More money has been lost by trading with impulse than by any other means. If you’re going to ask a beginner trader about the reason he went long on a currency pair, you will typically hear them say that it’s because the pair has gone down enough – so it’s going to bounce back. You can perform a lengthy face-palm gesture on that. That’s because it’s nothing but phantasm.
Trading impulsively is Gambling
It can be a big rush when a trader is on a winning streak, but one single bad loss can make the same trader give all of the profits and trading capital back to the market. Just like many Vegas stories end in a heartbreak, so does many several tales of impulse trading.
In trading, logic triumphs and impulse cause tragedies. This is true not just because logical trading is always more precise than impulsive trading. As a matter of fact, the opposite of most often the case. Impulsive traders can go on stunningly accurate winning streak, while traders using logical setups can be mired in a string of losses.
Reason always trump impulse because logical focused traders will know how to pput limit to their losses. Meanwhile, impulsive traders are never more than one trade away from complete, disastrous bankruptcy.
The Impulsive Trader
Imagine one trader, trader 1, who is an impulsive trader. He feels price action and responds accordingly. Now imagine the prices in the euro-USD pair moves steeply higher. The impulsive traders “feels” that he has gone too far and decides to short the pair.
The pair rallies higher and the trader is more convinced now that the pair is already overbought and sells more EUR/USD, building onto the current short position. Prices finally stall, but they don’t actually retrace.
The impulsive trader, who is sure that they are very near the top, decides to triple up his position and watches in horror as the pair spikes higher, forcing a margin call on his account. A few hours later, the pair does top out and collapses, causing trader 1 to pound his fists in fury as he watches the pair sell off without him.
You can say that he was right about the direction after all, but picked a top with impulse instead of logic.
The Analyzer
On the other hand, trader 2 uses both technical and fundamental analysis to calibrate his risk and time his entries. He also thinks that the EUR/USD is overvalued, but instead of prematurely picking a turn at will, he waits patiently for clear technical signal – such as a red candle on an upper Bollinger Band or a move in the relative strength index below the 70 level – before he initiates the trade.
Further, trader 2 uses the swing high of the move as his logical stop to precisely quantify his risk. He is also smart enough to size his position so that he does not lose more than 2 percent of his account should the trade goes against him.
Even if he is wrong like trader 1, the logical Trader 2’s methodical approach preserves his capital, so that he may trade another day, while the imprudent, impulsive actions of trader 1 result to a margin call liquidation.
