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The Hidden Variable in Your Trading Success

Most traders realize that trading involves a lot of psychology. And most traders readily admit that a significant portion of their trading losses, or lack of performance, is due to “psychology”. Although the term ‘psychology’ isn’t always mentioned as an explanation, you can see it easily enough in the following statements ……”I froze just as I was about to pull the trigger”….. ”I hesitated and missed that trade and was so pissed that I got myself into an impulse trade right after”….. “That large loss was not what I wanted, I held it thinking it would come back because last time I bailed out of this type of trade I got stopped out right before it reversed”….. “I was really nervous about losing money again so I got out of my winning trade way before my target”

Those are four common examples of trading psychology issues manifesting in one’s trading. Do you recognize yourself in the above statements?

All four of those statements have in common one thing, fear. Whether it’s the fear of not being perfect, the fear of being wrong, fear of losing money, fear of missing out, the fear of not being approved by others, or some other fear, the common theme is fear. Most trading mistakes are a maladaptive attempt to deal with fear or anxiety.

Emotions like fear and anxiety cannot be eliminated; it is part of the human experience. But how you respond (your behavior, the action you take in response) to anxiety and fear will determine how successful you are as a trader. Some traders recognize this and do something about it; they learn to work with the fear and anxiety to reduce the chance that they’ll continue to fall into the same old behavioral response pattern to fear and anxiety. (more…)

EMOTIONS-GREED and FEAR

Emotions, emotions and emotions, trading will always full of them, movement of the market based on them. Our rush to buy or sell sometimes overflow our plans. The common Forex traders question was “Why did I do this or do that?”

What is driving us to get into the market when we are not prepared and exit on completely different prices, which completely disagree with our plans? Two major factors, Greed and Fear.

Greed come when market goes as we expected then we want more! We believe it will continue for very long time. We forgot that everything changes. For successful trading you need a good strategy and discipline to execute that strategy. No matter how good it is, trading is completely useless without proper execution of the strategy.

We Fear when we afraid to miss the profitable move or to loose the money. And until fear and greed will dominate us, our results will be very unstable. And worse if our money management is not the strongest point, this is the weakest point for emotional traders, will soon will be out of money, before we even had a chance to establish ourself as a trader.

Seven Insights for Disciplined Trading

I’ve always been a fan of Mark Douglas’ work, as my copy of his initial book on trading psychology, The Disciplined Trader, is thoroughly marked up thanks to Douglas’ many innovative ideas about mastering the internal challenges we all face with trading.  His newest book, Trading in the Zone, is full of more great insights. I recently finished reading his excellent follow-up work, and it sparked my review of key points I take out of Douglas’ ground-breaking insights:

1) Develop consistency.  Douglas focuses on how we can create a mindset of consistency by developing beliefs which support us in obtaining this result.  In order to develop consistency, Douglas emphasizes beliefs such as objectively identifying your edges, defining the risk in each trade in advance, accepting the risk to be able to exit a position when a defined loss level is realized, and many other key mindsets that help traders work through the issues they face in taking a trade, making the trade and executing their exit from the trade.

2) Trading is a probability game.  You can’t be a perfectionist and expect to be a great trader. Your losses (that you hope will return to breakeven) will kill you.

3) Jumping in too soon or getting in too late.  These mistakes come from traders not having a well-defined plan of how they will enter the market.  This positions the trader as a reactive trader instead of a proactive trader, which increase the level of emotion the trader will feel in reacting to market movements.  A written plan helps make a trader more systematic and objective, and reduces the risk that emotions will cause the trader to deviate from his plan.

4) Not taking profits on winners and letting winners turn to losers.  Again this is a function of not having a properly thought-out plan.  Entries are easy but exits are hard.  You must have a plan for how you will exit the market, both on your winners and your losers.  Then your job as a trader becomes to execute your plan precisely.

5) Great traders don’t place their own expectations on to the market’s behavior.  Poor traders expect the market to give them something.  When conditions change, a smart trader will recognize that, and take what the market gives. 

6) Emotional pain comes from expectations not being realized.  When you expect something, and it doesn’t deliver as expected, what occurs? Disappointment.  By not having expectations of the market, you are not setting yourself up for this inner turmoil.  Douglas states that the market doesn’t generate pain or pleasure inherently; the market only generates upticks and downticks.  It is how we perceive and respond to these upticks and downticks that determine how we feel.  This perception and feeling is a function of our beliefs.  If you’re still feeling pain when taking a loss according to your plan, you are still experiencing a belief that your loss is somehow a negative reflection on you personally. 

7) The Four Major Fears – fear of losing money, being wrong, missing out, leaving money on the table.  All of these fears result from thinking you know what will happen next. Your trading plan must approach trading as a probabilities game, where you know in advance you will win some and lose some, but that the odds will be in your favor over time.  If you approach trading thinking that you can’t take a loss, then take three losses in a row (which is to be expected in most trading methods), you will be emotionally devastated and will give up on your plan.

A battle against human survival instinct

battleTrading is a battle against human survival instinct.
It takes a long time to have a person’s brain rewire to the point where trying to survive doesn’t override what that person does during the middle of it when the heat gets turned up. Everyone loses accounts their first year, many will lose accounts next years, no matter how well they were consistently doing demo trading because when emotions start happening it literally stops a person from being able to press the button out of pure fear.

9 Trading Rules

1. Move: Always be flexible.  The beauty of the stock market is polygamy is perfectly acceptable.  Never get married to a particular position or a particular strategy.   The market is complex, dynamic and always changing.  Learn to change with it if necessary.

2.  Plan de Vida: Always invest with a plan.  Have strict rules and a machine-like approach.

3.  Downshift: Pulling yourself out of the game when you’re not certain will help you from making debilitating mistakes.  When in doubt get out.

4. 80% Rule: Never let more than 20% of your portfolio put 80% of your portfolio at risk.  Position sizing is key to risk management.

5. Hope is a 4 letter word: Holding and hoping is not a strategy.  Cut your losses, learn from it and never look back.   Never ever get into something you can’t get out of.

6. Understand your risks: You can’t avoid black swans, but they don’t have to rip your face off.  Understand your risks and your rewards.

7. Goals and accountability: Set goals and keep track of your performance.  You are responsible for your own decisions.  Own your mistakes.

8. Psychology: Learn to control your emotions and understand the emotions of those around you.  Always remember what General Patton said: “if everyone is thinking the same then someone isn’t thinking”.   Also the famous Buffett quote: “Be fearful when others are greedy and greedy when others are fearful.”

9. Your Tribe: Always remember that there is more to life than investing.  Don’t live to invest.  Invest to live.  Being the richest man/woman in the graveyard is worthless if there isn’t anyone to bury you there.

Chasing a Trade and The Power of Regret

Everyone knows that chasing price is usually not beneficial, we either end up catching the move too late, or we get poor trade location, which makes it more difficult to manage the trade.

However, there are other forms of chasing that are just as common, maybe more common, and just as counter-productive. 

Traders who are not profitable are often too quick to chase after new set-ups and indicators, or a different chat room, if that’s your thing.  Obviously, we need to have a trading edge, whether it is from the statistical perspective of a positive expectancy, or simply the confidence in a particular discretionary strategy such as tape reading, following order flow, market profile, etc.

Chasing a trade is the fear of missing out. The fear of missing out is associated with various emotions, including regret. There’s a lot of talk about fear and greed in trading, but the power of regret is often overlooked. Some of my own worst trades, and those of my clients, often have a ‘regret from missing a prior opportunity’ component. When I finally finish my book on the psychology of financial risk taking, I will include much about this overlooked but very powerful emotion.

Somewhat related to chasing a trade, is impulse trading.  They both have in common the underlying feeling of the fear of missing out.  It’s tempting for me to talk about impulse trading here, but it really deserves its own piece.

The Secret Sauce: A Knowledge Advantage

“What is your secret sauce?

Click here to find out more!

No. 1, it’s possible, especially in inefficient markets, to gain a knowledge advantage. By definition, an inefficient market is one where hard work and skill can pay off. We can also control our psyche and emotions so that we don’t make the human mistakes that are so common. Of course the other thing is we have a philosophy of controlling risk. So that doesn’t necessarily make us the winner rather than the loser in the transaction, but it increases the probability that we engage in transactions of the sort that we and our clients want.”

There are a few ways to access better knowledge in an inefficient market.  You either have better sources, illegal information or you just simply have a superior understanding.  That’s why I always emphasize the importance of a sound top-down approach.  If you don’t understand the monetary system you’re more inclined to make mistakes in micro managing your portfolio.  You make silly mistakes like misunderstanding how the Fed operates, how QE works, how fiscal policy impacts the economy, how bond auctions works, etc etc. Misunderstanding these important macro functions has resulted in endless predictions for hyperinflation, rising bond yields, falling stock prices, etc.  But if you had a sound understanding of the system – if you had a better understanding – you sidestepped all of these predictions that were clearly wrong if you understood how the system works.

You don’t need to cheat or steal to get better information or knowledge.  Sometimes it’s a matter of putting in the effort to obtain it.

Wealth Principles

  • Your income can grow only to the extent you do
  • If you want to change the fruits, you will first have to change the roots.  If you want to change the visible, you must first change the invisible.
  • Money is a result, wealth is a result, health is a result, illness is a result, your weight is a result.  We live in a world of cause and effect.
  • Thoughts –> Feelings–>Actions–>Results TFAR
  • When the subconscious mind must choose between deeply rooted emotions and logic, emotions will almost always win
  • If your motivation for acquiring money or success comes from a non-supportive root such as fear, anger, or the need to “prove” yourself, your money will never bring you happiness
  • The only way to permanently change the temperature in the room is to reset the thermostat.  In the same way, the only way to change our level of financial success “permanently” is to reset your financial thermostat.
  • Consciousness is observing your thoughts and actions so that you can live from true choice in the present moment rather than being run by programming from the past.
  • You can choose to think in ways that will support you in your happiness and success instead of ways that don’t.
  • Money is extremely important in the areas in which it works, and extremely unimportant in the areas in which it doesn’t.
  • When you are complaining, you become a living breathing “crap magnet”
  • There is no such thing as a really rich victim!

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15 Points for Traders

1. Anger over a losing trade – Traders usually feel as if they are victims of the market. This is usually because they either 1) care too much about the trade and/or 2) have unrealistic expectations. They seek approval from the markets, something the markets cannot provide.
2. Trading too much – Traders that do this have some personal need to “conquer” the market. The sole motivation here is greed and about “getting even” with the market. It is impossible to get “even” with the market. Trading too much is also indicative of a lack of discipline and ignoring set rules. This is emotionally-driven.
3. Trading the wrong size – Traders ignore or don’t recognize the risk of each trade or do not understand money management. There is no personal responsibility here. Typically, aggressive position sizes are used, however if risk is not contained, then it could spiral out of control. Usually, this issue comes from traders wanting to make a huge killing. Maybe they do win, but the point is that a bad habit emerges if a trader repeats this behavior.
4. PMSing after the day is over – Traders are on a wild emotional roller coaster that is fueled by a plethora of emotions ranging throughout the spectrum. Focus is taken off of the process and is placed too heavily on the money. These people are very irritable akin to the symptoms of premenstrual syndrome (something I wouldn’t know about personally).
5. Using money you can’t afford to lose – Usually, a trader is pinning his/her last hopes to make money. Traders fear “losing” the “last best opportunity”. Self-discipline is quickly forgotten but the power of greed drives them, usually over a cliff. Here, the rewards are given more attention and overall personal financial risk is ignored.
6. Wishing, hoping, or praying – Do this in church, but leave this out of the market. Traders do not take control of their trades and cannot accept the present reality of what’s happening in the market.
7. Getting high after a huge win – These traders tie their self-worth to their success in the markets or by the value of their account. Usually, these folks have an unrealistic feeling of being “in control” of the markets. A huge loss usually sobers them up pretty quickly. It’s important to maintain emotional restraint after wins, just as you would for losses.
8. Adding to a losing position – Also known as doubling, tripling, quadrupling down, typically, this means that the trader does not want to admit the trade is wrong. The trader’s ego is at stake and #6 comes into effect as the trader is hoping the markets will “work in their favor”. If you are wrong, you have a near 0% chance of making a full recovery. (more…)

Ignore Your Guts

In my studies I have often found something that is rather interesting and maybe different than most would suspect. The most successful traders I have studied don’t rely on gut calls or feels, but rather adhere to a disciplined set of rules or guidelines and are humbled enough to admit that their emotional decisions aren’t consistent enough to hold up during the heat of the moment.

Ironically, most would think just the opposite that the more successful a trader is, the more ‘feel’ he or she has or the more ‘instinct.’ Sure, it looks macho to make calls or predictions and when proven correct a person is often praised and viewed as having some superior knowledge, but in reality these people are one step below those that have already moved through this stage and left it behind.

As an individual trader it is simply impossible to remain emotionless, making the proper trading decisions at all times, when the action is heated. Even when there is a lull, our emotions kick in and we feel a change is needed or something should be done, when in reality our rules may say to stay put or do nothing.