Trading Psychology By Ken Hodor 10/15/09

Overview Background on neurological trigger/response Identify the responding emotions involved How to successfully deal with these very strong emotions

Primative Emotions Fear and Greed come from most primitive part of the brain—amygdala 3-times stronger than logical mind

Nervous system responses to various triggers Touch something hot < .22 seconds Nerves close to spine pull you away It takes too long to get to the brain and respond Being attacked by a lion—fear < few seconds Amygdala responds saying run Amygdala also turns up heart rate and blood pressure Shuts down cerebrum—logic is out the window Financial attack->planning > days/weeks/months Logic function of brain the cerebrum—very slow! Only works if Amydala is not dealing with emotions

Fight someone 3-times stronger Use an equalizer…such as a weapon Sling-shot—David and Goliath Knife Sword…a bigger knife Gun Run him over with your car Walk/run away Amygdala Logical mind

Dealing with Trading Emotional Response Do not activate the trigger Complete confidence in strategy Any doubt triggers “fight or flight” emotional response Drugs Serotonin uptake inhibitors—you do not care Exercise—natural “drug” Generates serotonin minimizes emotional response

Measurements based on Market’s Emotional Response Fibonachii Retracements Measuring Individual waves Point A Demand Exhaustion Point B Renewed Demand Point C Exhaustion again Elliot Waves Multiple wave response Beginners enter here High Emotion I’ve got to get in! Experienced Traders enter here—No emotion If it goes against me…I am out.

Emotional Wave

14-Emotions Optimism – A positive outlook encourages us about the future, leading us to buy stocks. Excitement – Having seen some of our initial ideas work, we begin considering what our market success could allow us to accomplish. Thrill – At this point we investors cannot believe our success and begin to comment on how smart we are. Euphoria – This marks the point of maximum financial risk. Having seen every decision result in quick, easy profits, we begin to ignore risk and expect every trade to become profitable. Anxiety – For the first time the market moves against us. Having never stared at unrealized losses, we tell ourselves we are long-term investors and that all our ideas will eventually work. Denial – When markets have not rebounded, yet we do not know how to respond, we begin denying either that we made poor choices or that things will not improve shortly. Fear – The market realities become confusing. We believe the stocks we own will never move in our favor. Desperation – Not knowing how to act, we grasp at any idea that will allow us to get back to breakeven. Panic – Having exhausted all ideas, we are at a loss for what to do next. Capitulation – Deciding our portfolio will never increase again, we sell all our stocks to avoid any future losses. Despondency – After exiting the markets we do not want to buy stocks ever again. This often marks the moment of greatest financial opportunity. Depression – Not knowing how we could be so foolish, we are left trying to understand our actions. Hope – Eventually we return to the realization that markets move in cycles, and we begin looking for our next opportunity. Relief – Having bought a stock that turned profitable, we renew our faith that there is a future in investing. From: http://www.stocktradingtogo.com/2009/05/14/trading-psychology-stages-investor-emotions/

Fear and Greed

Additional consideration Emergencies that force emotional response Hit by a car Heart surgery emotionally drains both you and partner Divorce Children’s emergency How do you deal with trading in emergencies? Automation Other support people to help—non-emotional

Investools Expectations after classes

You do NOT feel these emotions. Paper Money Trading You do NOT feel these emotions. Because you can always get a “do over.”

Cannot Handle Fear Emotion

Emotional Journey Use each trade as an opportunity Use the wave to help identify your emotions Log what you are feeling in your journal. Forgive yourself and move on When logic returns Refine your strategy so it does not happen again. Ask yourself what should have been done?

Gambler or Bipolar Disorder Loves the emotional swings

Learn a Successful System

Build Confidence Focused equity and strategy Diversified equities and strategies Many equities, Strategies, Indicators Confidence Confidence

Doctors Dealing with Emotions Life and death situations Completely rely on plan There can be no emotion to cloud logic

Strategies Dealing with Emotion Start very small $ then grow larger building complete confidence—there can be no doubt Set it and forget it Brian Analyze the night before Put in trades Then go to work and don’t watch market Ken Program all possible outcomes in software Watch computer to make sure it is working

Professional Help “The Daily Trading Coach” book by Brett Steenbarger What type of trader are you? http://www.tharptradertest.com

Start Small Grow Large Start small $20 call Increase only when confidence in your strategy suppresses fear and greed. Suggest doubling investment size Modify strategy in writing/software

Compounding effect Gain 20% Initial capital $ 20.00 Day Week 1 Month $ 20.00 Day Week 1 Month 3 Months Days 1 5 20 60 Networth $ 24.00 $ 49.77 $ 766.75 $ 1,126,950

Ken’s Strategy Winners Stop Loss

Conclusion Deal with something 3-times stronger Use a bigger weapon Walk/run away Do not trade impulsively based on emotions of Fear and Greed. Do not focus on the money, instead focus on the strategy (your rules).