We’ve all heard it before: Some guy on Twitter bet the farm on a trade that he believed would solve all his money worries and bring him to an early retirement. Two weeks later, he’s disappeared completely from social media. He’s grown awfully quiet. No more bragging. No more pumping. It’s not a mystery what happened here.
Losing is a very, very painful business. It destroys more than your account – it destroys your ego, your future plans, and often your family. And just as demoralizing as this, such events make it seem that all retail trading is risky trading. It propagates the belief that you will never be smart enough, stable enough, or sophisticated enough to achieve your own financial independence through trading. As they’ve always said, “You can’t beat the market.”
But retail traders have never been the problem. The problem is the FOMO that retail traders (even pro traders) experience. So why does FOMO keep happening to us? I decided to dig a bit into the actual science behind FOMO. What is it exactly? And — like a surgeon — can we excise this tumor from our trading mindset?
FOMO is a response to threats with biological roots. It originates in the amygdala, a small but incredibly powerful part of our brains. So powerful, in fact, that “neurons there are involved with fear conditioning, a process by which we can learn to fear and avoid something,” says Regina Bailey, Biology Expert for ThoughtCo.
As FOMO intensifies, the amygdala also activates the pituitary gland to release cortisol. And according to Dr. Robert Stawski, Associate Professor at the College of Public Health and Human Services at Oregon State University, this cortisol can impact cognitive function by “interfering with neural transmission and subsequent behavioral performance.”
In summary, FOMO not only influences our short-term behavior, but solidifies the response by creating a long-term habit.
Applications to Trading Psychology
In trading, FOMO is more concerned with the threat of financial livelihood than actual survival. For most of us, money is in short supply or not enough. Therefore, any threat to losing it, or missing out on making more of it, kickstarts the whole FOMO-amygdala process.
For all traders, here are some of the most common FOMO-inducing scenarios:
- Information overload — You’re getting bombarded with “get-rich-quick” advertising, penny stock shams, or fear-based campaigning (e.g. buy gold coins now to protect yourself from economic meltdowns)
- Social media storms — Your friends, friends of friends, or complete strangers are making a fortune in a particular growth stock… and you’re not
- Poor risk management — You’re down a great deal of money on a losing position, so you take overly aggressive action to recoup your loss by “doubling down”, in the hope that it will bounce back
- Impatience — You just can’t wait for the setup to provide the proper buy-signals. You’re afraid it will run away on you. Perhaps, you even like the idea of being the first one in! Either way, you put more stock in fear than you do the actual stock.
- Expectations are too high — You’ve made it a goal to double your account over a certain timeframe, so in order to accomplish that, you bet bigger and risk more.
- No rules – Your only rule is “get involved” in trades, which means jumping in and out of trades with no system, banking entirely on a hope strategy without actual strategy.
In 2017, we had a number of stocks that created rampant FOMO, most directly through the form of social media. Some such stocks included DRYS, MNKD, and HMNY, just to name a few.
DRYS moved from $4 bucks to $100 in the span of 4 days. That’s a 2,400% return. On the fourth day of the move, the FOMO thought-process was basically this:
If it can go 2,400% percent, it can go at least another 100%. This is easy money. Don’t be stupid and miss it. People trade an entire lifetime to try and make 100%. Buy this now. You gotta buy this. Scared money don’t make money.
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Now, tell me honestly, does the initial move of this stock excite you? If so, you’ve got FOMO. You need to sit down. Take a breath. And consider buying a straitjacket to put yourself in.
Over the following 3 days, DRYS proceeded to give back all of its gains. I mean, ALL OF IT. People who bought at the top — or close to it — got crushed. And let me tell you something, the market is always fair. For every action, there is a reaction.
How Do We Stop FOMO
So, can we actually stop this FOMO? If it’s so engrained in our psyche, our human behavior, how can we ever get rid of it? On this question, I spoke with a few pro traders and got some good news and bad news about ridding ourselves of FOMO.
So bad news first, always. We won’t ever escape the THOUGHT of FOMO. FOMO strikes the very best and the very worst traders at usually the same time, in pretty much the same ways. The good news, however, is that you have a choice in how you react to it. Poor traders react to it, they simply have to! Pro traders just ignore it.
By simply NOT reacting to your FOMO-crazed thoughts, you can make a fortune.
Here are their personal strategies they shared with me:
- Plan the trade ahead of time — Trades take time to set up. The good trades take multiple days — often the very best can take weeks or months — to offer proper entries. You should always stalk chart patterns in advance. Then WAIT for your entry criteria to present itself (i.e. above-average volume, MACD crossover, overcoming a resistance level, etc.). If the trade does not have the right signal (or multiple necessary signals) do NOT enter the trade.
- Entering a trade too late — “Chasing” is a common problem. The IBD recommends never chasing a stock 5% above its entry point. TraderLion recommends not buying 2% above the entry. Prices often pull-in to re-test a breakout point, but can still be acting within its “normal character”. Most trades don’t go straight up, right away. They need room and time to work, and lower prices to accumulate more buyers. So why stress yourself by holding a stock that is pulling back because you entered at a higher price? The solution to chasing is simple: Don’t put yourself in that situation to begin with. Buy right the first time. Use price alerts. Chances are if you are “chasing,” you probably skipped strategy 1 (above).
- Accept the loss beforehand – Know exactly what you could lose on the trade ahead of time, and accept this. Really accept it. Understand that you don’t need this specific trade to be successful. Rather, you need a series of trades that have an edge to deliver profitable returns over time.
- Stop interfering mid-trade — This one was the hardest for me when I first got started. There will come a time when your stock goes down while other stocks are going up. But remember, as long as your trade is between your predefined stop loss and your profit target, it is still in play. Do not interfere, do not self-sabotage. There is nothing you need to do. All of your work should have been done BEFORE the trade was placed.
- Tune out distractions — This includes news, social media, and whatever else is clamouring for your attention. Seriously, nobody will have more interest in you becoming successful than you. You are responsible for your trades, both your losses and your wins. If you take a loss, own that outcome and try to understand why. If you win, own that too — you’re doing something right!