There are two emotions that tend to govern most of our financial decision-making: fear and greed.
The fear of losing money or the fear of missing out on potential opportunities to make it. And then the greed factor of wanting more money and greater returns on our money.
You see that everyday where something might be in a really, really strong uptrend and it might be looking like it's rolling over BUT you still see waves of buying interest coming into the stock. Even though you can tell that the overall trend is beginning to fail.
The uptrend is coming to an end thus it's purely people buying in towards the late stages of its rally based on greed and ignorance. They have seen people make so much money they finally get their act together and want to have a crack at it – only to be buying in right at the very top.
That's purely emotion that dragged them in there. If they took a step back and did some analysis on the overall trend and how it's performing and whether the momentum within the trend is increasing or reducing, they'd be far more objective and make better decisions.
Unfortunately, the human trait is to be emotional when making decisions.
The way to avoid this is to build a trading system or process. The consequence of having a trading system or process is that it enables you to have a very black and white, non-emotional approach to trading. With the trading plan I teach, we have a series of seven check boxes. The first three or four are absolutely non-negotiable. If there's no tick in those boxes, there's no trade. The latter three are a little more subjective.
By having a series of questions within your trading plan, you are looking at each individual component of the trade in an objective way. You arrive at either a yes or no answer. Once you have four, five, six or seven yes or no answers in place, you're then able to read that in a way that says yes, there is a trade here or no, there isn't.
We're talking about the trade set up, what your specific entry triggers may be to get into the trade, the points of confirmation that you are looking for.
When all those ducks line up then you've got a trade.
Whereas if you're thinking emotionally and a stock is really running hard – and you think you should get in now before it's too late – that's very much a random approach to the market. As a consequence, you're going to have much more random results in the overall performance of your portfolio.
It then almost depends on what sort of mood you get out of bed of in... whereas you should be working towards having consistent results day in and day out by having a mechanical, very robust approach to picking your stocks irrespective of your frame of mind.
The check box system works regardless of how you are feeling. It will force you to get the facts out on the table and study them as objectively as possible.
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