I have worked with thousands of traders and having watched our students trading in real-time in our Trading Simulator.
I’ve discovered the most common cause of failure revenge trading and poor risk management.
By understanding the intricacies of these struggles, new traders can learn how to overcome the most common hurdle.
If you’ve been trading long enough, you’ve likely had more than a few trades explode in your face in spectacular fashion. Maybe you noticed one of your favorite patterns, confirmed the trend, and jumped in at the perfect entry point – only to see the stock tank for no apparent reason.
No one expects to lose money when they make a trade, but some losers sting more than others, especially when you retrace your steps and see you did everything right.
When a trade goes south like this, it’s important to step back and take a deep breath.
Take a walk, get a coffee, curse your computer, but don’t jump right back into another trade.
‘Revenge trading’ happens when emotion takes the wheel and kicks logic into the backseat. Overtrading because you’re angry is a great way to start piling up losses.
Here’s how to recognize revenge trading and avoid it.
What is Revenge Trading?
Revenge trading is similar to a condition poker players find themselves in – commonly called being ‘on tilt’.
Here’s an example: a Texas Hold ‘Em player goes bust at the end of hand because the opponent drew the exact card they needed on The River (the fifth and final community card in a Texas Hold ‘Em hand).
There was only an 8% chance of losing the hand, but that 8% managed to come up this particular time. So what does the poker player do? A smart player will understand they got unlucky and move on to the next hand.
A player who’s ‘on tilt’ will throw their strategy out the window and immediately jump into the next hand trying to win their money back.
Revenge traders are traders who have gone ‘on tilt’.
Anger and emotion are running high and they often will double down on a bad trade, or immediately jump into a new trade trying to get back to even. Analysis and strategy are replaced by rage and the human urge to ‘do something’.
A revenge trader will double down, triple down, average down, and dig themselves deeper and deeper into a position.
The end result is that they either get lucky and the stock bounces up and they get out breakeven or for a small profit, or they are unlucky and they experience a massive loss.
Revenge trading can be triggered by experiencing an unexpected loss or going from big green on the day to big red and is always an emotional response.
Successful traders learn to separate emotions of fear and greed from their trading strategies.
Why Do We Revenge Trade?
So why do we partake in activities that are clearly harmful to our bottom line in retrospect?
Because we’re human!
We like to think we can perceive risk and reward with absolutely certainty at all times, but the human brain simply isn’t designed this way. Emotional responses to wins and losses are hardwired into our DNA.
And frankly, living in a cold, emotionless world isn’t something to strive for anyway. Imagine thinking your favorite NFL team had no chance to win a game just because they were a 7-point underdog.
Why even bother playing?
Losing feels worse than winning feels good.
That’s why we can forget about the hundreds of successful trades we’ve made and focus on the one big one that went wrong.
But don’t fret if your emotions get the best of you. Even someone as renowned for wisdom as Sir Issac Newton can fall victim to emotional responses. Newton is one of the most brilliant men to ever walk the Earth, but he still famously lost a fortune getting hooked into the South Sea Bubble in the 1700s.
The money quote from Newton: “I can calculate the motions of heavenly bodies, but not the madness of the people.”
Revenge trading is a natural response, so we need to train ourselves to avoid it. If Sir Issac Newton is susceptible to such impulses, then none of us are immune. So how do we beat back the urge to revenge trade?
By following a few simple rules listed below.
Poor Risk Management & Revenge Trading
Traders with poor risk management will take 10 trades, and may suffer from poor accuracy by being red on more than 1/2 of their trades. But what’s worse is that one or two of their losers will be huge.
When students start our Trading Courses we put them on a 3 month trading plan that beings with $50 of risk per trade. When a student in our class takes a $500 loss in the simulator, it means they had a blow up, taking a loss that is 10x greater than it should have been.
There are a few different scenarios that lead to these losses.
Tips for Avoiding Revenge Trading
Revenge trading can be a tough impulse to ignore. Here are a few tips to prevent compounding losses when trading gets emotional.
- Always Remember Your Roots
If you’re reading this, you likely have a strategy that’s much more diverse and diligent than throwing darts at stock symbols. You create trading plans, follow trends, look for patterns, and identify the best entry and exit points for each trade.
These skills were likely honed over a period of years, so don’t forget them just because you get angry. Refocus by reviewing your trading plans or rechecking the charts, anything but a revenge trade.
- Keep a Trading Log
If you want to be a successful trader, you need to be a bit of a reporter too. When executing a trade, always keep notes on the Where, the Why, and the How. Why did you make this particular trade? Where did the idea come from? How did you execute it?
When you review your log after a bad trade, you notice one of two things – either you made a mistake or you didn’t. If you made a mistake, you now know what to correct for next time.
If you didn’t, you can chalk it up to the market forcing some humility.
- Take a Break
Sometimes the best way to prevent revenge trading is to remove all temptation. Power down your computer, put your phone on airplane mode, and do something to clear your thoughts for an hour.
Whether it’s a walk, exercise, or treating yourself to a steak for lunch, get your eyes off the screens for a while. In my personal experience, a little sunlight provides tremendous perspective.
- Manage Risk
As momentum traders we are always looking for that stock that has the potential to move 50-100% or more.
Unfortunately new students often mismanage risk on these trades by taking too much size, or by chasing the momentum without understanding the proper stop.
The solution to this bad habit is to use smaller size on stocks trading in a large range and to always understand your max loss and stop loss price.
Trading is hard enough on its own.
You don’t need to further complicate things by getting aggressively competitive following a bad trade.
When your emotions are unchecked, your capital is at risk. Revenge trading can cause even the most meticulous trader to up their position size, stay too long in a fading stock, or use flimsy evidence to identify patterns or trends.
Trading requires a cold, calculating mentality, which is probably why the algorithms are so good at it. You don’t need to be a robot to trade successfully, but you do need the ability to recognize when your emotions rise and take steps to avoid revenge trading.
One of the best aspects of trading is that after a bad day, you get to sleep on it and try again in the morning. Don’t let your emotions put a dent in your capital.