So what constitutes an actual addiction? There are two categories of addictions, physical dependence and psychological addiction. There is a considerable amount of information on both and certainly beyond the scope of this article, but a brief summary follows
From Wikipedia, the definition of “addiction” includes:
“Psychological addiction, as opposed to physiological addiction, is a person’s need to use a drug or engage in a behavior despite the harm caused [emphasis added] – out of desire for the effects it produces, rather than to relieve withdrawal symptoms. …. it becomes associated with the release of pleasure-inducing endorphins, and a cycle is started that is similar to physiological addiction. This cycle is often very difficult to break.”
“Psychological addiction does not have to be limited only to substances; even various activities and behavioral patterns [emphasis added] may be considered addictions if they are harmful….”
From Merriam-Webster Online, the definition of “addicted”:
“1 : to devote or surrender (oneself) to something habitually or obsessively”
So an addiction could be described as a person feeling the “need” to repeatedly engage in a particular behavior to satisfy a desire for the emotional effects that is has, the feelings that it produces. It is a desire that they have rationalized into a need, to which they have surrendered control, and they have allowed the behavior to develop into a habit. This is physiologically compounded by the endorphins released into the system that provide a physical sensation as well. Let’s look at some of the necessary practices (behaviors) of trading to achieve consistent profits and some of the behaviors exhibited by many traders to see if they support our hypothesis that trading is addictive.
One recognized critical practice for profitable trading is good risk management. At the heart if this is making sure that the risks you take are measured and calculated risks. You want to keep your losses small when they occur and avoid them all together when possible (such as NOT getting into bad trades). Key tools commonly used for controlling potential losses include risk / reward calculations and stop loss orders. Risk/reward calculations are necessary on every trade so that you know whether each trade is a sound business decision. Stops are used so that then a good trade is placed but the market doesn’t do what you’d expected. With the leverage in trading that can work for or against you, risk management is essential.
General money management is another critical practice to make sure that your trading business will still have the doors open months and years from now. It includes risk management but the focus is on a larger scale and a broader scope, such as looking at what percentage of your available capital you are placing on any given trade, regardless of the details of the specific trade.
These practices may appeal to the intellect, but how they feel is where traders get into trouble. There are several common mistakes repeatedly made by traders that bring large losses, missed profits, and ruin for many. These mistakes run in direct conflict with the known and established good practices for consistent and profitable trading, yet are made over and over again by the same traders. Since they are repeated, it would be reasonable to say that they have become habits. Let’s examine these habits from the perspective of the emotional response for the individual.
Trading without a plan, also known as entering a trade without an exit strategy for the trade. The trader doing this is usually not following a technical system and is going more on their hunches than sound calculations. This right here is an indicator that they are allowing their feelings to dictate their actions more so than their reasoning and rationale. If the market moves in their favor, it reinforces the decision to follow their intuition and feeds the ego in being right. Another very elemental factor is suspense. If one has the trade planned out and there are no surprises, it takes all the suspense out of it. Why do people love a good mystery novel or movie? They love sitting on the edge of their seats and reveling in the suspense of it all. When you know the end of the story it takes all the fun out of it and who wants that? Same with sports. It is not the score at the end of the game that compels people to play or watch. It is not knowing how each play and the game itself will unfold that provides the enjoyment.
Refusal to use stops. The comment often heard by brokers is “No, I don’t want to get stopped out. I’ll just watch it.” This is true for initial stops and quite commonly for trailing stops after the market has moved in one’s favor. The trader is putting a lot of energy in to their feelings hope and anticipation. The ego is also being fed here, “knowing” that the market will do as they desire. As the move goes their way, they are experiencing a tremendous thrill, plus the validation they desire about them being a better trader than they truly are. When the market moves against them, the opposite feelings are amplified and only create a greater need to be validated. This also again, involves a lot of suspense, anticipation and thrill of watching events unfold.
Over-trading regarding frequency, A.K.A. trading too often. Usually in this circumstance the trader is feeling the need to satisfy their perception of lack. They may have just experienced a string o
f losers or a very large loss and now feel that they have to recoup their losses and absolve themselves for the previous errors. They are feeling bad about themselves and rather than do what they know is right, they simply want to have the bad feelings go away.
Placing trades that are too large for the account. One of the more interesting aspects of this particular mistake is that besides the greed factor, people get a bit of a thrill going against the rules and particularly stepping outside their comfort zones. The simple act of rebelling or being adventurous is what many got a taste of when they first got into trading since it was so different from what they’d ever done before. The new territory has its appeal and stepping out of the norms and standard rules has a strong gratification associated with it. Of course the greed factor is pretty strong here as well. Only risking 2-5% of your account and the prospect of a measly couple hundred dollars just doesn’t match up with the big numbers one had in mind with trading, or what’s heard often in the ads for the various trading systems available. When you’re only making $800 on this trade and you see and an for a whiz-bang system that claims “I made $9,700 on my first three trades!!!”, that reasonable profit you made just isn’t very satisfying.
One thing worth pointing out right now, and it directly relates to our subject is the fact that people will make mistakes, but will only knowingly repeat them when there is a problem. If you get up out of bed in the morning and stub your toe on the footboard of the bed, you wouldn’t stand there and keep smashing your toe again and again. You’d stop, unless of course there was some sort of additional response that was strong enough to compel you to do it repeatedly until your foot was completely mangled. You’d only smash your thumb when hammering a nail once before you changed how you were holding the board – unless something was wrong.
In comparing the repeated trading mistakes with the established good practices, it is in the emotional responses of the mistakes being made. Suspense, personal absolution and validation, excitement, feeding the ego, being right… the list goes on and on. These can be very powerful and provide enough stimulus for the person for it to over-ride their better judgment. The actions involved in the two sets are in direct contrast regarding both the financial results and how they feel to the trader. Knowing the outcomes for a given trade, keeping the risk small, managing money wisely – these are boring by comparison and provide no suspense. Lacking surprise and done with a knowing, good trading provides a much ‘quieter’ confirmation of a traders ability on the emotional level. When you’re good and you know your good and produce consistent results, those consistent results are not a huge celebration. When you’re a rookie and you do well, it is much more gratifying, especially if you hit a big one. That’s a huge ego feed.
There is an inverse relationship between the discipline necessary for good trading practices and the emotions involved in unhealthy trading. The discipline itself runs 180 degrees against the satisfying emotions and denies them to the trader. That is one of the primary reasons that so many traders struggle with the emotional aspects of trading. It is the way that they are trading. They are trading in a manner that fuels their emotions, and establishing poor habits – both active and emotional habits. If they would focus on establishing healthy trading habits and practices, follow the established wisdoms and observe themselves in their trading, do the simple things that they are supposed to do, their emotions would not flare up so badly and they could begin to break the cycle.