Trading Psyche: Fear and Courage

A couple of days ago I said I would start a series of posts on honing our psychological edge as traders. I suggested that psychology plays such an important role that it can easily overwhelm (positively or negatively) our trading system or strategy.
To a great degree, managing our own psyche means managing the many emotions that come up throughout our trading days, and careers. I'll address the many facets of trading psychology through the lens of those emotions - the first one being Courage.
Courage is one of the first emotions that traders hear about, but it’s generally mentioned by addressing it’s antithesis - Fear.  It doesn't take long before you hear some talking head mention fear and greed in the markets. Fear is a real emotion however, and manifests itself in many ways. So, here are a few things that might be signs of fear (lack of courage) influencing our trading:

• Not taking trades. I've said it to myself many times: "I just took a trade like that and lost... should I do it again?" Even if I know I have a time-tested set of trading rules I might start to question the rules. Systems that are proven (at least in the past) often rely on taking all the trades. What to do: If you find yourself not wanting to take trades that are based on your own reliable criteria, try this... Stop trading and take a step back. Review your trading plan. When you are comfortable and confident that it works, make a commitment to trade it precisely according to the rules for a period of time. That might be a week, a month, three months... it depends on if you are a day trader, swing trader, etc. Then at the end of that time (and write it on your calendar) make an appointment with yourself to evaluate the results. Did the approach work? Do you need to reevaluate your strategy? The point is, don't make the decision to skip trades in the heat of battle. Plan the trades, and then trade the plan.
• Trading with scared money. Worrying about losing money you need to put food on the table is one of the quickest ways to sabotage your trading. It causes you to not be able to stomach the losers that will come. What to do: If you find yourself losing your appetite after a loss, reduce your position size. There are many people who will give a formula for maximum risk, like 2% per trade, but I think this is a personal thing. For me, it varies depending on which system I’m trading. Therefore, I set my position size accordingly.  If you have a solid plan that wins over the long haul, a tolerable loss can be taken in stride, especially when they happen infrequently.
• Changing the rules. This is very similar to the first item above. It's very easy to have your trading plan start to experience "strategy creep". In other words, the trader says,"That loss I just took could have been avoided if I had just made this tweak." Then one tweak leads to another, and so on, until the strategy is different and completely untested. We do this because fear has crept in. We are afraid to lose and continually try to solve the problem. What to do: The solution for this, in my view, is the same as above. Step back, reevaluate your strategy, make a commitment to trade exactly according to the plan, and then evaluate. Analyze, Plan, Execute. It's very possible that the plan isn't good, in which case you need to reevaluate and alter it; but NOT in the heat of battle.

By the way, fear is not a useless emotion. It tells us something. Is it telling you that you can't afford to lose that money? Reduce size. Is it telling you your system doesn't work? Evaluate. But it can also trigger a survival instinct that might be the worst thing for our trading success. People who are afraid tend to search for less painful solutions. Losing is painful and triggers fear. But losing is also a part of trading. Therein lies the conundrum. That's why I believe I need to take a proactive approach to manage my fear responses and develop the courage to follow my proven plan.
Good Trading...