Psychology: Most traders neglect one of the most important parts of trading: The psychology of the game. How mentally prepared are you for the trials and tribulations that are important in the trading activity?
After a few trading experiences it becomes obvious how important your mental approach (psychology) is to the market. In fact, your trading success, the difference between winning and losing, depends upon your mental attitude. It is the main factor, before anything else, that determines whether you win or lose.
It is obvious how much training is necessary to learn the technical aspects of trading. Hundreds of books and courses have been written on every tiny aspect of trading, each with something worthwhile. The internet barrages us daily with the latest and greatest method or system, the “Holy Grail,” we all seek. A review of pitches on the net reveal hundreds of technical offerings for every ONE emotional piece, mental preparedness, psychology studies, etc.! Fewer than ten offerings on how to prepare emotionally against thousands on how to prepare technically. Does that suggest the unimportance of mental fitness? No way! Rather, that points to the reasons fewer that 5% of all beginning traders find their way to a successful trading career.
Mental fitness is easier to say than psychology, but the meaning is clear, how we feel about what we’re doing impacts how we do it.
But what psychology, what emotions are we talking about that are so important? Consider the following short list:
There is one paramount aspect to trading we all learn early in the game: Successful traders both win and lose, with losing trades coming as often as winners. How we handle the losses is a state of our mentality! How well prepared are we to lose in the market? Can’t we just find the perfect method or system that prevents losses? We will often even deal with more losing trades than winners. Those kind of returns will mess with our outlook, with our emotions! We needn’t go through all the mind-games that take place when we are in the heat of the battle. …the baby needs diapers, the car just blew a gasket, the rent is due, etc., etc.
Specific conditions must be observed and obeyed if we are to create the Mental Attitude required to trade successfully! Steps must be taken to address this very important phase every day that we trade. It hinges upon one word: DISCIPLINE!
There are dozens of very successful systems used to trade the market. Yet, most traders are losers who have traded these systems. Let’s try to see why. Two important rules in any book/course/system/plan on trading:
“Buy low, Sell High”
“Cut your losses short and let your winners run.”
Easy enough to understand, but tough to handle when the time comes. The execution of any trading system or plan assumes the rules will be followed. The rules have been developed after countless hours of study and experience. But until the trader has many hours of experience executing the rules, many appear to be only suggestions. See where the one word, Discipline, comes in?
The first adage, “Buy low, sell high,” is also easy to understand. But emotional baggage plays hay with the simple rule. We respond to the news, market letters, television gurus, etc., about market action. A respected financial figure touts a new Initial Public Offering with prospects going to the moon and everybody watches. The price starts up, the public greedily jumps in, buying on its rise, with volume up the kazoo. We think this is it, we gotta get on board, and buy at the top just as the market starts down. We hang on, waiting for the upturn which will surely come as promised, disregarding any stops since it WILL turn around. Finally, we get out, selling at the bottom, just before the price finally starts back up. Does that sound far-fetched? That is a very common scenario among beginners in the trading world. Look at Fig. 1 below which is the last few months of the S&P 500 index, the most popular indicator reference to the market.
As price rises to the peak there is more danger of a pullback (meaning higher risk). But this is where buying pressure is highest, before it turns down. When price nears the bottom of the cycle more people are bailing out just at the time the risk is lowest. Selling pressure is highest here.
What emotions are played out with the chart above? Fear got us in at the top of the wave, afraid we would miss the train which was pulling out of the station, with dollar signs in our eyes (Greed) about how high it would go. Greed kept us in as the expectation (hope) caused a delay we finally couldn’t abide while struggling with Fear. Quite an emotional tug of war going on within, impacting our action and/or our inaction. Thus, the two sides of fear are: Fear of losing, and Fear of missing out. This recurring pattern in a stock chart is a testimony to the psychology of trading.
The second adage posted above, “Cut Your Losses Short and Let Your Winners Run,” is the salvation of our trading plans. Since we will both win and lose, big winners outshine small losses every time!
Here’s a rule we can take to the bank: Whenever you identify HOPE as the primary reason for holding a position, CLOSE IT IMMEDIATLY!
It is a big problem for beginning traders to not feel bad when a trade goes sour. But why shouldn’t they feel bad? It’s only natural. It is very natural and that’s the problem. When you can distance yourself emotionally from the action of the day you’ll keep the proper mental attitude for the next trade or trades. This means staying with, adhering to your system! One way of lowering unwanted clutter is to design your system so that buy and sell decisions are made only when the markets are closed.
Just remember that no one can always succeed. Every trader goes through cycles including failure and success. The good traders realize this and will pull out of the market for a time after a series of wins, regaining an objective state of mind understanding the importance of psychology.
Final takeaway: Replace the fear of losing with a fear of not following the plan!
Bob Robertson can be contacted at Provident Investing