Psychology and Gaining Confidence


Hi All,

There has been a lot of talk on the forums about the psychology of trading and getting rid of fear etc. I think that one way to help is to understand the performance parameters of your trading system and this means extensive backtesting and changing the way you think when entering a trade.

Now whenever I have placed a trade I have assumed that I was wrong and so if the market did not immediately prove my position correct I would be taking measures to reduce my position and, if necessary, get out. This kept my losses small and when correct I was able to do nothing and just move my stop up. This is contrary to the way most people trade in that they place a trade assuming they are right and wait for the market to prove them wrong.

IAlso if you have backtested a system thoroughly you will know what percentage of profitable trades you can expect. From this you can also determine the number of consecutive losing trades that you can expect for a given number of trades. The formula is quite straight forward and is:
Consecutive losses = LN(N)/-LN(S) where
N = Number of expected trades
S = (100-strike rate %)/100

Now if you place say 30 trades a month and you have a 50% success rate, you can expect to have 5 consecutive losing trades.

But the more trades you place the bigger the chance of consecutive losing runs. So if our trader has 12 x 30 trades a year = 360 they can expect to have nearly 9 consecutive losing trades.

Of course the opposite is also true in that you could expect to get 9 consecutive winning trades as well. The problem is that I have seen many systems that have only a 40% success rate and in the same example above this would result in 12 consecutive losing trades. Psychologically this is very difficult to handle yet if you had backtested your system thoroughly it is easily seen that this is to be expected and means that your system is operating within normal parameters.

Food for thought I hope

Good stuff there. In addition I'd say that if you lower your expected return per trade, increasing your win loss ratio to 10 or 20 to 1 becomes a realistic possibility. Worth thinking about if you're struggling with the psychological side to trading.