With emotional involvement, everything depends on HOPE
Jessy Livermore advised his readers in “How to trade in Stocks”:
“Wishful thinking must be banished!”
You will read something similar to this in many publications about trading and risk-management. Market direction in your favor as wishful thinking or hope that markets will turn in your favor might leave you with serious problems in the near future.
When you enter an investment and only hope, that your predictions will be fulfilled, you enter the first step of a dangerous psychological trap. Even if your investment shows gains, you won’t be “cool” enough to handle this. You won’t be able to cope with upside volatility, because you fear losing your gains, and therefore you’ll take your money out of the trade too early.
On the other hand it is even worse if your investment turns into the red.
Let’s have an example:
You want to buy 100 Apple shares at 100.00$ but not because Apple seems to be in an upward trend or the market is in a bullish mood. No, you do it because you think Apple is a good buy. You’ve calculated quarter-numbers, highs and lows of the stock and some other indicators you believe in and in the end you’re convinced, that this stock will go up.
So, you buy these 100 shares, even though the market didn’t confirm your judgement!
Apple has lost for days but you believe, that the market’s turn in the other direction is imminent. Apple falls –and alongside does your account. You didn’t spend any time thinking about how to handle losses before you started investing, so now you just accept the loss hoping that your stock will soon turn green. It doesn’t.
After a few days of losses you begin to fear that your judgement could have been wrong. But you don’t take any action. After all - you have calculated the turn, didn’t you? Thus, it must happen soon, you think. It doesn’t.
If the downward trend doesn’t stop and you realize how much money you are losing, you begin to panic. But you still don’t sell, because it would be too hard to take that loss now. You are still hoping too early buying was the mistake.
From this point on you are paralysed and don’t know what to do anymore. There is no risk-management, -rule, or -system, that could have told you to sell the stock and take that loss.
As the stock continues falling, you fall into desperation trying to escape from this by not watching your account for days. At the end you resign and try to ignore the feeling of being wrong.
This scene could also have displayed an investor who owned stocks of the so called “new market” in germany when it crashed at the end of the 1990s. Those investors never sold their stocks or did it when it was way too late and burned most of their invested money because they had seen these stocks rise for years and couldn’t believe the winning streak could ever find an end.
But beware!
Investing emotionally like this can also be successful. So it actually is possible to win without doing anything “right” or having a risk-management. But an investment like this is no strategic one and you are quite unsafe.
If you gain by using hope, you are pretty much endangered to get too euphoric and take more and more risk in your account. It can lead you to overestimate your capabilities and create a false feeling of control.
If a trader acquires such behaviour for a longer term, it can backfire on him drastically. Because sooner or later he will have a negative investment, yet no clue how to handle it.
