4 Causes of Anxiety in Trading and How to Eliminate Them

Some tried and true ways to keep from getting overwhelmed.

Anxiety and trading go hand in hand.

Today's guest author is Adrian Reid, private trader and founder of Trading System Life. You can also follow him on Twitter @TradingSysLife

Once upon a time I experienced anxiety and stress every time I took a trade. I had trouble sleeping and I found myself regularly checking my positions and second guessing myself constantly.

But that was a long time ago now. In this article, I want to share that trading should not bring anxiety or stress into your life.

So how did I eliminate anxiety from my trading? I implemented 4 simple changes which anyone can adopt:

  1. Position Size: must be small enough to allow you to sleep well
  2. Worst Case Drawdown: must be within your tolerance
  3. Timeframe & Market Selection: should fit your lifestyle so it is easy and natural
  4. Trading System Confidence: back tested and fully understood

Let's look at each in turn.

Position Size

It is so tempting to think that we have to be aggressive to make the big profits. After all, when we take a small position we can only make a small profit right?

Unfortunately, this thinking is backwards. Profitable trading is about preserving capital first and foremost. You should always ensure you don’t lose big when you are wrong on a trade. Here is the reason:

DrawdownReturn Required to Recover

1%

1%
5%5%
10%11% - Lose 10% & you need to gain 11% to get it back
20%25%
30%43%
40%67%
50%100% - Lose 50% & you need to gain 100% to get it back
60%150%
70%233%

 

As the graphic shows, once you have a big drawdown it is very hard to recover.

When you think about profit first, your impulse is to size your positions larger because you WANT profit. But as soon as your position moves against you this quickly turns to fear and anxiety.

Instead, think about potential losses and risks first, then you will naturally size your positions smaller because you DON'T WANT losses.

Each trade should be sized from a mindset of caution rather than aggression. Your anxiety will fall because your losing trades are not big enough to hurt you.

Worst Case Drawdown

A second major cause of anxiety in trading is the knowledge (or fear) that your worst case drawdown could be far bigger than you are willing to tolerate. I have found this can be a constant cause of low-level anxiety which rapidly escalates when the market moves against you.

Setting your worst case drawdown is critical because your worst outcome can be VERY BAD if you are not careful. If you use high levels of leverage, multiple correlated positions and aggressive position sizing, your worst case drawdown could to wipe out your entire account (or worse!).

I eliminated this source of anxiety by deciding how much of my account I was really willing to lose in the worst case scenario. I then reduced my leverage and total risk limits to achieve this goal. My anxiety dropped immediately on completing this change and yours will too.

Timeframe and Market Selection

A third major  cause of anxiety can be a mismatch between your personal situation and your timeframe / market choice. I have two personal examples of this:

The first was when I tried day trading early in my trading career when I still had a 'normal' job.

It might sound obvious, but to day trade you need to be focused on the markets throughout the day. If you are trying to do a job and day trade at the same time, something is going to suffer. In my case both my job and my trading suffered. DON’T DO IT.

The second personal example was when I tried to trade across too many time zones. I primarily trade stocks and I was looking for some diversification. I have developed a really great trend trading system which works on pretty much any stock market globally, so I had a lot of choices.

I was trading stocks on the Australian stock exchange, Hong Kong and the US markets. While each of these only took about 15 minutes of my time each day, my trading system required me to be at the computer at each market open - this meant late nights and early mornings.

What is the point of being free if you have to be at the computer late at night AND early in the morning? That is not freedom at all!

So I rationalised the markets I was trading into more convenient time zones - again my levels of anxiety and stress dropped immediately.

Trading System Confidence

The fourth area that I have found really drives anxiety is confidence in your trading system . I have tried many trading systems so I know first-hand how this affects me.

One of the mistakes I made early on was thinking that if a trading strategy was published in a book then it should be credible and actually work - WRONG!

Any time I tried a method without fully testing it myself I found my confidence faltered and anxiety set in. But if I had fully back tested the system and understood how and why it worked then my confidence holds up and anxiety remains low.

Fully back testing a trading system is beyond the scope of this article, but the important lesson is this: Regardless of who published the system, no matter how good their credentials, no matter how compelling the data, you MUST TEST IT FOR YOURSELF FIRST! If you don’t then you will suffer from anxiety because of the uncertainty you have. Plus you will probably make mistakes and lose money.

Conclusion

Anxiety and stress are a common part of many trader's lives, but they don't need to be. Addressing some common issues such as position size, worst case drawdown, timeframe / market selection and testing to get confidence in your trading system will go a long way towards eliminating these negative feelings. They certainly did for me!

Photo Credit:    Aleli Dezmen /Cultura/Getty Images