Trading Psychology
95% of traders fail.
Why traders fail:
- Poor psychology (emotions, discipline)
- Poor risk management
Notice that "bad strategy" isn't on the list. Most traders don't fail because their strategy is wrong. They fail because they can't control themselves.
The Emotional Trap
Here's where most traders go wrong. They attach an emotional response to what they see in the market and to their trades. They try to figure out which trade will be successful and which won't. They go so far as to say - and to act - that they only take trades they believe will be successful. And if they don't believe a particular trade will be successful, they won't take the trade at all.
But that's fundamentally flawed thinking. Your job isn't to predict individual trades. Your job is to execute a system that has an edge over many trades.
Traders get disappointed and feel betrayed when they assign some sort of certainty to their trades. They only take trades they believe will be successful. But it's not the job of a trader to believe in any one individual trade. The responsibility is to believe in a series of trades, over probability, over a long time horizon.
This concept is explored in depth in Understanding Probability: The Core Truth of Trading.
Emotional Trading
Most people can't get a handle on their emotions when money is on the line. It takes a lot of being exposed to those emotions to be able to conquer them and keep them in check.
The Emotions You'll Face
Fear
- Fear of losing money makes you exit winners too early
- Fear of missing out (FOMO) makes you chase trades you shouldn't take
- Fear of being wrong makes you hesitate on valid setups
Greed
- Greed makes you hold winners too long until they turn into losers
- Greed makes you risk too much on "sure things"
- Greed makes you overtrade when you're on a winning streak
Hope
- Hope makes you hold losing trades, waiting for them to "come back"
- Hope makes you ignore your stop loss
- Hope is not a strategy
Frustration/Anger
- Frustration after losses leads to revenge trading
- Anger makes you abandon your plan and take stupid trades
- One emotional trade can undo a week of good work
Disappointment/Betrayal
- Disappointment follows when a trade doesn't go the way it was expected to
- Betrayal is felt when "everything was done right" but the trade still lost
- These feelings come from assigning certainty to individual trades - expecting them to work out because they were believed in
Rules to Follow
- If you're not in the right headspace, don't trade
- No revenge trading - chasing losses only creates more losses
- No "compensation" trading - trying to make back what you lost in one big trade
- No overtrading - more trades doesn't mean more profit
- Don't be a sore loser - you'll lose most of the time anyway. If you can't handle that, don't trade.
The Hard Truth
Good trading practices are very much counter to natural instincts.
When things are going well, there is fear that they will stop going well. When things are going badly, there is hope that they will turn around.
This leads to traders:
- Taking very small gains the moment they're up on a position
- Holding losers for much bigger losses, hoping they'll recover
The right thing to do:
- Hold (and even add to) your best positions
- Cut your losers quickly
But that is VERY psychologically hard to train yourself to do. It goes against every instinct. This is why most people fail - not because they don't know what to do, but because they can't make themselves do it.
Chopping and Changing
One of the biggest mistakes: not giving enough time to a strategy to see it through.
The reality is most strategies work. But not all at the same time. Every strategy has winning periods and losing periods.
If you switch strategies every time you hit a losing streak, you'll never give any strategy the chance to prove itself.
The problem:
- You win one time. You lose another.
- How do you know if it was luck or your strategy?
- If it was your strategy, you don't even know which part worked because you changed things each time.
There has to be consistency.
You can't make a fair evaluation of something if the conditions keep changing every time. Stick with one approach long enough to gather real data. Only then can you decide if it's working or not.
The Danger of Creating Patterns
Trouble starts when relationships are assigned between trades. It's dangerous territory to say "because the last three trades were losers, the next one should be a winner." That's not how probability works.
Creating relationships between trades is where disappointment starts. "The last trade worked. The last trade was successful. So therefore this one must also be successful."
The exact same setup, the exact same price action, can have two very different results. When one setup gives a successful trade, and then the exact same setup appears again, a pattern is created in the mind. The assumption is that because it worked last time, it must work this time.
And that's where disappointment comes. That's where the feeling of betrayal comes. But it's all false. It's all fabricated.
Every trade is a completely unique circumstance. Relationships or patterns cannot be created between individual trades.
Too much importance gets placed on each individual trade. It's not the job of a trader to believe in any one individual trade. The responsibility is to believe in a series of trades, over probability, over a long time horizon.
Things to Remember
Right Idea, Wrong Time
Sometimes you could have done nothing wrong. You could have done everything perfectly, but still lose.
That's okay. Don't take it personally. It's not a reflection of your strategy.
The market doesn't owe you anything. Even the best setups fail sometimes. What matters is whether your setup wins more often than it loses over many trades.
Just keep it stepping. Not every trade will be a winner.
Your Strategy is an Edge, Not a Prediction
Once you understand that your trading strategy is not a prediction but an edge, you lose that emotional response to events in the market. You stop feeling betrayed. You stop getting disappointed. You stop getting excited. And you just get on with your day, following the process through and through.
Each individual trade has roughly a 50% chance of winning or losing. But on a wider scale, that's where the edge comes into play. It's not your responsibility to guess or analyse which trades will be successful. It's your responsibility to follow the process from start to finish, irrespective of the outcome.
Manage Your Expectations
Trading is not get rich quick.
The game plan is consistency over time. Not big jumps in one move.
Reality check:
- It takes most traders on average a couple of years to become profitable
- You will lose most of the time, especially in the beginning
- It doesn't take hundreds of hours - it takes thousands of hours
- It takes several years to become consistent and profitable
It takes education and practice to become successful, and most people skip out on both.
No patience. People want to get rich overnight. After a couple of months when they realise they can't get rich overnight from trading, they just quit.
Don't be that person. Don't rush.
Expect to Lose
Understanding probability has a direct impact on your expectations. Because now you actually expect to lose - on some trades.
This is liberating. When you expect losses as part of the process, they stop hurting. You stop assigning meaning to individual outcomes. A loss is just one data point in a long series of trades.
It's not about taking the next trade. It's about taking the next 20 trades.
The horizon has to be zoomed out. Less focus on each individual trade. More focus on trades overall. That is the responsibility of a trader.
Trust Your System, Not Yourself
When you're in a trade, your brain will lie to you. It will tell you to move your stop loss. It will tell you to take profit early. It will tell you to hold a loser "just a bit longer."
Don't listen.
Trust the system you built when you were calm and thinking clearly. That version of you made better decisions than the version watching a trade go against you.
If your system says exit, exit. If your system says hold, hold. Remove yourself from the equation.
Keep It Simple
The more complicated your strategy, the more ways it can break down. The more rules you have, the more likely you are to break them under pressure.
Simple strategies:
- Are easier to follow consistently
- Have fewer moving parts to fail
- Are easier to review and improve
You don't need 10 indicators and 20 rules. You need a few things that work, applied consistently.
Discipline is Everything
You can have the best strategy in the world. It means nothing if you don't follow it.
Discipline is:
- Taking the trade when your setup appears, even if you're scared
- Not taking a trade when your setup isn't there, even if you're bored
- Following your stop loss, even when it hurts
- Sticking to your position size, even when you're confident
- Walking away after your daily loss limit, even when you want revenge
Discipline isn't about being perfect. It's about following your rules more often than you break them.
The Process Over the Outcome
Don't judge a trade by whether you won or lost. Judge it by whether you followed your plan.
- A winning trade where you broke your rules is a bad trade
- A losing trade where you followed your rules is a good trade
Over time, good process leads to good results. Bad process, even if you get lucky a few times, leads to failure.
Focus on the process. The profits will follow.
Good to Note
While not necessary, the more you understand your own behaviour and psychology, the better. You'll have a grip on your downfalls and how to combat them.
Pay attention to:
- What emotions trigger your worst decisions?
- What time of day do you make the most mistakes?
- What situations cause you to break your rules?
Self-awareness is a trading edge. Know your weaknesses so you can protect yourself from them.
Fundamentals complete.
You now have the foundation. Next step: build your strategy.
Continue to: What is a Trading Plan?