We’ve all been there!
You look at a chart, suddenly see the price move around in one direction or the other, or the graphs might form a short-term pattern, and we jump in before considering risk/return, other open positions, or most of the other key factors we need to think about before entering a trade.
Other times, it can feel like we place the trade on automatic preliminary. You might even find yourself observing a freshly opened position thinking “Did I recently place that? inch
All of these terms can be summed up in one form — the impulse trade.
Impulse trades are bad because they are executed without proper analysis or method. trading floor Successful investors have a particular trading method or style which serves them well, and the impulse trade is the one which is done outside of this usual method. It is a bad trading decision that causes a bad trade.
But why would a investor suddenly and automatically break their tried-and-true trading formula with an impulse trade? Surely this doesn’t happen many times? Well, unfortunately this occurs all the time — even though these transactions fly facing reason and learned trading behaviours.
Even the most experienced traders have succumbed to the impulse trade, so if you’ve done it yourself don’t feel too bad!
How it Happens
If it makes no sense, why do traders succumb to the impulse trade? As is usual with most bad investing decisions, there’s quite a bit of complex mindsets behind it.
In a nutshell, traders often succumb to the impulse trade when they have been keeping bad trades for too long, hoping against all reason that things will ‘come good’. The situation is made worse when a investor knowingly — indeed, willingly — places an impulse trade, and then has to deal with additional luggage when it incurs a loss.
One of the first psychological factors at play in the impulse trade is, unsurprisingly, risk.
Contrary to everyday opinion, risk is not necessarily a bad thing. Risk is simply an inevitable part of playing the markets: there is always risk involved in trades — even the best structured transactions. However, in smart trading, a structure is in place prior to a transaction to accommodate risk. That is, risk is factored into the setup so the risk of loss is accepted as a percentage of expected outcomes. When a loss occurs in these situations, it is not as a result of bad/impulse trade, nor a trading mindsets problem — but simply the result of adverse market conditions for the trading system.
Impulse trades, on the other hand, occur when risk isn’t factored into the decision.
Risk and Fear
The mindsets behind taking an impulse trade is straightforward: the investor has a risk because they are driven by fear. There is always anxiety about losing money when one plays the market. The difference between a good and a bad investor is that the former is able to manage their fears and reduce their risk.
An impulse trade occurs when the investor abandons risk because they’re afraid of missing out on what looks like an especially ‘winning’ trade. This impulse feeling often causes the investor to break with their usual formula and throw their money into the market in the hope of ‘not missing out on a potential win’. However, the impulse trade is never a good one — it’s a bad one.
If the investor identifies a potential opportunity and automatically decides the doctor has to have the trade — and then calms down and uses good strategy to implement the transaction — then this is no longer an impulse trade. However, it the investor disregards a set-up trigger or any form of method in making the trade, they’ve thrown caution to the wind and have implemented a bad trade.
Consequence of the Impulse Trade
Impulse trades typically end in one of three ways:
The ill-conceived impulse trade results in a loss (odds-on outcome! )
The impulse trade results in a loss, but subsequently becomes the trigger of a valid setup. The investor ignores the setup for the health of their previous loss and misses on the next win.
The impulse trade that basically wins. Occasionally an impulse trade will work out in the trader’s give preference to. This is sheer luck!
From another viewpoint, however, an absolute impulse trade is bad luck because it reinforces the taking of a bad trade simply due to a good outcome.
One winning impulse trade will spur on more and under the right market conditions some of these may also have good outcomes. It’s a natural tendency for traders to pay attention to winning outcomes — regardless of the quality of the decisions which caused them.
This is a particularly dangerous situation for traders as their negative trading characteristics (which would usually cause losses in normal market conditions) are increasingly being reinforced.
As you would expect however, more often than not, bad trades made from bad trading decisions will result in losses. When the market eventually ‘rights itself’ and the aberration which allowed some bad trades to have good outcomes is gone, the investor is left confused about what constitutes a successful approach, and is undoubtedly nursing big losses.
The investor has failed to pay attention to the standard of the trading decision, but rather than the quality of the outcome. In this way the impulse trade is bit more than playing, because playing is based on pure chance whereas good trading is based on calculations and reason. There is risk inherent in both trading and playing, but in the former, risk is accommodated and is simply an expected outcome in an overall proven winning strategy.
One must remember at all times that trading mindsets is an incredibly important part of setting up an absolute trading career.
If one doesn’t remain calm, a few winning impulse trades are going to be outweighed by the eventual losing impulse trades, and create a whole bundle of trading mindsets issues down the track.
Curing the Impulse Trade Urge
So, how does one know that they’re susceptible to an impulse trade, i. e. how does one stop the problem before it develops?
If you’re feeling panicky about your collection or a potential trade, that is the first sign. Stress will push you into the region of ‘unreason’, and you’ll are more susceptible to making a bad, impulse decision.
If you think you might be susceptible to making an impulse trade, ask yourself these questions:
Do you feel that you are flowing to get into a trade in case you ‘miss’ it?
Are you basing whether to take this trade or not on a earlier trade, either missing that trade or it being a loss?
Do you feel sick or nervous just before, or just get ess entered a trade?
Have you focused on making a good trading decision, that is, are you following your trading technique?
If the answer is ‘yes’ to the first three questions, and ‘no’ to the last question, then you are very likely making an impulse trade.
As with all trading mindsets problems, there is one solution — don’t panic. Of course, quelling panic isn’t easy. Remember that panic comes when a fixation causes an issue to look direr than it actually is.
The best way to avoid panic and indecision is to always trade based on a successful trading plan which clearly becomes the conditions by which you enter and exit the market, along with perhaps more importantly, how much of your capital you are going to risk on each trade.
Any sense of disappointment which includes a losing trade is therefore the result of adverse conditions in the market for the traders trading system — not the investor. When this is the case, you should not ascribe self-blame and create a massive trading mindsets complex.
You have to remember that not all trades will win and that when you lose cash using a proven system, you shouldn’t panic. When you’ve lost money on an unstructured, impulse trade however, it is time to start looking at your trading mindsets mindset.
In both cases stay away from panic or it will control your next move.
Trading Mindsets is a key part of out Workshops. We’ll educate you on the common pitfalls which catch out novice traders and give you the mindset to take your trading to another location level.
Carl has delivered presentations on trading and investing to over 20, 000 people throughout Australia and New Zealand and has helped countless clients to improve their trading outcomes. He also writes the long running and popular ‘Terms of Trade’ column in the finance section of Melbourne’s Sunday Herald Sun newspaper.
Carl is currently the pinnacle of Education at Foreign Stock Report. Carl and his team teach technical analysis, money management, and trading mindsets to intimate classes in a live trading environment. These workshops make use of strategies designed to take advantage of trading opportunities on all asset classes including equities, FOREX, items and indices.