“Most traders who fail have large egos and can’t admit that they are wrong.” – Brian Gelber
One of the biggest pitfalls that many traders fall into is letting their ego control their decision making process. This can happen very subtly without the trader even realizing that it’s happening. An inflated ego can cause a trader to hold a position too long, trade positions that are too large for their account, or forget that they are capable of losing.
The scariest thing about these ego traps is that no amount of experience will make you immune to them. Actually, in many cases, gaining experience is the root cause of the problem. After a few years of profitable trading, many investors begin to feel like they have “figured it out.” At that point, their confidence in their approach can become overconfidence as they set themselves up for failure.
Admit You Were Wrong
The easiest ego trap to fall into is refusing to admit that you are wrong about a position. No one is right about every market call. Many stock traders have made fortunes from strategies that are only right on 30% of their trades. There is no shame at all in taking a loss.
However, once a trader finds some success, he is often far more reluctant to accept the possibility that he might be incorrect about a position. As confidence develops, so does the desire to continually outperform your previous accomplishments. Many traders will find themselves holding on to losing positions because they refuse to admit that their initial analysis was wrong.
The key thing to remember here is not to confuse the outcome with the process. Just because a position is a loser does not mean that the process that supported that position was incorrect. If the market always behaved the way it was “supposed to,” then we would all be millionaires. Always remember that taking a loss does not mean that your judgement or evaluation were incorrect. It just means that the market didn’t behave the way you expected it to.
Trading Too Large
Another way that ego can creep into a trader’s decision making is through position sizing. Your strategy should have some method for determining the size of your trading positions. Trading a larger position because you have a strong feeling about a particular position is a sure way to crash and burn.
This happens to many traders who become overconfident after a string of successful trades. They figure they’ve been on a roll, so they keep doubling down and eventually get wiped out. It can also happen the opposite way to traders with losing steaks. After a bunch of losses, they start to feel as if they’re “due” for a win, so they bet the farm. Either way, this can end in disaster.
Not Respecting The Markets
Still another way that ego can manifest itself in your trading is through a lack of respect for the markets. This can most easily be found in strategies that take tremendous risks to achieve small profits. The common analogy used here is picking up nickels in front of a steamroller. It is critically important to always keep in mind the possibility that the market can completely wipe out your account.
While these ego issues can vary in severity, the one thing that they all have in common is that they are very hard to detect internally. You must be on constant guard against an inflated ego. If left unchecked, it could take down your entire account before you even realize what is happening.