[转贴] Exploiting Emotional Traders

farshine

Most of us realize that emotion has no place in trading or investing. An emotional trader is likely to act impulsively and make trading errors. Seasoned traders realize the error in this approach and understand that, in all time frames, there are points at which neophyte traders are clearly operating out of strong emotion, whether it be fear or greed.

To be successful, you must be able to make the psychological jump to see fear and greed for what they typically are -- opportunity. This is true whether you are a long-term trader or a day trader or something in between. The principle still applies, and you have to be prepared to act when strong emotion becomes apparent.

Consider an example. When the market is in an up trend, and you are a day trader, when does opportunity present itself? Very frequently, the answer is when the market is selling off and takes out the previous day's lows.

Traders who are holding long positions begin to wonder if the trend is over. The market shakes some of them out, and they sell. However, the vast majority of the time, the market quickly recovers, and new highs are, once again, made.

Most of these little sell-offs in an up trend are buying opportunities. They will frequently be short-lived and will look like impulse moves on a 5- or 15-minute chart. In terms of Elliott Wave theory, they are usually small wave C's.

Of course, sooner or later, all trends come to an end, and one of these little sell-offs will morph into something significant. So, the successful trader will always use stops to protect his or her trading capital because there are no guarantees in trading, and risk is something that must be controlled carefully.

Something similar happens when a market is trending up and makes new highs. Some traders who are long begin to wonder if the trend might be exhausted. They have made some money and do not want to give it back, so they take profits, and the market corrects back into the middle of the day's range or reverts to the mean.

In this case, you can find opportunity on both sides of the market -- long or short. If you are a bull, you can make money quite easily in this environment. If you are a bear, you can also make money in a bullish up trend by correctly playing on these cycles of human emotion. Of course, it's probably easier for most traders to do so with the trend, but it can be done either way if you know what you are doing.

These same principles apply to short-term, intermediate-term and long-term trading or investing. The difference is that you are looking at longer cycles, and more time and patience are required to let these cycles play themselves out. In all cases, you must be able to make proper use of leverage and manage risk because nothing works all of time.

Sometimes, a cycle or wave of fear or greed does not manifest itself in a typical fashion. We see similar variations in almost all complex systems.

For example, sit and watch the waves come ashore at a beach, and you see definite patterns in their size and duration. A pattern is present but also some chaos. If you sit there long enough or examine historical records of the waves, you will see some wide variation or even rogue waves.

This phenomenon does not prevent people from going to the ocean or even living near the shore. If they are careful, they find ways to deal with these aberrations that all but eliminate the danger for most of them -- they have a plan for dealing with them.

Of course, if a large meteor strikes the ocean and sends a 100-foot rogue wave onto shore, the plan is probably not going to save them. There are no guarantees in life or in trading. Terrible things can and do happen in trading and investing just as they do in life. But, for the most part, you can manage the risks carefully and avoid disaster.

There is great emotional freedom and peace of mind to be had in understanding these cycles of human emotion and knowing how to manage risk correctly and follow a well-thought-out trading plan. Ultimately, this is what separates those who are successful from those who lose control of their emotions and wipe out their trading accounts.