Trading Psychology

Most of the traders are in it for making a quick, easy buck. They look for a Holy Grail, a black-box trading system or strategy that will generate buy and sell signals or better yet, an automated one which will do the trading and generate huge profits. There are really good books on trading psychology with good advice on how not to trade. As every trader, I read most of them but when it comes to real trading, usually I used to break my own rules.

Here are some common mistakes most traders do

  1. Chasing a trade : You see the price moving up and your plan suggests to wait for a pull back. But now doubt creeps in, will the price really pull back ?  What if it doesn’t ? Am I going to miss a nice opportunity ? I have seen charts with no pull backs, I have to take this trade right now …. pooh there goes the trading plan.  Some people always trade like there wont be a Market tomorrow and end up buying at the top of a pivot or swing.
  2. Moving the Stops: You enter a trade and place the stop based on your analysis. Now price starts moving against you and you are worried of getting stopped out. You think that this could be just a spike and Market will move higher, at least that is what your analysis revealed, thus you start moving the Stop lower. Instead of taking the small loss now you are holding a loosing position hoping the price will move higher and end up taking a bigger loss.
  3. Over-trading: Most traders over trade for 3 reasons: pure greed, vengeance and fear.
    •  Greed: You crunch the numbers and see how much a 5 point move can generate by trading  3 contracts. You look at the maximum risk you can take per trade and put 3 contracts in the trading plan.  Once the price starts making a strong directional move, greed kicks in and trading 10 contracts become more appealing as it will make 3 times more profit for the same trade. You end up trading 10 instead of 3. Now you are on the edge of your seat and heart rate rises with every tick. You have risked more than you can afford and thus the anxiety. Chances are price might make a small pullback and given your emotional state, you might think price is going to reverse and exit the trade prematurely.
    • Vengeance: You started your day with some bad trades and loose some money in the morning. You thought it was a perfect setup and Market made a spike low and took out your stops. Tried it couple of more times and Market reversed with every trade. Now you start getting a feeling that Market Makers are out there to get you. You being smarter than the rest cannot allow this and have to get the money back and some more. Now the real fight begins, of-course this time with more contracts than you can afford as you are going to get the money back, faster.
    • Fear: You may have a daily profit target set for each trading day. Once you have some loosing trades, fear kicks in looking at the account balance. You want to make up for the loss and most of the time will end up trading more contacts than your trading account can afford.
  4. Trading without a plan: At the bare minimum a trader should be aware of how much he can risk per trade. If not, one will end up over trading and wipe out the trading account fairly soon. Real preparation for the next trading day starts once the Market closes, identifying support/resistance zones, value areas etc and derive a possible bias for the next trading day. Never enter a trade without understanding the context of that trade. One should always be able to answer why the trade was entered and why you think it was a high probability trade. Plan will help the trader to see the risk-reward ratio, profit targets and stops before entering the trade.  Traders who fail often do not have a plan or fail to stick with the plan.
  5. Market Context: Market context is the piece of the puzzle a trader puts together to make the trade a high probability one. This could be a confluence of indicators or the directional bias you derived by analyzing the price action etc. Knowing the context will let the trader enter high probability trades with required confidence. Once you understand the trade and its context, you are confident about the trade you entered and the stops you placed. Minor pullbacks will not upset you or make you exit the trade prematurely. Traders who fail often enter trades without having a full understanding of the context. Such trades are like gambling or speculation.

It is fairly easy to give and take good advice, the problem is practicing it. Same is true with trading, you know the drill and the rules but discard most of it while trading. Once you are on the edge you will start cursing the Market and its Makers who are out there to get you, bang the key board and shout at anyone comes in your way. Once your mind is agitated, it is hard to make rational decisions and most of the time trader will commit all the mistakes mentioned above.

Given the fact that it is hard to stick with the rules, first step is to develop the discipline to stick with the rules.  Sit thru some good trade setups without placing a trade. Know the Market will be there tomorrow and it will present ample opportunities  as always. Missing an opportunity is not big deal and you don’t have to over-trade to make money.

If it is hard for you to miss a trade and sit there watching it pass by, you have issues to be dealt with.  Watch your emotions and observe what exactly you feel. Force yourself to do this until you can sit there and watch it with out a surge of emotions.

Emotional balance and discipline is quintessential in trading. With out a healthy state of mind it is impossible to make rational decisions and stick with the trading plan without caving into greed and fear.

As a matter of fact, once you tame your greed, fear and emotions, it will help you in every aspect of your life, not just trading. Given money is the major cause of stress , strained relationships, family feud  etc, taming the greed monster is the first step in your spiritual evolution and trading.

Related Blogs

The Random Trader

Practical Meditation For Trading