Markets can trend higher for a long time, but when they suddenly correct, our daytrader mindset can get inappropriately negative.
It’s not unusual for the Nasdaq to correct 5-6% in a couple of weeks, with strong downward momentum. Market leaders can be taken down double-digits from recent highs and psychologically, this will feel like double that figure.
Why? Because the human mind is programmed to pay extra attention to bad news.
Additionally, our reactions to market declines are proportional to our use of margin. Interestingly, futures traders are almost always margined to the hilt and many might not realize it.
A single S&P emini futures contract controls about $85,000 of index value, which means a leverage factor of roughly 16X. And leverage can cut both ways.
Complacency plus margin sets up the perfect circumstances for a surprise reversal and sell off. When markets move suddenly against us, we can easily lose perspective, but it can be worse than that.
A sudden loss, even on paper, can trigger a shock response in the nervous system similar to what happens when one is diagnosed with a fatal disease.
This can trigger a 5-step process that starts with Denial and then moves to Anger, Rationalization and Bargaining, Depression and finally Acceptance or Resignation.
Surviving as a trader means avoiding this type of unpleasant mental-emotional cascade.
When it comes to bad news, take your medicine as soon as possible.
Until next time,
Dr. Kenneth Reid holds a Ph.D. in Clinical Psychology. He is currently a trading coach and has published articles for Forbes, SmartMoney, and SFO Magazine. He has also appeared on CNBC and writes a column on The Trading Psychology for Trader Planet. Kenneth Specialized in trading stock and futures and is working on a futures trading book.