Introduction
One of the surest ways to lose money in the markets is to indulge in impulse trading. Impulse trading is when the traders takes trading decisions on impulse or gut without proper research or trading plan. This is the hallmark of inexperienced traders who lack an understanding of the markets. Though impulsive trading is associated with novices, there are also many traders who have spent a considerable time in the market, but because of their nature or their inability to learn, still indulge in impulsive trading.
Professional traders on the other hand, base their trading on research and understanding of the markets. Most, though not necessarily all, of their trading decisions are based on a trading plan. It is often said in professional circles that you should plan a trade and trade a plan. Impulsive trading is one of the most corrosive habits to inculcate in your trading and it sure can cause a significant dent to your trading capital.
Why do some people indulge is impulsive trading?
There are various reasons why people indulge in impulsive trading. Most of them are related to nature of the person and their emotional profile. Those who are unable to check strong emotions such as greed and fear often fall victim to this form of trading.
Recognising the emotional triggers that lead to impulsive behaviour is key to controlling it. Detachment is one of the most important tools that can be useful in the journey to becoming a successful trader.
The question then arises as to why people indulge in impulsive trading. There are quite a few such reasons, why people indulge in impulsive trading, some of which are as follows:
- Emotional cues: Those who suffer from strong emotional cues and in particular those of greed and fear and those who are given to much emotional excitement and fear of missing out often indulge in impulsive trading.
- Cognitive biases: Very often cognitive biases influence decision making. Some are very given to using short cuts or heuristics to make trading decisions. Moreover there are a slew of cognitive biases like confirmation bias, overconfidence and anchoring that can lead people to make irrational decisions and miss critical and relevant information.
- Lack of emotional intelligence: Many traders lack the emotional intelligence to be self aware of their decisions and are therefore unable to self regulate. They are caught up in the flow of things and indulge in herding.
- Influence of market volatility: During periods of heightened market volatility, traders can feel compelled to respond quickly to market movements. This is again because of lack of self awareness and a heightened sense of basic emotions such as greed and fear.
What are the different forms of impulse trading
By definition, impulsive trading can be of many different kinds, which would be too many to enumerate. But the two main categories into which they would fall are as follows:
- FOMO driven: This is a phenomenon witnessed particularly during market rallies, and in particular nearer to the market tops. People see or hear about money being made by their neighbours and acquaintances and get seduced by rosy forecasts of future prospect. Usually FOMO driven trades invariably get the people into the stocks at the wrong time.
- Emotional panic sale: Financial markets are rivetted by events and volatility. In order to navigate through the turbulence, traders need to have good nerves and calmness. But such traits are rare and for the most part traders are driven by market volatility to sell the shares they own indiscriminately irrespective of their quality. This can result in losses as the selling will invariably happen at the worst time.
Risks associated with impulsive trading
Impulsive trading is very risky and can involve significant challenges to a traders performance in the financial markets. Because decisions are driven by emotions rather than rational analysis, it can result in unpredictable outcomes and involve heavy losses.
Risky impulsive trading that results in substantial losses can result in lowering of economic standing. It can also have psychological impact leading to depression, loss of confidence and a sense of inadequacy.
Conclusion
Not indulging in impulsive trading is a crucial aspect of becoming a successful trader. Impulsive trading poses significant risks to a trader’s performance and profitability. By understanding the emotional triggers and cognitive biases that fuel impulsive behaviour, traders can develop greater self-awareness and emotional intelligence. With mindfulness and discipline, traders can overcome impulsive tendencies and make more rational and informed trading decisions.
Developing a solid trading plan, setting clear stop-loss and take-profit levels, and utilising technical analysis provide a structured framework for trading that reduces the influence of emotions. By embracing patience and avoiding impulsive actions driven by the fear of missing out, traders can wait for favourable market conditions that align with their strategies.
Successful trading is a journey, not an endpoint. With perseverance and a commitment to mastering impulsive trading, long-term trading success is achievable.
Mr. Soumitra Sengupta