Individual Psychology in Trading

A successful trader masters psychology, market analysis and risk management. Here is the first step.

Disclaimer: content is summarised from the Introduction & Part 1 (Chapter 1 - 10) of 'The New Trading for a Living: Psychology, Discipline, Trading Tools and Systems, Risk Control, Trade Management' by Alexander Elder

Psychology is Key

The essential element of winning is management of your own emotions. Managing oneself leads to good risk management. The ability to focus on reality, seeing the world as it is is an important principle of good psychiatry & trading. Trade with your eyes wide open. Recognise real trends & reversals of trends. Do not waste time on regrets / wishful thinking.

The Odds Stacked Against You

Markets are set up such that most traders lose money. In the past, traders were slowly killed with commissions & slippage. Commissions are paid when entering & exiting trades while slippage is the difference between price when order is placed vs. price when order is filled.

The trading market is a minus-sum game wherein winners win less than what losers lose, implying that you must be head & shoulders above the crowd to win. With the digitalisation of trading, commission rates have plummeted. Nevertheless, scout for lowest possible commissions, especially for stocks (not so for Forex)

Slippage

Limit orders guarantees prices but the order might not be filled. Whereas market orders fills the order at the prevailing price. Slippage occurs when a market order is filled as the price rises all of a sudden. Since an average trader spends 3x more on slippage than commissions, one should always resort to limit orders. Use market orders only if you are a day trader (one who is constantly moving in & out of the market on a trading day). As a mid to long-term investors, get in slowly but get out fast (once profits are secured of course)

Spreads

Bid spread is what people offer to pay. Ask spread is what sellers demand. Spreads are thin in liquid markets (heavily traded, active markets) and may only be huge after severe rallies (increases) / drops.

Reality vs Fantasy

Be a realist by knowing your abilities & limitations. Make realistic plans. Do not cut corners during market analysis. Be shrewd. Keep your feelings in check to ensure rationality.

Self-Sabotage

Most failures in life are due to self-sabotage hence, be aware of such tendencies. Take responsibility for your results. Keep a trading diary that documents reasons for your entry & exit of every trade. Then, look for patterns leading to success & failure.

Trading Psychology

You compete against the sharpest minds of the world. Hence, follow set rules to a tee. Do not deviate from rules / plans just because you’re on a roll. Trading must be objective. Follow money management rules. You may also analyse yourself more so than the markets.

Parallels to Alcoholism

Profits give traders an emotional high & a feeling of power. They try to get high again, with reckless trades. However, successful traders treat draw-downs (losses) the way social drinkers treat alcohol. They have a little and stop. If they take several losses in a row, they take that as a signal that something isn't working: perhaps their system isn't in gear with the current market environment. It's time for a break and a fresh look at the markets

Define your businessman's risk—the maximum amount of money you'll risk on any single trade. (never take a loss greater than this predetermined risk) The maximum a trader may risk on any trade is 2% of his account equity. Keep in mind that poor record-keeping is a sure sign of a gambler.

Like an Ocean

The market is like an ocean—it moves up & down regardless of what you wish. You can do nothing to influence it. You can only control your behaviour. "A sailor cannot control the ocean, but he can control himself. He uses his intelligence to study currents and weather patterns. He can learn when to sail and when to stay in the harbour. An ocean can be useful—you can fish in it and use its surface to get to other islands. An ocean can be dangerous—you can drown in it"

In Charge of Your Life

You need drive, knowledge & discipline. Here are several rules that could work in preventing emotionally charged trading:

1. Be in it for the long haul

2. Read & listen to experts, but keep a degree of healthy skepticism

3. Take your time to learn. The market will be there.

4. Develop a method for market analysis

5. Develop a money management plan. Focus on survival first.

6. Winners think, feel, and act differently than losers. Look within, strip away your illusions, and change your old ways of being, thinking, and acting.