Trading psychology 101
I heartily agree with the sentiment that trading psychology is the bedrock for profitable and consistent trading. One of the reigning authorities in this field, Mark Douglas, who wrote the industry classics “The Disciplined Trader” and “Trading in the Zone”, states: “The first step on the road is to understand and completely accept the psychological realities of trading.” The first step. In other words, the psychology part comes before anything else.
Although the field of trading psychology has had many books published, not to mention courses and consultants, I do not believe you have to spend years trying to master it. You can grasp it in a heartbeat. Good trading psychology is simple enough that it falls into the realm of common sense.
The psychology of trading revolves around making certain you maintain your discipline. Discipline, as one dictionary definition puts it, is “behavior in accordance with the rules”.
The rules in this case are the rules of your trading method. They generally fall into two categories: entry and exit rules and risk management rules. The rules could be highly systematic or discretionary, but as a trader, you have decision-making criteria on what gets you in and out of a trade (entry and exit rules) and how much you want to risk on each trade (risk management rules).
When you are trading with real money on the line, you are managing emotions to make certain you trade in accordance to your rules, which, assuming the rules are tested, you are confident will provide you a profitable outcome over a series of trades. The two emotions most sited in trading are Fear and Greed. Most of what is discussed about trading psychology explores what you can do to prevent Fear and Greed working against you.
Discipline in trading is not that different from discipline in other areas of your life. In the end, you have to do what you say you are going to do. In trading, that simply means following your trading plan. After all, your trading plan is you stating how you will trade. Some days it will be easy and other days it will feel like a fight to trade according to your plan.
My closest trading friend recently asked me, “When you take a loss, do you have a routine or mental visualization afterwards?”
My answer was, “No. Nothing.”
Most of the time, I am fine with a loss, or two or three losses, and I just continue. But there are times when it stresses me out. It is a minority of the times but a significant minority, maybe 20% or 25% of the time, I stress out or even lose my temper over a loss. On one occasion, I kicked a garbage can so hard that it left a hole in my wall that needed repairing. On the other side of the fence, after a string of wins, I feel invincible. This is not good either because you can get sloppy by being overconfident. I do not like that part of myself. After so many years of trading, I wish my psyche were more automated. I never fully learned to reign in those emotional ups & downs. Ultimately, I am a human being. But what I have reined in is that no matter how I react, I take the next trade and I do exactly what I am supposed to do. That is all that matters. I do not skip a trade out of fear or take a profit too early because I did not get a profit on my last trade. I would not double my risk because I looked in the mirror that morning and told myself I am a Trading God. I execute the next trade in accordance with my rules regardless of what has happened in the past or how I am feeling in that moment.
What I love about the markets is that it does not matter how you are feeling, or what your haircut is like, or who your friends are, like how those things may matter in your regular life or job. All that matters is that if you do the right thing, the broker will give you the profit that you have earned from the market. Put in your entry, your stop-loss, your target, you will get the result regardless of your emotions. The market will anonymize all of those emotions. Just ask yourself, “are you doing the right thing by your plan?” and you will get the right results.
Experience your emotions. They will happen. Then trade according to your rules and you will get the results you have earned.