Traders are the best salespeople in the world. Although used car salesmen are saddled with reputations as being pushy and dishonest, they don’t hold a candle when compared to the average trader. Why is this? A trader, once in a position, can deceive himself or herself into believing half-truths faster than a house cat pouncing on a freshly escaped hamster.

The problem is simple. Many traders feel they can rely on their judgment while in a trade. On paper, this makes a lot of sense. After all, before a trade is placed, a trader is at his most objective. However, once the trade is on, the degree of objectivity diminishes immediately and in direct proportion to the number of shares or contracts being traded relative to the account size. Think of it this way: If one trader is long 10 Emini S&Ps in a $10,000 account, and another trader is long 1 Emini S&P in the same sized account, who is going to be sweating bullets over each tick? A trader relying on their judgment while their brain churns with extreme trading emotions is like trying to row a boat upstream with a piece of Swiss cheese—it simply does not work. 

This perpetuates a vicious cycle, with the end result being a trader who, like a bad used car salesman, is consistently selling himself a faulty collection of beliefs that sets himself up for slaughter. Instead of following a game plan with which to exit a position, the trader in this situation will close a position for one of two reasons.  First, the pain of holding becomes so great he cannot “take it” any longer. Once he reaches this “uncle” point, he starts frantically banging his keyboard to sell (or cover) “at the market” in order to relieve the pain. Second, a broker exits the position for the trader.  Not because he is a nice guy, but because the account has run out of margin. This trade is also placed “at the market.” In these situations, there is no plan, no thought, and no objectivity. Just a batch of forced sell orders, or, in the case of someone who is short, a batch of forced covering. This act of capitulation, traders exiting a position because they have to, not because they want to, is emotions-based trading at its finest.  Whether it is a sustained multi-month move to the downside due to continuous capitulation selling, or a quick 10 minute rally due to shorts being forced to cover, these acts are responsible for the major moves in all markets, on all time frames,. In the end, markets don’t move because they want to. They move because they have to. 

This imbalance of market orders causes rip-like movements that result in even worse fills. Disgusted with themselves and red in the face, the victims of these trades stalk off to contemplate the insanity of the universe. Meanwhile, another group of traders took the opposite side of this “capitulation trade” and made great profits. How does a trader get on the winning side of these trades?  The key is for the trader to use his or her own emotions as triggers to that take advantage of these “get me the hell out of this position” panic runs.  To fully understand how to do this, we must first step back and understand why traders continually and instinctively sabotage themselves in the first place.

The problem is that the tactics an individual uses to achieve his or her goals in everyday life do not work in trading, and in fact are one of the main reasons for failure. While “good judgment” is critical to an individual who wants to climb the corporate ladder or start a business, we have already seen why it doesn’t work in the middle of a trade. In addition, stubbornness and determination are prerequisites for success in many aspects of life, yet in trading these qualities will get you killed. To say that the trader who is unaware of this phenomenon is set up for failure is like saying that Donald Trump “dabbles in Real Estate.”   

In addition, traders who “play the markets” with a mental framework oriented towards how external society rewards and punishes “good” and “bad” behavior are set up to lose from day one.  For example, “cutting losses short” is difficult when there is the possibility of the market coming back to the breakeven point.  At breakeven, the trader is not a “loser.”  Thus, according to the benchmarks of society, if the trader can exit a position with a gain, they are “successful.” This leads to the removal of stops “once in a while” in the hopes of getting out at breakeven . . . in order to be a winner in the eyes of society (sigh).  This can work ten times in a row, but it is the one time it doesn’t work that knocks a trader flat on his back.  On this particular day, this trader will be one of many who cause a “rip like movement” in the markets.  This habit of removing stops, even if it is only once in a while, is reinforced by the societal belief of what defines a winner versus a loser.  This is a habit that will destroy an account faster than The Donald can mutter the words, “You’re fired.” 

These “societal beliefs” imbed into the trader’s brain the following account killers:

1. Fear of Missing a Move: The trader sits and sits, amazed that the market continues to run away without him. Finally, he can’t take it any longer. He doesn’t want to miss any more of the move. He jumps in and buys, or in the case of a market that is in a free fall, shorts. These buys and sells are easy to see on a chart, as they often represent the high or low print of the day.

2. $250 Isn’t Enough: Let’s say a trader has a $10,000 account, and is cranking out $250 a day with a steady system for taking trades and managing positions.  One day he wakes up and thinks, “$250 isn’t enough.  I want $500.”  When greed kicks in, this automatically starts a process in the brain that causes all of the classic trading mistakes: overtrading, not sticking to parameters, rampant emotions, yelling at screen.  The “Home Run” mentality is the downfall of all losing traders.  This is where a trader refuses to take a $300 profit because he “wants a bigger trade” in order to make that new, greedier, $500 goal. This is how winning trades turn into losing trades, and how a $100,000 account turns into a $5,000 account.

3. I’ve Got that Loving Feeling: This happens when a trader has a great trading day, and the position they have is moving their way nicely and is causing minimal stress in the form of deep retracements.  In this situation, the trader feels great.  It’s a joyous, overwhelming feeling of warmth that a trader rarely feels when trading the markets. So what does the trader do?  In order to experience even more joy and warmth, they start adding to their position, doubling and even tripling up.  Smart? To put this action in perspective, this is like a trader being in a fantastic relationship with his wife. He has nice warm and joyous feelings about his wife.  He loves her dearly. One day he decides he should expand these great feelings of warmth even further. To do this, the trader goes out and starts dating another woman. Like pyramiding a position, this will only end in one way, and in one way only: Very, very badly.   

Okay, so now we have a basic understanding of why and how traders get themselves into trouble. Let’s shift our focus and see how to take advantage of these unfortunate souls.  (It sounds cruel when stated that way, but it’s the truth. Any money that a trader loses is sitting comfortably ensconced in the account of a better trader). 

1. Four Seasons: When I am in a trade that is going my way, and I start to feel overly excited and feel the urge to add to my position, I instead use this as my trigger to set up a “double stop order.” As an example, let’s say I’m long 10 Emini S&P contracts. The market is screaming higher. I find myself thinking of how many nights I could live at the Four Seasons on Maui with the day’s profits. I take the “Four Seasons Trigger” and place a trailing 2 point stop for 20 contracts; double the size of my current position. What happens is that I will stay in the trade as long as it is moving higher, but once the market turns, not only am I out of my position for a nice profit, I also simultaneous get short 10 contracts. This process takes advantage of the market dynamics of human emotion in a very clean fashion. The sell off that occurs will be from other traders who succumbed to their emotions to buy at the top, due to fear of missing a move or the euphoria of having a current winning position. Once the market does reverse, it will be these traders that provide the fuel for the move down, as they start dumping their positions once they can’t take the pain of losing any longer. 

2. Thank You Sir May I Have Another: When in a trade, I visualize what a newer trader would be doing – or what I would have been doing years ago. “If I entered here, where would be my pain point?” I’ve found on the S&Ps a move of 6 points without any meaningful retracements is the maximum “uncle point” for most traders. When I see this, I picture myself with a newbie entry, and try to imagine the pain they are feeling. After about 6 points, I know they won’t be able to take the pain any longer, and I step in and take the opposite side of this move. 

3. When I Tick You Tick We Tick: A more technical way to measure emotion is to watch the ticks. Whenever I see readings of over +1000 or -1000 Ticks, I start fading the move. If we get a +1000 tick reading and I am already long, I start exiting the move and initiating a short position.  The reverse is also true.  In these instances I am using a 4 ½ point stop and a 3 point target on the Emini S&Ps.  If neither my stop or target is not hit after 25 minutes, I exit the trade at the current price.  

4. Dive, Captain, Dive: My trading partners and I run a trading room, and one of the things we all like to do is watch how the newer traders react to the market action. There are “noises” that the people in the room can use.  One of the classics is when the market is falling, and one of the newer traders initiates the “submarine dive, dive, dive” noise. Immediately upon hearing this, I know it is time to cover my shorts and go long. The experienced traders in the room also know this, and of course we then share this information with the newbie trader. Once he catches on, we just have to wait for the next free trial to show up.

5. High Five, Baby: Whenever traders I work with, or myself for that matter, start slapping each other on the back as the result of a trade, I immediately close out my position. This is the result of extreme emotion, and extreme emotion is not sustainable. I call this the “high five sell signal.”

The financial markets naturally take advantage of and prey upon human nature, especially when it comes to greed, hope and fear.  The key to remember is that the biggest movements in the markets occur not when traders in general “feel like buying.” They occur because groups of traders are all getting skewered all at the same time, and are forced out of a position. In reality, traders are not trading stocks, futures or options. They are trading other traders.  The profitable trader learns to be aware of the psychology and emotions behind the person who is taking the opposite side of their trade.  In addition, they go a step further and learn to recognize their own feelings and emotions, letting them run amok, generating buy and sell signals worth their weight in gold.