While no one at the firm is a trained psychologist, nor have any of us ever played one on TV, we know from experience, personal and corporate, that psychology plays an important role in trading. This not only includes how a particular trader’s personality will influence how he or she approaches the markets, but how external events, and the trader’s reaction to them, affect that trader’s actions regarding trades, risk management, and portfolio management.
As traders, when money is on the table in a trade, we like to think that we will always be disciplined machines, following our trading plans to the letter, and that nothing can get in the way of a well-executed plan. In reality, as human beings, we have to recognize that we are often at the mercy of the chemicals are own brains produce, especially early in a trader’s career.
This section is designed to shed some light on how internal and external events and our reactions to them, collectively psychology, affect traders. It’s important that you not try to fight your reactions, but recognize them, understand them, and put procedures in place so that these reactions don’t negatively affect your trading.
The Trader
You can set up the most methodical plan, set triggers, and have step by step algorithms in place for order entry, trade management, and trade exit, but in the end, you, the trader, are the most volatile variable in the entire equation. Understanding this is one of the keys to mastering the effects psychology has on trading.
To be a professional trader, you have to understand your personality type. You must understand the strengths of your personality. This is easy for most people, as recognizing our strengths feeds our egos and makes us feel good about ourselves. The hard part is understanding the weaknesses of your personality. Most people don’t like to do this because it is uncomfortable and makes us evaluate past actions that may not have had positive outcomes. Finally, you must understand that both your strengths and weaknesses will inform the tendencies of your reactions in multiple scenarios. Only by recognizing all three of these factors, studying them, and by putting procedures in place to capitalize on or minimize the impact of your reactions and tendencies will you be able to master your personality as it pertains to trading.
Included Sessions
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Programming
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Brain Chemistry
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Habits
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Behavior Change
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Overtrading
Before the Trade
As humans, we are generally pretty good at leveraging the gray matter in our pre-frontal cortices when there is nothing at risk (i.e. money on the line). This means that prior to the trade, when evaluating setups, we are generally fairly clear-headed. This theory is accurate when examining a single trade in isolation.
But, what happens when you have the baggage of previous trades bolstering or weighing on your mind? Is the trader who just experienced four consecutive losses in well-planned trades really trading with the same mental clarity as if those losing trades had never happened? Is the trader who just enjoyed four consecutive winning trades in danger of abandoning tested risk management techniques and over-leveraging a portfolio due to a misplaced sense of infallibility? These scenarios, and countless others affect traders prior to the trade even being executed and must be studied and understood for success in the long run.
Included Sessions
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Confirmation Bias
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Familiarity Bias
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Recency Bias
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Anchoring
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Herd Behavior
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News Cycles
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Hesitation
During the Trade
We’ve all heard the mantra: “Plan the Trade, Trade the Plan.” In theory, this is easy to do. In practice, it can be incredibly stressful and difficult. Internalities and externalities can and will affect your mindset during a trade, especially if you have very few positions, or have come off an extended winning or losing streak.
Concern over a single particular trade can quickly lead to an unhealthy, albeit short-term obsession with the trade. When this happens, it is much more likely for the trader to “poke” a trade that should have been left alone, double-down on a losing position, or prematurely exit a winning trade out of fear. Ego, fear, and greed all have the potential to impact a trader’s mindset during a trade.
Included Sessions
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Fear
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Greed
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Adrenaline
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Screen Watching
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Misuse of Stops
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Cutting Winners
After the Trade
Trading is a game of probabilities. We work to put as many probabilities on our side of the equation as possible in order to have a profitable trade. Eventually though, all probability waves collapse into an observed reality.
Whether that observed reality is win, lose, or break-even, our reactions to a trade or series of trades have the potential to inform our actions in future trades, for good and ill. Understanding your personal reactions to each of these scenarios is another key to understanding your personality and using that knowledge for success in trading.
Included Sessions
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Envy
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Regret
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Revenge Trading
Losing
Nobody likes to lose in trading, or in life. First, it negatively impacts us financially. Second, and often more detrimental long-term, is that it negatively impacts our egos and self-images.
A prolonged losing streak, or even a single (often over-leveraged) trade can have such an outsized negative impact that a trader may abandon a perfectly functional trading system and begin to trade with no plan or risk management out of desperation for a win or despondency over losses. Not placing yourself in that type of situation is the best preventative, but these situations happen to every trader at some point. Understanding your personal reaction cycle to losses is a key to avoiding desperate but self-destructive behavior.
Included Sessions
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Dealing with Slumps
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Physical Changes in the Brain After Loss
Winning
Everyone likes winning. Our chemically dependent brains get a measurable shot of adrenaline and dopamine when we exit a winning trade. We feel good. We feel smart. We feel invincible. Our ego is fed. We feel we have mastered this beast called The Market and we can and shall bend it to our Will.
Perversely, in trading, even winning is a two edged sword. The chemicals our brain produces and the euphoria we experience in winning trades can drive us to do things that would have been unthinkable just a short time ago. We skirt the danger of abandoning risk management principles that brought us success because we feel we are unstoppable and can’t lose in our next trades. Along these same lines, we also run the risk of trading indiscriminately (because we can’t lose) or overtrading because we want to feel the joy of success more often. Understanding these dangers allows us as traders to learn to bask in the joy of the win, but also come back down to reality and regain the humility required for longevity and success as professional traders.
Included Sessions
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Chasing Perfection – The Holy Grail
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Physical Changes in the Brain After Winning
Miscellaneous
In this section, we’ve addressed with a very broad brush the major facets of psychology in trading. That said, in trading, as in life, there are a multitude of scenarios that don’t necessarily fit neatly into one of our previous sections. In this section, we will address those hard to quantify and categorize scenarios that all traders will experience at some point in their trading careers.
Included Sessions
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TBD
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