Trading Psychology: The importance of reflecting on your mistakes.

We are aware of greed and fear when we talk about trading. Gordon Gecko said the famous movie quote line “greed is good” in Wall Street the movie. But what exactly greed and fear mean and how does it affect our trading psychology.

Well, this past week was a perfect example of these emotions playing out for me. Luckily, I was able to spot these emotions, correct them, and profit $1,600 from this initial mistake.

If you’re interested in the making money in the markets, you will know how important trading psychology is to your account. This past week was the perfect example of that.

This past week, the Fed Chair Janet Yellen opened her mouth on Tuesday. Now this is different from the typical Wednesday 2pm Fed announcement on interest rates policy — this was more just a speech she made on a Tuesday.

Still, it had drastic implications on the market.

But before we get to the Fed speech, let’s talk about trading psychology.

Trading Psychology: Greed and fear.

Greed for more money.

But fear of what?

Usually it’s fear of losing money. But in this past week, it was fear of missing out.

You see, every chartist and chart technician was calling for a massive crash this past week — and for good reason. The market had already rallied from 1800 all the way over 2000 and we got to 2047 — that’s almost 250 points of pretty much nonstop rallying. A lot of fund managers and technicians were calling for a top — shorting heavily.

And for a day and a half, things went their way. The market drifted lower and lower for a full day — and even overnight, it could not even get a slight bump on the upside. Everything was down.

Maybe all the bears were right this time. I haven’t seen such continued downside in a while. Maybe that WAS the top.

Everybody who was short the market — if they were right and we were going down big — then they would stand to make A TON of money.

Already, people were messaging me talking about how much money they made.

And I thought, I can’t miss out on this opportunity of a lifetime to short and make it a big–a big short.

So I went short — even though I could not clearly understand the structure of the wave pattern.

You see, I was going against my own rules of only trading if I clearly see a wave structure.

Instead, I was entering a trade because of my emotion – in this case fear of missing out.

Of course, when I entered this trade, I did not know this was a fear of missing out.

Oftentimes, when you’re into what you’re doing, you won’t see things from an outside perspective.

And this is where it helps to talk with someone else.

In my case, I had my daily walk with my fiancee around the lake – and we talked about the mistake I had made.

Why did I make this mistake?

After talking it through — she helped me spot my mistake. My mistake wasn’t necessarily that I went short — although that’s how the mistake manifested itself. The real mistake was that I fell into the trap of having a fear of missing out.

A fear of missing out on money that everybody else was about to make and that I wouldn’t make if I didn’t jump in.

But I’m a wave pattern trader — I only trade on recognizable wave patterns. Once I start trading based on fear of missing out — I’ll start to lose money in the long run — even if this one works out.

In this case, this short did not work out.

I was down 10 E-mini S&P points and decided to exit this trade.

I wrote extensively about this mistake on my blog – LifeStyleTrading101.com — and some readers even commended me for sticking out my neck and talking about it.

As you may know, a lot of people in this stock market industry are really shady. They will make money, but when they lose money, they won’t tell anyone. I try to be as transparent as I can with my mistake so we can all learn from it.

I looked really carefully at the wave structure of that pattern and potential support levels — and I concluded that this was NOT the beginning of a crash. Instead, it was what I call an extended 4th wave into support. And that we would be heading higher from here.

I immediately switched from short to long.

The pattern started to coil – and sure I did have to endure some temporary pain – I’m not going to say my timing was absolutely perfect to the second — it was off by a day or two.

But by Tuesday, the structure was starting to form to the bullish side. I didn’t even know Yellen was about to speak. The pattern was already in place and the market was slowly rising. Then Yellen spoke and it jumped the markets up.

I looked into the language that she provided — and it was dovish. So last December, the Fed began raising interest rates with intentions of raising a few more times in 2016.

What Yellen said was that they need to be more cautious about raising rates due to the nation’s economic health. Of course, this is not great for the economy – but any kind of hesitation on the Fed’s part means it reduces the likelihood that they will raise interest rates. Keep rates low is bullish for stocks.

So Yellen basically told everyone to jump into the market. And so we got what I expected — a 3rd wave up in the wave structure with support from the Fed.

From my entry at 2030.75, I exited at 2062.5 — more than 31 points — or $1,600 in profits –– which more than made up for my mistake last week.

Additionally, I also alerted a bullish put spread that expired today for max profit for another $400-$500 –so altogether — $2,000. Of course, my mistake last week cost about $500 — so net profit was closer to $1,500.

If you can spot your own mistakes and adapt as the market changes, you can turn losers into winners – that’s exactly what I did this past week.

You see, that’s what happens when I can identify mistakes that I make — quickly reverse directions and make money. Had I stayed short like almost every chartist, blogger, and fund manager I know — I would’ve been destroyed — and I would’ve been part of the short squeeze that has been happening since the Fed speech.

Instead, I was able to ride the wave on the right side of the wave. I was able to alert my subscribers to be on this right side of the trade and profit alongside with me.

Trading Psychology: Self-Reflection

This is why trading psychology – and understanding / identify greed and fear is important. Avoid these mistakes and I guarantee you’ll not only be able to rest better and sleep better at night, but you’ll also make more profitable trades.

Self-reflection is really important both when you lose and when you win. It’s like journaling — you get a better sense of who you are and what works for you by documenting your mistakes and your winners. You’ll learn from them over time and become a better trader.

Learn to avoid the fear of missing out. Learn to avoid the greed for more and more money. Learn to be consistent. Learn to enter only when you see recognizable wave pattern structures. These are key lessons to become a better trader.

For any of you traders out there, I encourage you to constantly reflect on your mistakes as I do. Think about what you did, what you could have done differently to avoid making the same mistake next time. By becoming more self-aware, you will make fewer mistakes and ultimately make more profitable trades.

Trading Psychology of 2016 S&P Market YTD

So that’s a bit of trading psychology that I went through this past week. Let’s talk about the psychology of the market.

We just finished Q1 of 2016 — and we were actually up for the quarter. Can you believe that? Year-to-date we are actually up on the S&P — even after all those nasty drops in the market in January.

Recall that the first week of January was the biggest stock market opening week drop of a New Year in history.

Yet, as we closed out Q1 of 2016, we were actually in positive territory.

We went as low as 1800 and now back up to where the drop began above 2050.

Based on sentiment, I do not believe we will revisit the 1800 lows anytime soon. Instead, I believe we will be heading to new highs in the months ahead — even with all these gurus calling for a crash.

I mean, starting off 2016 in my 2016 S&P Outlook , I was also calling for a potential crash as well. I predicted the drops in January and February — but once that rally continued basically from just before President’s Day 3 day weekend in through this recent Good Friday 3 – day weekend, this sustained rally is in support of a bullish 5th wave up — not a market crash — at least not yet.

So now that the correction that began last August 2015 and basically ended middle of February 2016 has finished — that’s about a 6 month correction, we are now beginning a 5th wave up. We are about a month and a half into this 5th wave up and should have at least a few months more to go.

There will be a lot more range-bound movement in the next few months especially after the non-stop straight up rally that we’ve had for the past month and a half.

All the people who were caught short before the recent Fed announcements will have covered and we will see a bit more consolidation before we reattempt new highs over 2100.

2100 has been a huge psychological resistance level all of last year 2015. I suspect, we may be able to break through to the upside in the coming months. Probably not on the first try, but after some coiling, I think we’ll be at new all-time highs.

And since the Russell lagged the Nasdaq and S&P during this correction, I think the Russell will lead the way to the upside. Already in the past week, we see the Russell – which is comprised of small cap stocks – lead the way.

It’s about Investor Sentiment, Not Logic

So many people ask me why are the markets going up? We have all these problems.

And I always say – don’t apply logic to the markets. The markets are psychology and sentiment driven, not logic-driven.

You can’t say our economy is doing good, therefore the market is up. The market is up due to sentiment. And part of that sentiment is due to the Fed ensuring all market participants that they will wave their magic wand over interest rates in such a way that supports a healthy stock market. That was clear in their last Fed announcement 2 weeks ago and was reinforced by their speech this past week.

So this is very much a Fed-induced rally. Don’t try to over-analyze economic data and justify reasons for shorting the market. The Fed trumps all of that stuff. Don’t fight it. Instead, go along with it. Surf the waves as they come. Never go against them, or you’ll drown.

If the Fed raises rates, it’ll cause a surge in the US dollar, which crushes corporate profits and oil prices. That’s basically what we saw with oil prices going below $30 in February. Of course with the Fed’s recent announcements, we are back up towards the $40 region. If Fed lowers rates back to 0, asset prices would explode higher and magnify the eventual mean reversion. So the Fed is stuck.

The Fed is actively trying to avoid a crash and trying to talk down the dollar, which will help boost corporate profits, exports, and commodity prices.

But regardless of what actually happens in the stock market in coming months – whether I’m right or wrong — make sure you put your trading psychology in check. Learn to identify when you’re being too greedy or when you’re acting out of fear.

If you have good trading rules, constantly evaluate yourself and see whether you are sticking to those rules. If you are making exceptions, make sure you understand the risks.

I know for me, my trading rule involves trading only recognizable patterns. That usually serves me well, but occasionally, I make mistakes. And when I do, I treat them seriously – I blog about them and I make sure the subscribers who follow me learn from these mistakes and most importantly, profit from them.

Even with this tiny $500, we’ve been making >$1,000 every week since this podcast started at the end of 2015 into the 2016 New Year. If you’d like to learn how we spot these wave patterns and profit from them week after week with weekly options, trading the SPY, check us out at LifeStyleTrading101.com – make sure you subscribe to our daily updates so you get an email alert for daily updates.

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