Revenge Trading: Deep Dive into the Causes and How to Avoid it

“These losses are hitting harder than I expected. My track record is taking a beating. But no problem, I've got something big in mind to bounce back quickly. I’m doubling down on some high-risk, high-reward trades. Gotta show the market who's boss.”

This is a revenge trader with a bruised ego speaking,

trying to assert his authority in the community, failing to recognize that losses are part of the trading journey, and in no way should we deviate from our trading strategy and Risk Management plan.

The Scenario brings us to our main topic,

What is Revenge Trading?

Revenge trading is a topic frequently discussed in Trading Psychology.

Its the behavior where a trader, motivated by emotions like frustration or anger resulting from previous significant losses, engages in impulsive, often irrational & high-risk trading decisions to recover the losses quickly.

Instead of adhering to a well-thought-out trading strategy and risk management plan, a trader involved in revenge trading breaks the rules, pushes harder, taking bigger bites than the stomach can handle. All of this is done seeking to recover the losses incurred in prior trades hastily

.In this game, sometimes the biggest enemy is staring back at you from the reflection of your trading screen, or as they say it,

Nothing can protect you from yourself in trading.

How does revenge Trading Differ from Regular Trading/Investing?

There are stark differences between the two approaches;

The first and most apparent difference is

Emotional Motivations:

While Revenge Trading is driven by emotions such as frustration, anger, or a desire for quick vindication after experiencing losses in previous trades,

Regular Trading/Investing is Grounded in rational analysis, market research, and predefined trading or investment plan adherence. Emotions are kept in check, and decisions are based on a systematic approach.

They also differ in

Time Horizon: 

While Revenge Trading is typically driven by a short-term focus, seeking to recover losses quickly, even if it means taking higher risks,

Regular Trading/Investing, on the other hand, emphasizes a long-term perspective with a focus on consistent and sustainable returns over time. Decisions are aligned with broader financial goals and a strategic investment horizon.

Another Major difference between the two approaches is

Risk Management: 

Revenge Trading Often involves disregarding risk management practices, with traders taking more prominent positions to recover losses rapidly.

Meanwhile, regular trading/investing prioritizes risk management, including using stop-loss orders, position sizing, and diversification to protect capital and manage downside risk.

And the last thing on our list that separates revenge trading from regular trading/investing is;

Market Awareness: 

Revenge Trading may lead to a need for more awareness or consideration of broader market trends, as the focus is primarily on recovering immediate losses. In contrast, Regular Trading/Investing Involves a comprehensive understanding of market conditions, trends identification, and potential catalysts that may impact investments over the long term.

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So, How does a Human Mind work in revenge trading?

We discuss this below:

Psychological Aspects of Revenge Trading

Psychologically speaking, there are three aspects of Revenge Trading;

1.  The Emotions

2.  The Motives &

3.  The Triggers

Emotions:

You might have noticed by now that,

Revenge trading is deeply rooted in human psychology,

It arises due to emotions like

anger, born of losses and the desire to retaliate;

and

frustration because the outcomes were not as expected, creating impatience, fueling hasty decisions for rapid recovery, leading up to

anxiety, a relentless companion in the face of financial losses.

Did you notice?

This is a complete chain of emotions, originating from anger to frustration, leading to impatience and anxiety.

Under this anxiety, the trader does "revenge trading."

The Motives

If we could dive deeper into the human mind, do you know what we would find as the biggest driver of revenge trading?

It's this thing called Loss Aversion.

So, when traders face hefty financial setbacks, they go into this all-out mission to "get even." FOMO kicks in, pushing them into impulsive moves, and past successes make them too Overconfident, causing them to ditch their well-thought-out strategies.

Talking about, States of Mind, Mark Douglas has a really famous saying;

 And you know what gives these revenge traders the confidence to pull it off again?

It's the "Fake Sense" – that feeling of invincibility. They think, "Hey, I did it before, so I can do it now, too." In Psychology, we call it the "cognitive bias."

Now, this bias has many different types.

If a trader thinks they can hit those highs from the past and cover their losses, they're falling for the Anchoring Bias.

Those past victories become more than proof of skill; they become a mental anchor, shaping what they expect in the future. It's like a magnet pulling aspirations and risk tolerance back to a familiar high point. This magnetic pull messes with the traders' judgment and makes them throw too much money at high-risk trades, all hoping to relive the glory days.

And if it's not the Anchoring Bias, it might be the Confirmation Bias. This is when a trader only pays attention to info that agrees with what they already believe.

Dangerous move!

It is because it messes with how a market should be seen. Ignore signals that suggest a different story, and the trader might miss crucial insights or warning signs.

There's also this Sunk Cost Fallacy.

Some traders can't accept a loss as a done deal.

They see it as an investment that must be recouped, no matter what.

This mindset makes them obsessively chase recovery at any cost. Instead of seeing losses as part of the game, they treat them like debts that must be repaid, and it's a slippery slope from there on.

This brings us to the topic of ,

The Triggers of Revenge Trading

Well, there can be plenty; we summarize the most common ones below;

Significant Losses:

Most of the time, it's a considerable loss.

Experiencing a substantial financial loss is the most common trigger for revenge traders. The emotional toll of the loss may lead to a strong desire to recoup the money quickly, often resulting in impulsive and high-risk trades.

Missed Opportunities:

Ever kicked yourself for not jumping on a profitable opportunity?

That frustration can drive revenge trading. Traders may feel compelled to chase after perceived missed profits, even if it means deviating from their established strategy. 

Ego and Pride:

As shown in our opening Scenario, traders may seek validation or aim to restore perceived status by taking excessive risks.

Facing criticism for trading decisions can also lead to a desire to prove oneself, potentially fueling revenge trading as a response to external pressure.

Unexpected Market Events:

Sometimes, it's not personal;

It's the market throwing a curveball. Sudden and unexpected events, like economic crises or geopolitical shake-ups, can cause those impulsive decisions. Trying to regain control and recover losses incurred during turbulent times can push them into revenge trading mode.

Impatience:

Who likes waiting?

Impatience to hit financial goals within a specific timeframe is a big trigger for revenge trading. Instead of sticking to a patient, long-term approach, traders might ditch it for impulsive actions in the pursuit of immediate results.

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How to Avoid Revenge Trading?

Preventing revenge trading is not a challenging task;

it's manageable.

There's no need for concern; it's about effective management. Various measures can be taken to steer clear of revenge trading.

Take a Break!

It’s the easiest and the most immediate action you can take.

Once you are feeling an impulsive desire to enter into a trade,

Just get up from your seat and walk!

Taking your eyes off that screen will calm your nerves and allow you to refocus.

If facing frustration or disappointment, consider taking breaks from trading to regain perspective and prevent impulsive actions driven by emotions.

And why do we need a break?

Because Revenge trading is a sticky trap, often lingering on even after the market closes. Even Seasoned short-term day traders can find themselves stuck in its "mode" for weeks if they have no awareness. Think of it like a trading hangover, but pushing through won't cut it. You'll just wake up every morning with that market headache, bleary-eyed and ready to jump into another negative session, snowballing down a mountain of red.

The good news? Experience is a great detoxifier. Seasoned traders learn to steer clear of "Revenger Mode," unplugging from that emotional rollercoaster and protecting their capital for the long haul. It's the key to a healthier balance sheet and, ultimately, a brighter P/L horizon.

Remember you had a Risk Management Plan? Apply It.

Always stay on your risk management plan, no matter what kind of urge it is!

Implement stop-loss orders based on technical analysis, support/resistance levels, or volatility ( Volatility based stop loss includes ATR-based Stop Loss). This automated risk management tool helps limit losses and prevents emotional decision-making during market fluctuations.

Diversification across different assets or instruments reduces the impact of a single loss on the overall portfolio. This strategy minimizes the temptation to engage in revenge trading to recover from a specific setback.

Determine position sizes based on a percentage of your total trading capital. This ensures that each trade aligns with your risk tolerance, preventing overexposure to potential losses.

Stay Disciplined

Maintain a trading journal to record trades, emotions, and outcomes. Regularly reviewing your diary helps identify patterns, emotional triggers, and areas for improvement, fostering self-awareness and learning.

Recognize Emotional Triggers.

Develop self-awareness to identify emotional triggers that may lead to revenge trading. Understanding your emotional responses allows for more conscious decision-making.

Stay Present in the Moment.

Mindfulness involves staying present and focused on the current market conditions rather than dwelling on past losses. Being mindful helps prevent impulsive actions driven by emotional baggage.

Reflect on Your Trading Behavior.

Regularly reflect on your trading behavior and decisions. Analyze successful and unsuccessful trades to understand patterns, strengths, and areas that require improvement.

Seek Feedback and Mentorship:

Establish relationships with experienced traders or mentors who can provide guidance and constructive feedback. A support network helps navigate challenges and reduces the isolation that may contribute to revenge trading tendencies.

Continuous Learning:

Stay Informed and Educated: Embrace a mindset of continuous learning. Staying informed about market dynamics, strategies, and psychological aspects of trading enhances your ability to adapt and make informed decisions.

And don’t worry, we have some effective;

Educational Resources to Manage Revenge Trading:

Below are some Excellent books to manage the risk of Revenge Trading,

1.      "Trading in the Zone" by Mark Douglas:

This is a must-read for any serious trader. It offers extensive insights into developing the professional trader's mindset, including the impact of emotions on decision-making. It provides practical advice on developing the right attitude and overcoming common trading pitfalls.

2.      "The Disciplined Trader" by Mark Douglas:

Another work by Mark Douglas discusses the importance of discipline in trading and offers strategies to overcome emotional challenges, including revenge trading.

3.      "Market Wizards" by Jack D. Schwager:

This book features interviews with successful traders and highlights their diverse strategies and experiences. Reading about the challenges they faced and how they overcame them can provide valuable lessons for traders dealing with revenge tendencies.

4.      "Trading Psychology 2.0" by Brett N. Steenbarger:

Dr. Steenbarger, a renowned trading psychologist, explores the psychological aspects of trading and offers practical techniques for improving performance and managing emotions.

Conclusion:

In conclusion, managing revenge trading goes beyond market analysis and strategy formulation; it involves emotional discipline and risk management. By understanding its causes and implementing effective management strategies, traders can do more resilient and successful trading.

Remember, the key lies in staying calm under pressure, learning from mistakes, and adhering to a well-defined trading plan. With these principles in mind, traders can confidently manage their trades and increase their chances of long-term success.

So,

Trade Smarter!

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