Fear of Missing Out in Penny Stock Trading
The fear of missing out mentality or FOMO is a common trading mistake that many penny stock beginners make.
In fact, It was one of the mistakes that I used to make when I first started trading and it cost me a fortune. It would probably have crushed my whole portfolio if I didn't learn to deal with it.
In this article, I am going to show you how the fear of missing out mentality is generated and what I did to prevent it from happening.
What Causes The Fear of Missing Out Mentality?
The main cause of the FOMO mentality is fear of missing out on big opportunities in the stock market and there are a few scenarios where the FOMO is formed and enhanced.
- Let's say you have found a pattern that is profitable and works about 80% of the time.
- There is a stock called ABC that is about to form the pattern that you are hoping for.
- You have set a limit price to buy the ABC stock at the perfect entry price. However, ABC missed your limit price by just a few cents and your order didn't get filled.
- Then, the next day, ABC goes up over 100%. You started kicking yourself and cursing the market for your bad luck.
- The next time when you see the same pattern forming on another stock, it reminds you of the missed opportunity that you had last time.
- You will then have the tendency to buy the stock early and jump on a trade before your "profitable pattern" has formed.
Why is The Fear of Missing Out Mentality Dangerous?
The FOMO mentality is dangerous because it causes traders to jump on trades earlier.
Again, let's say we have a profitable pattern that works about 80% of the time. We have tested this pattern using historical data and with our trades.
If we decide to jump early on every trade, it might reduce our winning pattern to work only 50% of the time. By jumping on trades early, we are actually trading with a "new pattern" that we have not tested and is not proven.
Our brain is biased. When we missed a big opportunity, we would remember the pain forever.
However, we forget that there may be hundreds of other stocks that have formed a similar pattern as our winning pattern and they fail if we jump in early. But we don't know these stocks because we didn't trade them, so we didn't take them into our memory.
Why is Jumping on Trades Early a Bad Thing?
Jumping on trades early not only breaks our profit pattern but will also ultimately crush our confidence and portfolio.
Here is a scenario where FOMO causes a trader to get on a trade early and fails to get out on time.
- Assume your normal stop loss is 12% for every trade, and your profit pattern has a winning rate of 80%.
- Let's say you jump on a trade early before your profitable pattern is formed and the stock falls, the pattern is only going to look more attractive because then it looks more like your "profitable pattern".
- If the stock keeps falling and hits your 12% stop loss, you then face 2 tough decisions. You can either cut your losses and move on or hang on to your losses and hope the stock would make a comeback. Both decisions are equally bad, let's see why.
- You follow your stop loss rule and sell the stock for a loss, you are actually selling at a price where you should be buying according to your "profitable pattern". In other words, you are doing exactly the opposite of what your pattern tells you to do.
- If your "profitable pattern" works for this trade and the stock rebounds right after you cut your losses, you will be kicking yourself and feel bad for not following your "profitable pattern", and might feel stupid of having a stop loss in the first place.
- Image what will happen on the next trade. You will be tempted to set a bigger stop loss to remove your stop loss rule from your trading system altogether.
- Trading without a stop loss is one of the worst mistakes that a trader can ever make.
- If you hang on to your losing position you are officially breaking your stop loss rule.
- Your loss could get much bigger once you break your own rules of not cutting losses at 12%. The stock can keep going down 20%, 30%, 50%, and even 80%. At that point, you throw in the towel and give up on the trade which is way too late.
- In this case, not only do you lose a lot of money, but you also lose confidence in yourself and in your trading system.
As you can see, both scenarios put you in a tough spot. To avoid making this mistake, the best thing to do would be to wait for your "profitable pattern" to be formed rather than jumping on the trade early and expecting the pattern to be formed. Don't anticipate a pattern, wait for the market to decide whether or not you should take that trade.
Remember, a "profitable pattern" only gives you an edge for a trade, but it doesn't work 100% of the time. If you jump on trades early 10 times, 2 of those trades will fail. You want to cut losses quickly on the 2 times that the trade fails rather than losing big money those 2 trades.
How to Prevent FOMO in Trading?
There are four ways that I deal with the FOMO mentality.
Step 1 - Watch a Lot of Stocks
By watching a lot of stocks, I force myself not to fall into love with any particular stock or trade. I set a limit price to buy a stock only if it is trading at the perfect entry price for my "profitable pattern". My entry price should give me a risk-reward ratio of 1:2 or better.
Following is my watchlist for today on my Fidelity account. As you can see, my watchlist kept getting bigger, and so does my profits from penny stocks trading. You can learn how to find penny stocks to watch with my penny stock guide. Please note the below chart is my watchlist, not all the stocks I own.
Step 2 - Focus On the Data
Every penny stock trader should collect stock charts and study the winning charts and try to find a pattern from these charts. After you have studied thousands of charts, you will likely find a few profitable patterns that work well.
Test these patterns against historical stocks and you will get a sense of how often the patterns work. You want to focus only on the patterns that have a winning ratio of 80% or better.
The next time when you are about to jump on a trade early, pull out this data and convince yourself that your winning pattern is the one you have, not the one that tells you to jump in early.
Step 3 - Think Long Term
Always remember, you will be trading penny stocks for the long term. You might execute 10,000 trades in the next few years. One or a few big winners don't really have that much of an impact on your portfolio. However, a few big losses will definitely ruin your portfolio.
When you think of every trade as only one of the 10,000 trades that you are going to make, you will be less likely to jump on a trade early. A dozen trades with a 50% in missed profit is not going to make a difference in the long run, that is if you manage to stay in the game.
Step 4 - Focus On the Pattern
One of the reasons for the FOMO mentality is short-term thinking. Beginners often think in terms of money instead of patterns. When they see a missed trade, they think in terms of how much money they have missed, and what they can buy or do with that money.
Remember, that money is not yours to begin with, so you are not really losing anything. A winning trader doesn't start counting money that they haven't made yet.
Instead of focusing on the money, you should always focus on the pattern. When you have found a profit pattern, just do what the pattern tells you to do. In fact, that's all you do. Trading doesn't have to be all that complicated.
We are not robots. From time to time, I still make this FOMO mistake, but it doesn't happen that often anymore and I don't allow it to ruin my portfolio. I always exit early whenever I find that I jump on a trade too early or when I'm not following my profitable chart pattern.
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