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TME 025: Trading Psychology

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Do you have what it takes to be a trader? When we watch sports sometimes someone comes along that defies what normal people can do. When the game is on the line they rise to the occasion. Some say they have a gut of steel. Look at old videos of Joe Montana or current players like Tom Brady. It seems that when the game is on the line these guys get better.

That’s what it takes in trading.

DEFINITION OF ‘TRADING PSYCHOLOGY’
Trading Psychology is emotions and mental state that dictate success or failure in trading securities. Trading psychology refers to the aspects of an individual’s mental makeup that help determine whether he or she will be successful in buying and selling securities for a profit. Trading psychology is as important as other attributes such as knowledge, experience and skill in determining trading success. Discipline and risk-taking are two of the most critical aspects of trading psychology, since a trader’s implementation of these aspects is critical to the success of his or her trading plan. While fear and greed are the two most commonly known emotions associated with trading psychology, other emotions that drive trading behavior are hope and regret.

INVESTOPEDIA EXPLAINS ‘TRADING PSYCHOLOGY’
For an understanding of trading psychology, consider some examples of the emotions associated with it.
Greed is an excessive desire for wealth. Greed often causes traders to stay in a profitable trade longer than is advisable in a bid to squeeze out extra profits from it, or to take on large speculative positions. Greed is most apparent in the final phase of bull markets, when speculation runs rampant and investors throw caution to the winds.
Conversely, fear causes traders to close out positions prematurely or to refrain from taking on risk because of concern about large losses. Fear is palpable during bear markets, and it is a potent emotion that can cause traders and investors to act irrationally in their haste to exit the market. Fear often morphs into panic, which generally causes markets to decline at a much faster rate than they advance.
Regret may cause a trader to get into a trade after initially missing out on it because the stock moved too fast. This is a violation of trading discipline and often results in the trader getting in too late on the trade.
Successful traders have some common psychological traits that contribute to their success. These traits include –
• Know your limits and do not over trade.
• Risk management is the key to preserving trading capital and attaining trading success.
• Maintain trading discipline at all times.
• Know the difference between not fighting the trend and following the herd.

 

Below are 3 ways to get control of our emotions in trading.

1) Forget Right and wrong

One thing we have to do is forget about right and wrong. No one likes to be wrong. Sometimes when you are in a trade that goes the wrong direction we don’t want to sell because for some reason in our mind that is admitting defeat.

I like to fish. If I go fishing with worms then I understand to catch a big fish you have to give up a few worms. It’s the same with trading. To catch a big trend you have to be willing to lose on some trades. The key is to cut your losses when it is time. Don’t hold onto a trade longer than your trading plan tells you to.

We need to realize that it is not about right and wrong. It is about giving up when the trade goes the wrong direction.

 

2) Trade With a System

To me this is the key to having a good trading psychology.

When you look at the car commercials on TV sometimes they show robots building or welding on a car. That robot is programmed to do the same thing over and over and over. The robot does not have feelings.

That is how our trading should be we should trade like a robot. The robot does not think I need to make money for college or to pay rent. It just does the same thing over and over.

When we trade like a robot we do the same thing over and over no matter what market. We trade all of them the same way. That is what trading with a system is about. You build the system and then you just do what the system says. That takes your mind and feelings out of the equation. When you trade with a system then you have no emotions or if you do they don’t effect your trading. You only follow the trading system.

3) Trade Position Size

If you are risking your whole account on one trade then you will not sleep very well at night. When a trader takes too much risk they will not be in the trading business very long. One large loss can take years to recover from.

If too much money is on the line then we are going to get out to early or lose too much money.

 

Systematic Trading VS Psychological Trading

Systematic trading takes most of the emotions out of trading. If you know how much you will lose before you ever get into a trade it make it a lot less stressful. Just look at yourself as an example. Some days you are happy. Some days you are sad. Some days you have great confidence some days you have no confidence. Do you want that person making split second decision on what, when, and how much to buy? Imagine if our accounts were tied to our emotional state. For me that would not be good.

What if while the market was closed you built a system that would think for you while the market was open? That would be a much better way. It tells you when to buy, when to sell, and how much. It has no opinion except the opinion that you programmed it to have. Its decisions are calculation based. What would that do for your trading psychology?

When a person moves from a Psychological trader to a Systematic trader it is a light bulb moment. It all starts to make sense. You become a thoughtless trader. Trading becomes boring and that is the way it should be.

You go from spending all day looking at a computer screen to making a 15 min daily updated once the market is closed.

Conclusion

The goal of a trading system should be to eliminate trading psychology. Remove thought while the market is open and you will be on the road to becoming a systematic trader.

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