Breaking the Emotional Cycle of Fear and Greed

I made a huge realization today regarding to the psychology of trading. The cycle of emotions resulting from fear and greed. I will be positive here and call it the cycle of being too cautious and then too careless. This cycle has happened to me at least 3 times now. The last time, on demoralization, I decided to be positive and face the failure and find the out exactly what I did wrong so I will do right in the future.

At first the trader (me) is afraid of losing, so he waits for best setups. They come along, but because of fear he doesn't take them. Or if he does, he closes out early due to fear. After this occurs a few times, he decides that he will absolutely take and hold the next great setup.

The next great setup comes, and he holds. It works out, and he makes a big win. He is now filled with the emotion of joy, and becomes greedy. The next trade comes, and he holds again, and it works. He now thinks he is infallible. And, becoming impatient, he no long just sticks to best setups. Or when best setups fails, he refuses to stop when a trade is invalidated, and keeps going at it stop after stop.

Soon all his winnings are wiped out, and he back to where he started. He is back to being fearful, or rather, overly cautious again. Which will make him skip the best setups out of fear. And the cycle starts over again.

Hopefully each time the cycle ends with his equity at break even, but often is the case that he is down. If the trader focuses on the negative emotions instead of the lesson to be learned, he will go through this cycle more than once until he learns what he must learn in order to succeed. This is not the time to be emotional, but to be positive and objective.

What is the lesson to learn from the failures? What state of mind was actually profitable? The answer is the state of mind when the trader was determined to take and hold the next best trade, but only the best trades. And should he be stopped out, he will wait for the next play and not recklessly re-enter. And that is the state of mind we need to be in at all times in order to break this cycle.

Interestingly, this cycle can sometimes coincide with the volatility of the market. Lets say the trader starts the cycle coming out of base of accumulation where volatility is high. Lots of good setups show up, and near the end of it he gets one or two. Then, as volatility decreases where two days of the week are inside days, the trader gets impatient and start taking non-optimal setups. One or two may work, fueling the err. But then a solid correction occurs and volatility picks up again. During this time, the trader loses all his winnings from non-optimal setups and re-entering after being stopped out. The timing of volatility could be reversed depending on the trader's setups.

So the takeaway here is:

1. Enter fearlessly on only the best setups, and hold to target.
2. If stopped out when taking the best setup, then it's okay. Now wait for the next setup at a new swing and possibly in a different direction. It's a numbers game, and this is expected.
3. Don't get fooled by low volatility into taking non-optimal setups. One or two may work, but in the long run, they have negative expectancy. Trade another instrument or just wait for volatility to pick up again.