"Revenge is a dish best served cold". How many times have you heard that! Here...for trading this concept doesn't really work well.
Revenge trading is a common practice in the financial market and is one of the worst trading practices. It involves attempting to make a profit after one has made a big loss. Often acting on impulse, being dominated by emotions and without a real analysis (technical or price action) to support our idea.
In this article, we will look at what revenge trading is, its dangers, and some of the top tips to use to avoid the practice.
Revenge trading definition and example
Revenge trading is defined as the practice of attempting to make a quick profit after you have made a big loss. For example, assume that you are having a relatively good week in the market. You have a target of making $2,000 per week.
Then, on a Friday, you realize that you are short of about $50. And so, you decide to open a trade with the goal of making the $50. Unfortunately, the trade goes south and you lose, say $200. Therefore, you decide to open a trade with the goal of covering the loss. If it goes well, you could make $300 and reach your weekly goal.
On the other hand, revenge trading may not work as intended and it could lead to a substantial loss. Unfortunately, this is one of the most common implications of revenge trading. Indeed, most trading experts recommend avoiding to start a revenge trade at all costs.
Why revenge trading happens
Revenge trading happens to all types of traders. In our experience, We have not identified a trader who has never revenge traded.
In your early days of trading, it was common to open an opposite trade whenever you made a big loss. In this, if you lost a short on a stock, it was common to open a buy position in a bid to make some money.
There are three main reasons why traders revenge trade. First, it is part of human nature to want to reverse some of their previous losses, as described above. Second, they revenge trade because of the overall uncertainty in the market. They point to the fact that if a trade made a loss this time, there is a possibility that they will make a profit in the next trade.
Finally, revenge trading can be seen as part of a Martingale trading strategy. This is a strategy where a trader opens a bigger trade after making a loss. In Martingale, they assume that the next trade will lead to a substantial profit, which will help them recoup their previous losses.
In general, these reasons can be summarized into:
- Anger - In anger, a trader is generally disappointed that they made a big loss and so they want to recoup their initial losses.
- Greed - As you probably know, greed is one of the key sentiments in the market. Therefore, traders often revenge trade as they try to make more money.
- Fear - Traders revenge trade because of the overall fear in the market. Precisely, there is the overall fear of making a big loss. For example, if you make most of your money trading and you make a big loss, fear can push you to revenge trade.
- Shame - Some people revenge trade with the goal of avoiding shame. This is mostly common when you are trading as part of a team.
Is revenge trading good?
While it is possible to make money by revenge trading, it is one of the worst trading approaches in the market. In our experience, We have seen many people lose a fortune just by attempting to recoup their previous losses. There are several reasons why this happens.
First, when revenge trading happens, you don’t have a lot of time to do a complete fundamental and technical analysis on an asset. Therefore, opening a trade without having done such an analysis can lead to substantial losses in the long run.
Second, the emotional toll that happens when you revenge trade can be overwhelming. For example, if your first trade makes a loss and your second trade also make a loss, it could affect your overall emotions.
Loss of discipline
Third, revenge trading makes it difficult to have good discipline in the market. Basically, when you open a trade in haste without doing any analysis, you put yourself at substantial risk.
How to avoid revenge trading
There are several strategies you can use to avoid revenge trading in the market. These are the following.
Adding a stop-loss
You should ensure that you have a stop-loss on all trades that you implement. For starters, a stop-loss is a tool that automatically stops a trade when it makes a pre-determined loss. This is one of the most important tools provided by most brokers.
With a stop-loss, you will always be sure that you won’t lose more money than you can take.
Having a trading journal can help you avoid revenge trading. The journal is a document where you write all details about your trades. It will always make you a disciplined trader.
Learn from your mistakes
Another way of avoiding revenge trading is learning from your mistakes. If you lost money during the previous revenge trading practices, learn from the mistake and don’t repeat them.
» Related: Top Mistakes You Should Avoid as a Trader
You should establish a good trading routine to become a successful trader. When you create a good routine, there is a probability that you will become a disciplined trader.
Revenge trading is not a sustainable trading approach in the financial market. It involves attempting to make a profit immediately after you make a loss. While it could make you some money, in the long term, it is not a good trading approach in the middle and long term.
External Useful Resources
- How can I overcome the mental barrier of revenge trading? - Quora