Trading Psychology - Developing a Traders Mindset Part 4
Will controlling fear make us better traders?
In the previous posts in this series we have focussed on fear, as it is often cited as having the biggest impact on our trading psychology.
I would certainly tend to agree, but it is not the only emotion traders need to master.
In this post I’m going to talk about a couple of sins that traders also need to be aware of if they want to learn how to trade profitably.
Ego and Greed
“Ego is not a dirty word” according to the band Skyhooks, and I’d suggest a healthy ego is a prerequisite if you are serious about trading.
But having a healthy ego is not the same as being greedy or egotistical.
With a few successes behind them, it can be all too easy for new traders to become overconfident and start believing they can disregard their trading plan. They may well have noticed some activity on a stock they’ve been following before their trading system provided an entry signal, or thought that they should exit a trade before the actual exit trigger told them to.
In either case, once the trader starts to believe they can do better than their trading system, then they will start to ignore it. Their trading rules will soon become merely trading ‘guidelines’.
This can be the beginning of a downfall for inexperienced traders.
They may start to ignore their money management strategy and start placing larger percentages of their trading bank in each trade, or trading a greater percentage of their overall bank than they should at any one time.
Does this happen? Yes it does! I know this from personal experience in my first year of trading and I’ve seen it happen to others as well.
Why does it happen? Greed!
With smaller accounts and smaller trades, brokerage fees and the other costs of trading (such as your data provider) consume a larger proportion of profits than with larger trades, so the temptation is to try and get more ‘bang for your buck’.
The thrill of receiving ‘easy money’ can also have your mind spinning with possibiities as well. The idea of being able to achieve your objectives much earlier than expected can have a disastrous effect on your discipline. Especally if one of those objectives includes giving up a day job that you hate.
You also need to ask yourself if you may be feeling a little competitive as well? It’s all too easy to find details of how experts are trading, or how others are doing with their trades. So be careful if you start to feel lured into overtrading as a way of ‘keeping up with the Joneses’. You may end up holding onto a trade after your stop has been triggered out of a need to be “right” or to keep rolling out a losing trade so that you can eventually call it a ‘win’. Keep in mind though that if you roll a trade out, then that process consists of TWO trades; one trade that you’ve closed for a loss, and one new trade you’ve opened which you hope will offset it. Being honest with yourself is good for developing your mindset.
So what can you do if your trading is being affected by emotions such as fear, greed and ego?
Follow your trading plan!
As a traders experience grows, the more they are going to develop a feel for trading, particularly with those stocks or markets they watch regularly.
If they can identify some ‘tweaking’ of their trading system rules so that it provides better entries and exits for a particular stock or market, then they need to treat it as a new system. In other words, have the discipline to backtest the new rules and compare the results with the original system before implementing the changes.
Keep in mind that all systems have their pros and cons. For example; if you are frustrated that your exit rules get you out of a trade too late & you’re leaving too much profit behind, then just remember the flip side. If your system gets you out too early, then you may miss longer profit runs, or be in and out of trades more often than you need to be. It’s all a “trade-off” (pun intended!)
I personally believe that if mechanical traders start to become dissatisfied with following their system, then they may want to consider setting aside a small portion of their trading accounts for the occasional discretionary trade. This way they can maintain their focus on their trading plan without feeling so constricted by their system that they become frustrated with it.
Sooner or later however, a trader is bound to outgrow their original trading plan.
This happens with any business as it grows and becomes more established. Those of you reading this that have management training or experience would be famiiar with the planning cycle, and the constant process of re-planning as objectives are achieved.
Why not make it a point to review your plan each financial year after you’ve prepared your reports for your tax return?
If you find you are satisfied with how it looks and operates, then simply endorse it as your business plan for the next year. If not, then you may need to go back to the beginning and review your objectives.
Your trading plan is one of your best defences against trading on emotions, so you need to be happy with it, and trust it.
Happy Trading
Brian Dibbins
Elite Insiders Group - Trading Systems
Trade Profitably © 2006 - 2007
