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How to Trade Stocks Without Foolish Emotional Influence

This article is based on my experience from over 45 years of perfecting my stock-trading strategies and risk-control skills.

Trading on emotion can be devastating!

Trading on emotion can be devastating!

What Happens When You Trade Stocks Emotionally?

Emotional stock trading causes you to sell when you see losses because you feel the pain. Conversely, it will cause you to buy when you see stocks rising because you feel the need to ride the trend.

However, both of these cases can become a losing experience because you could end up buying high and selling low.

This article describes how to keep your emotions in check to improve results by using a pre-defined plan for better profitability.

Why We Make Unwise Decisions With Emotional Thinking

When we trade on emotion, we tend to do the wrong thing for the wrong reason. For example:

  • We buy stock in hopes that it will go up. Then it goes down, and we hold on because it would hurt our ego if we had to admit we were wrong.
  • We tend to buy too high because we see a stock going up and want to get in on the action. But we end up buying at the highest price out of greed, and then the stock tumbles.
  • We don’t want to admit we are wrong, so we ride a bad trade down—making it even worse.
  • We do get out at some point but not when we should. Instead, we get out when we reach our pain threshold.

We tend to do the wrong thing with each of these examples, but we can improve the results with self-discipline using a specific procedure that's essential for successful trading. So let's review all that in detail.

How to Take Emotions Out of Trading

The only way to avoid emotions with stock trading is by having a rule of entering and exiting every trade with a specific pre-defined plan and sticking to it.

That is known as a mechanical trading strategy—making your actions follow a strict rule of implementation.

When you have a pre-defined plan and follow it instead of letting your emotions get in the way, you can increase your chances of buying low and selling high. Therefore actually making a profit from your trades.

A pre-defined plan means exercising a mechanical buy-and-sell protocol that does not involve ill-judged decision-making. That's how to avoid selling low out of panic or buying high out of greed.

Implementing a Pre-Defined Mechanical Trading Strategy

You can do this with any stock, but I'll use SPY in my examples, which is an ETF indexing the S&P 500 that you can buy and sell just like a stock.

First, choose an amount you want to invest on an ongoing basis based on your level of risk and the amount you have available for trading. For this example, let's say $200 per month.

Next, start your trading plan by buying $200 of SPY on the first trading day of the following month.

Then, on the first trading day of every month, do one of the following:

  1. Buy $200 worth of SPY if the SPY is lower than it was on the first trading day of the prior month.
  2. Sell $200 worth of SPY if the SPY is higher than it was on the first trading day of the previous month.

You might need to round that up or down since SPY does not trade in fractional amounts. You could use a different quantity for each trade and a period other than monthly. But whatever you do, keep it consistent—that's being mechanical.

Some brokers will let you specify the dollar limit, and they will adjust the shares accordingly, as shown in the example below:

Online order entry example. Dollar amount will be rounded up or down to full shares.

Online order entry example. Dollar amount will be rounded up or down to full shares.

Trade at a Specific Time of Day

Always make the trade at roughly the same time of the day. Otherwise, you’ll let emotions corrupt your plan, waiting an extra hour or two on a fast-moving day thinking you’ll get a better price.

That can work sometimes, but it can also go against you. So it's best to leave that out of the equation and just stick to a specific time of day.

Whenever you buy stocks, there is always a 50/50 chance of the price going in either direction—up or down. It never makes sense to wait for a better entry or exit point with the odds as even as that.

Don’t Overthink Anything

You already defined your strategy, so stick to it. It doesn't help to overthink it. Keep the amount of each trade the same. You can use any amount, but don’t increase it because you're becoming greedy, and don't lower it out of fear if the stock drops.

You'll remain consistent by removing your emotional behavior from the decision-making process.

I'll explain why these emotional responses work against you.

One month, SPY may be so far down that you want to double your next investment. But don’t do it. It may be lower the following month.

You already would be getting more shares because you're investing a fixed amount each time. Be happy with that. It's known as dollar-cost averaging.1

What if the stock goes higher?

  1. At first, you're upset that you didn't put more money into it.
  2. Then you want to add to the trade because you feel you want to catch up.

That's greed! And you need to get control over that. I use a trick to catch myself by asking, "Am I doing this out of greed?" That's often all that's necessary because we may only realize we are being greedy when we're confronted with that question.

When you find yourself overthinking a trade position, it often involves a greedy emotion. Otherwise, you'd be fine merely going with the planned strategy.

The beauty of mechanical trading is that you don’t need to think. You don’t need to follow trends. Just carry out your trades according to the plan—mechanically!

See better profits when you trade according to a specific plan.

See better profits when you trade according to a specific plan.

What Can Go Wrong?

Nothing is a sure thing. World events can negatively affect markets. If the stock or ETF keeps going lower and lower, you could invest $200 endlessly every month until you have no available funds remaining. And you may never have the opportunity to take money out at a profit.

Of course, the theory is that the stock market won’t go to zero. But to be honest, one never knows. You may need to change your plans if a crisis, such as war, develops. That's the only time you'd sway from using a mechanical technique.

Key Takeaway

You want to remove as much human emotional behavior as possible from the decision-making process.2

You'll see better results when you trade consistently according to a specific plan because you will be taking money off the table at a profit rather than holding too long until things turn against you.

You will also be dollar-cost averaging as you buy more shares at lower prices. That also creates a routine of recycling your funds, which could be an endless journey to wealth.

References

  1. Adam Hayes. (August 19, 2022). Dollar-Cost Averaging (DCA) Explained With Examples and Considerations.” Investopedia
  2. Oddmund Groette. (July 18, 2022). Mechanical Trading Strategies Vs. Discretionary Trading Strategies.” Quantified Strategies

This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

© 2014 Glenn Stok