When the trader loses money on a trade, his/her natural tendency is to try to recover it. Sometimes the desire becomes so strong that trader act irrationally. The Trader takes multiple positions and total loss amount can be more than original loss amount because of irrational behavior of the trader.
Revenge trading is one of the most common mistakes in trading as it is an emotional reaction when the trader suffers a significant loss. Revenge trading is not limited to new traders. Every trader does it but some does it frequently.
Reason Behind Revenge Trading?
- Greed: Greed is very dominant emotion after a big loss, a trader may enter a fresh trade to recover old loss.
- Fear: Fear of realizing and accepting a loss is so real that they would rather put on a revenge trade right away.
- Early exit from previous trade
Example of Revenge trading:
- Let’s assume a trader is holding a long position in the XYZ stock at 100 points. The price is falling, and their floating trading losses are increasing. Trader’s stop-loss order is placed at 98, and the price keeps falling, leaving the trader with a loss of 2 points. At this point, the trader could decide to accept their loss and exit the position or patiently wait for signs that things will turn around. But they are so consumed with anger at the market that they don’t even take the time to analyze it before placing another trade. Their trading strategy goes out the window, and the only thing they want is to recover the loss. So the trader opens another long position with the same stock and in the same direction on the hope that the downturn will reverse since the prevailing belief is that what comes down must eventually go back up. But then the stock drops down another points, and the trader is now left with a total loss of 4 points. Now they think perhaps it’s time to call it a day, so they exit the position. A few moments later, the price recovers and glides past the 100 points.
- The above scenario is a perfect example of how not to trade.
How to fight with Revenge trading?
- Stop Trading Temporarily: It is difficult to keep an objective view and to control your emotions after a loss, the best course of action is to stop trading even for a short period of time. Take a day or two off from trading, stop trading or if you really must, place a small trade if you feel you need to be in the markets. You could also consider revising your trading plan. Instead of making trades adjust how you are going to trade moving forward after your small break.
- Assess your trading strategy: It is also important to assess your own trading strategy to see if it is appropriate for the current market conditions. This will give you the opportunity to make adjustments to the way you trade.
- Assess market conditions: Sometimes market can be too volatile for your trading strategy. Sometimes major “corporate action” boost volatility. In that case it is possible that your strategy can perform very poorly. Don’t overtrade if market condition is not in your favor or your trading strategy.