fears when you are in the market.
How to overcome the fear of losing
To overcome this fear, you need to understand that losing is a necessary part of the game. Every winning trader wins some and loses some, so losing is part of winning. You have to learn how to accept losses and not let them interfere with the way you execute your edge in the market. The thing is, if you don’t learn how to accept losses as part of the game, you will never be consistently profitable as a trader.
Having said that, you need to find out why you are afraid of losing. Is it that you’re afraid you don’t yet have adequate knowledge to be trading with real money, or you don’t trust your strategy? It could also be that you’re trading larger position size than you should, thereby risking more money than you are comfortable with. Another issue may be that you haven’t realized that trading is a game of probability where there must always be some wins and losses, and what matters is having more wins than losses.
In fact, with a good reward/risk ratio, you don’t even need to have more wins to make money, and here’s how: If you win $2 in every win and lose $1 in every loss, a strategy with 40% win rate will make you $2 in a sample of 10 trades. So, losing is a part of the game, and you have to accept that. These are some tips that can make it easier for you to accept losses:
- Have a stable source of income so that you won’t be under pressure to make money from every trade
- Trade with an amount you can afford to lose
- Do not risk more than 1% of your account balance in each trade
How to overcome the fear of being wrong
You should realize that you don’t have to know, with certainty, what will happen next in the market before you can make money, so throw away that perfectionist mentality that leads you to analysis paralysis or pushes you to keep searching for a trading Holy Grail that you will never find. Trading is a statistical game; some of your analysis will be correct, while some will be wrong. Accept that and move on.
If you don’t know whether your strategy can make money, trade it on a demo account first and analyze the result to be sure it has a positive expectancy. This way, you know, for sure, that you have an edge in the market so that when you play enough hands, you expect your edge to manifest with either more wins or more money in each win than each loss. Hence, you are making money overall, irrespective of whether you are wrong more times than you are right.
To further make it easy to accept the uncertainty in each trade, trade with a small amount you can afford to lose so that when you are wrong, as you will definitely be on many occasions, you won’t be losing too much money to the market. To put it simply, with a better reward/risk ratio, you don’t have to be right more times to make money.
How to overcome the fear of missing out
Well, you will definitely miss some trades that meet your entry criteria whether you like it or not, so you have to accept that. It could be from distractions or momentary self-doubts. What matters is that you are disciplined enough to let such trades go. The market will always be there for you, and more trading opportunities will surely come.
However, if you are particular about reducing the number of trades you miss, you may make use of limit or stop orders if you are experienced enough to use them. A limit order can be used when you are anticipating a reversal at a strong support or resistance level, while a stop order may be used to enter a breakout trade. Please note that using these types of orders may be risky for your strategy, so make sure you are experienced enough before trying out these advanced strategies.
Whatever happens, don’t chase a trade that has moved because it will mess up your stop loss strategy. If you happen to miss a trade for any reason, let it go and wait for another setup.
How to overcome the fear of letting a profit turn into a loss
This is a valid concern, but the way you approach it — closing your trades too early out of fear — is wrong. The best way to manage this fear is to have a trade management plan before you enter a trade and make sure that you strictly follow the plan. Your plan should specify whether you want to manage the trade passively or actively.
In passive trade management, also known as ‘set and forget’, you set your stop loss and profit target once you enter a trade and walk away. It is either the price hits your profit target, making the trade a winner, or it hits your stop loss, making the trade a loser. Whatever the outcome is, you accept it wholeheartedly knowing that you are following your plan.
For active trade management, you will not only set your stop loss and profit target but also specify when you move your stop loss to breakeven and how you will trail your profit — moving average, ATR value, preceding swings, specific number of pips, or percentage of pips. Your trailing stop can be manual or automated. If you want, you can leave your trade open-ended by not putting a profit target and just trail your profit using your preferred method. Whichever way, when you are using an active management plan, don’t ever allow a trade that has made a reasonable profit to end in a loss.
By following a clearly defined plan created before you enter the market, your actions will be more objective rather than based on your dominating emotion. So, have a plan and stick to it.
How to overcome the fear of the unknown
The cause of this fear is a lack of trading education, so the only way to overcome it is to make sure you get adequate training before you start trading on a real account. Pro Trading School is a good place to start.
But learning from experts is not enough. You have to practice on your own using a demo account and do your own research to find out what works for you as a person. People have different personalities and follow different trading styles — day trading, swing trading, and position trading. Find out the style of trading that suits your personality and focus your effort on learning that style.
Furthermore, have a trading plan and make sure you use a stop loss whenever you place a trade. It limits your risk. Again, only trade with an amount you can afford to lose.
Final words
There are many types of fear you can manifest when trading — fear of the unknown, fear of missing out, fear of loss, fear of being wrong, and fear of letting your profit turn to a loss. What you do to overcome fear in trading depends on the type of fear you’re manifesting.