A Rational Strategy To Reduce Emotion In Trading

Equity trading strategies are as easy to find as advice on romance. Unlike romance advice, trading strategies can be measured and assessed. Everyone from novices to seasoned technical traders can find a trading strategy that will produce results.

Almost all trading strategies are based on trading stocks on large exchanges. Every trader knows the first, most fundamental rule of stock trading. Buy low – sell high. That should be easy enough.

Until you discover there’s an Achilles Heel in stock trading that throws everything into turmoil and interferes with success. It’s the “human” factor and if it weren’t for this simple yet powerful complication, all traders would be successful beyond their wildest dreams.

Humans often seem compelled to join in on buying a rising asset, even when we know it’s priced too high. Our humanness also creates a strong compulsion to hold onto assets, even in the face of obvious loss.

The result of these two human behaviors is often buying high and selling low, the exact opposite of the most fundamental rule of stock trading. Humans are emotional creatures. Emotion is the enemy of successful asset trading.

Don’t give up just yet. There is hope because humans are also rational creatures. You can radically increase investment performance by allowing your rational side to devise a strategy – a trading plan that eliminates emotion. Once you have a plan, you need to stick to it.

So where do crypto-currencies and token assets fit into the world of trading strategies? CryptoStops provides risk management tools that help traders plan when to sell an asset. Traders use this proven technique to remove emotion from the trading equation. CryptoStops ensures declining asset prices won’t lead to a catastrophic event.

The CryptoStops risk management tools use selected price level stops just like many equity trading strategies. One of these tools is the trailing stop. A trailing stop is a price set at a defined threshold below the current price of the asset. The trailing stop price rises when the market price of the asset rises. If the market price falls, the trailing stop price does not go down along with it.

A trailing stop prevents an asset from being sold too early. If the price falls, the selling price is predetermined. The asset cannot be held too long. Research shows that traders who use trailing stops in a disciplined way average higher returns than those who don’t.


Trailing Stop Example – 25% Decrease

Time Point 1: Asset purchase price = $10. Trailing Stop percentage = 25%, therefore = $7.50

Time Point 2: Asset price decreases from $10 to $8. Trailing Stop not met, therefore notification = No

Time Point 3: Asset price increases to $20. Trailing Stop price now $15 (still 25%). Notification = No

Time Point 4: Asset price decreases to $16. Trailing Stop still = $15 (as price decreases Trailing Stop price remains constant as measured against the highest price attained). Notification = No

Time Point 5: Asset price increases back up to $20. Trailing Stop price still = $15. Notification = No

Time Point 6: Asset price decreases to $14.90.  This is less than $15 and greater than 25% decrease from highest price attained. Notification = Yes

Time Point 7: Asset price continues to decrease, but was sold at 14.90.

Human beings are neither completely emotional nor completely rational. The conflict between emotion and rational-thinking doesn’t always play out in a predictable way.

Daniel Kahneman and Amos Tversky theorized that traders are risk-seeking when it comes to losses, but are risk-averse when it comes to gains (Prospect Theory: An Analysis of Decision under Risk, 1979).

According to Kahneman and Tversky, when traders have losses they are willing to take bigger risks to try to avoid further losses. They feel like they need to recover, to get back to a break-even point. When traders have sizable gains they tend to want to sell to “lock-in” those gains.

Kahneman and Tversky, March 1979, Blackwell Publishing Ltd. Permission courtesy of John Wiley & Sons, Inc.

Kahneman and Tversky, March 1979, Blackwell Publishing Ltd. Permission courtesy of John Wiley & Sons, Inc.

The figure shown represents risk tolerance relative to losses and gains. The left side of the figure shows losses and the right side shows gains. As losses increase, (shown by the line moving from left to right), the emotional effect of those losses increases. However, as gains increase, the positive emotional effect levels off.

According to the graph, losses have more emotional impact than gains. This emotional reaction is what causes us to sell assets that show positive gains and hold onto assets that show loses.

In summary, CryptoStops risk management tools are part of your trading plan. The major result is removing emotion from your trading decisions. Two things will begin to happen more often than not: 1) Accepting small losses rather than suffering big losses, 2) Letting your winning assets run as opposed to selling them too early.