There are quite a few emotions involved in trading. While I’m a strong advocate of emotionless trading, I still believe it is important to understand the emotions of the market. This is what gives you an edge over other traders.
One of the strongest emotions that most traders deal with at one point or another is panic. People may experience panic in different ways including stress, fear, and anxiety. If you want to be an emotionless trader, you need to control your panic. That being said, if you ever feel panic while trading, it is not necessarily a bad thing. This can allow you to understand how everyone else may feel at a given time, which allows you to get into the minds of other traders. The key here is to not let panic influence your trading. When you are trading under the influence of panic, you are not making wise decisions. You begin thinking of the worst case scenario and making it a reality in your head. This should be avoided at all costs.
Here are a few ways to avoid feeling panicked when trading:
- Have a plan and know your risk – If you have a plan when trading a stock, there is no reason to feel panicked. Having a plan means understanding your risk when you enter a stock and being prepared to accept that risk if things don’t go as planned. You can determine your risk level based on your personal risk tolerance, support levels, or a maximum dollar loss. For example, if you enter a trade and decide that you don’t want to lose more than $100, you should sell your shares when you are down $100; it’s that simple. You were prepared to lose $100 and you lost $100, meaning there is no reason to panic. Of course, you need to make sure you choose a risk level that you are truly okay with. If $100 will hurt your account, set a $50 risk level, or whatever works for you. Some people struggle with accepting the losses. “Well, I’m down $100, but what if it bounces soon?” Unless you are 100% confident that the stock will bounce, you should ignore “What if?” statements. You won’t get every trade right, but that’s just part of the game. If you ignore your plan, you have no rules to guide you and panic can take its toll. You may miss out on some gains, but you will also protect yourself from losses that you are uncomfortable with. This leads to my next point
- Use proper size – When you enter a trade, you need to be using the proper position size that allows you to play the stock properly. I’ve heard the phrase “If you’re worried, you’re in too big” thrown around. If you have a mental risk tolerance of $100 per trade, find your risk level, and choose your position size accordingly. If a stock has $0.10 of risk, you can buy 1000 shares. If a stock has $0.20 of risk, you can buy 500 shares. I learned this lesson the hard way a few times while trading sub-penny stocks. I would take huge position sizes because I was focused on the potential reward. When the stock would start dropping, or simply fluctuating within it’s range, I would get worried because I was in too big. This would cause me to sell minimize profits, take losses, average down, or make other poor trading decisions. Some sub-penny stocks may need to drop 20-30% before running up 50%+. If you panic when the stock drops 20% and sell your shares, you will miss out on the future gains. While you may not be comfortable losing 20% of a $10,000 position, you may be able to stomach losing 20% of a $1000 position. Once I started taking smaller positions, I started trading better. I would assess my risk and choose a position size accordingly. I wouldn’t panic when everyone else was selling because I knew my risk and I was comfortable with it. Considering there is so much uncertainty in the markets, smaller gains and smaller losses are better than bigger gains and bigger losses. If you take too many big losses, it can mess with your confidence and may even prevent you from being able to trade. When choosing a position size, focus on your risk and not the potential reward.
- Don’t listen to other people – When you are down on your position, you may get curious about how other traders are handling the situation. You may check message boards or Twitter to see what people are saying about the stock. This is a good part of being a diligent trader, however, you shouldn’t believe everything you read. Not all traders know what they are doing, and the internet allows people to hide behind their shields of anonymity. It’s okay to listen to people who you know are credible, but you should ignore the others. Some people like to prey on panicked traders because they are short the stock or want to buy shares for cheaper. You don’t know people’s motives and you don’t know their trading abilities, so don’t let them influence you. People tend to panic when a stock is dropping. You do not want to get consumed by the panic of others. Panic can spread like the plague. If you can’t stomach hearing what others have to say, just avoid listening to them. Of course, this recommendation is contingent on the fact that you had a well formulated plan based on your risk tolerance (as discussed above).
- Use your panic to understand others – All traders have been worried about a trade before and this panic can influence stock prices because traders will buy and sell accordingly. It’s okay to be worried as long as you are conscious of the fact that you may not be able to make the best decisions. When I feel worried about a trade, I like to use that emotion to understand how others are feeling. I combine this with my level 2 analysis and other tools. For example, assume a stock is dropping and you expect it to bounce. Bid support is dwindling and sell orders are being stacked on the ask. The stock keeps dropping and you are tempted to sell it to cut losses even though you are confident that it will bounce higher in the coming days. Understand that your desire to cut losses is triggered by panic and many other people are feeling the same way. This means there will be a strong sell off triggered solely by panic. Keep in mind, there are also traders who do not have positions in the stock that are waiting to buy in at these lower prices. When the panic fades and new investors have purchased cheaper shares, the stock will have room to run. If you sell into the panic, you may find that you sell your shares at the bottom. Understanding how panic trading works gives you an edge over other investors. When everyone else is blinded by their emotions, you can think clearly and hold or buy shares accordingly. This doesn’t mean that you should buy into or hold onto a losing play. It means that you should focus on why a stock is dropping. If the drop seems random, or like a “chain reaction”, and there is no known catalyst, you can assume panic may be present. Assessing whether a stock is dropping due to panic is not easy. I use level 2 as my basis for this and I only apply this strategy to lower volume penny stocks because there are less orders to analyze.
Towards the end of last week, I was trading a company called NWGC. I liked the company from a fundamental perspective and they had just run up from a pump so there were a lot of eyes on the stock. Normally, I don’t like buying into pumps this late, but I was not buying the stock because it was a pump. I was buying it because I liked the company and figured the pump may have been helpful in attracting some fundamental traders. That being said, I knew it was a pump so I waited for the stock to pull back a bit. I wanted to get shares under $0.01/share so I waited patiently. As it started to dip below $0.01 I decided to load some shares. I started loading shares at .0095/share while flipping some along the way to take advantage of spikes so I could buy cheaper shares later. I was actually looking forward to every price drop so I could get more shares. Based on my fundamental analysis, the company was extremely undervalued. Plus, I thought it would eventually bounce of one of the support levels. Eventually, the stock pulled all the way down to .0052/share and I was down a good amount on my investment. Luckily I was locking in profits on the spikes, or I would have been down a lot more.
Anyway, as the stock was dropping you could tell that people were panicking. I had a plan and I knew my risk (Rule #1) . Unfortunately support levels were being taken down too fast for me to exit my position where I had planned so I was stuck holding too many shares. However, I liked the company, and I knew they were worth more money based on my fundamental analysis. It’s not like the company’s fundamentals were changing as the stock price was dropping. There was no dilution or negative catalyst present, so there was no real reason for the drop, other than traders getting bored (or, of course, panic). Since I got into this stock because it was undervalued, I decided to not worry so much about these drops. Unfortunately, I ignored Rule #2 so I was entering positions that exposed me to too much risk. I was able to minimize losses by analyzing the level 2 screen for good entry and exit opportunities, but, I was still in too big. The selling continued and the stock kept dropping Wednesday through Friday. By the time the stock was in the .0055 range on Friday, I was down about 25% on my investment, which was substantial considering the size of the position. I had to make the difficult decision of whether or not to cut losses and move on, or hope for a bounce. I checked the stock message boards and Twitter to see how other traders were reacting. I noticed there was a lot of negativity and fear. The crowd that was praising the company during the run was now panicked and forgot why they invested in the first place. Each time another sell order went through, more traders were tempted to unload their positions before it was too late. I wasn’t going to fall victim to this trend (Rule #3). I realized 2 important things.
First of all, the 50-Day simple moving average was at .0042. This should act as support if all else fails. Of course, it could break, but I was already down a lot so I didn’t mind waiting to see if it held. Plus, the risk/reward ratio was better at these levels. I reanalyzed the trade and set a new risk level (Rule #1). I sized out a bit and unloaded some shares at break even just in case the stock dropped further (Rule #2). I ignored the negativity on the message boards and even added some optimistic insight (Rule #3). And most importantly, I thought about how I was feeling and applied it to how other traders may be feeling (Rule #4). I noticed that every time there was a big order on the bid after support broke, I was tempted to sell and move on, but every time someone took out shares on the ask, I became bullish again. This made me realize that all this stock needed was a little bit of buying pressure for it to see a nice bounce. The ask side of the level 2 screen was thin; there just wasn’t any buying pressure quite yet. Once a bottom had formed, this would have more room to run. So, after reformulating my plan, I decided to hold my shares and hope for the best. As you can see from the charts below, NWGC opened up at .0055 on Monday, got some buying pressure and ran up over 60% during the day. I didn’t time my exit perfectly, but I saved a hell of a lot of money by not selling into the panic.
Seeing the Panic in the Charts
In my opinion, it is easier to see panic on a level 2 screen, but I do not have that available so I will use the charts below.
Look at the 10-minute chart for NWGC below (The highlights are not exact, but you should get the main idea). Notice that the stock would run, then consolidate, then repeat. This went on for a few days until eventually the stock hit a top. There were some big drops, but the stock held above .01/share for a good amount of time. Even during the pullbacks and consolidation, the overall trend was still bullish. When it broke the .01 level and couldn’t move back above it, the panic started to set in. Suddenly this was a sub-penny stock again and people’s perspectives changed. Previously, there were huge dips and huge spikes as the bulls and the bears battled it out. After the drop below .01/share there were no big spikes, however, there were a few big dips. The spikes would need to return to support a bullish sentiment.
Now look at the 5-minute chart below for the time period of the panic. Notice how support levels were being taken out again and again. Each time a support level was broken, the stock would plummet and “consolidate” at the next support level until there were almost no support levels left. The chart was now clearly bearish, so even the bulls were in a panic. As of June 12, the stock could no longer move above .01/share. The trades were more scattered throughout the day because there was uncertainty in the markets. Buyers didn’t want to load up on shares because the stock was bearish and sellers were still hoping for a bounce. There was a lot of uncertainty. When the stock would dip, the uncertainty translated to bearish sentiment and even more people unloaded shares, triggering a chain reaction. This uncertainty was both good and bad. It meant that if the stock dropped more, people would be bearish. It also meant that if the stock showed signs of strength, people would be bullish. As you can see, on Monday, the stock started off bullish and continued the trend for almost the entire day.
Last but not least, let’s take a quick look at the daily chart. Notice the area where the panic started to sink in. It started June 11 (the first red candle in the red panic box) as the last few minutes of the trading (as seen on the 5-minute chart above) day sent the stock plummeting, creating a big red candle. Until then, the daily chart looked like it could be consolidating above .01/share and preparing for another run. That big red candle made the daily chart look bearish, which triggered panic.
How the Stock Ran (Relative to Panic)
Of course, there are many reasons, but let’s focus on things from the perspective of panic for the sake of the article. I already talked about how there was a lot of uncertainty and any bullish signal could push this up fast, but there is another important principle involved. During this whole time period (the red box), the panic was actually being filtered out of the stock. Buyers who bought during the peak of the run were selling for losses, meaning they no longer had a stake in the company and could no longer be panicked. Every time someone sold out of panic, their panic was removed from the market and their shares were transferred to someone who had a better entry point. For example, someone who bought shares at .016/share during the run may have sold his shares to someone at .006/share during the drop. Now, when the stock drops to .0055, there is less panic in the midst. The guy who bought shares at .016 would have a 65% loss when the stock price dropped to .0055/share. That is a recipe for panic. Someone with a loss that large could sell into the bid or put up a wall on the ask at anytime, which continues the downward trend. Meanwhile, the guy who bought shares at .006/share would only have an 8% loss when the stock dipped to .0055, which is not too bad for a volatile stock like this. This guy has no reason to sell the shares on the bid or put up a wall on the ask because his loss is minimal. Essentially, shares were exchanging hands from panicked investors who didn’t time their entries properly to traders who bought on the drop and had less fear of downside due to their better entry price. Of course, there were still people who held despite their large losses, and their risk tolerance would be tested every time the stock dropped further. That being said, at a macro level, panicked traders with massive losses were being replaced by traders who had less to worry about. Of course, the stock could keep dropping, but it’s important to remember that this company had good fundamentals and active pumpers. If it dropped too low, traders would jump on the chance to get cheap shares, which would provide the bullish signal this stock needed in order to bounce.
How to Use all of This
Understanding panic in the stock market should just be another tool for you to use when you are trading. You don’t want to place trades solely based around the principles discussed above, however, you can incorporate these principles into your current trading strategy. Obviously, NWGC’s price action in the example above was not solely driven by panic, however, it definitely played a role. Understanding panic in the stock market means that you understand another element of the market environment, which gives you an edge over other traders. Level 2 is the best tool to use for analyzing panic. Pay attention to the different orders that go through and think about their significance. Sometimes a stock may be dropping because of dilution, in which case you shouldn’t expect the same bounce as you would if a stock were dropping mainly because of panic. By analyzing level 2 trends you can pinpoint the reason for a drop. Not all drops are caused by panic, but all drops do cause panic. Be conscious of your own panic and the panic of others and you can learn how to place trades without emotion. The end goal should be to eliminate panic from your own trading while taking advantage of the panic of the market.