All traders have both wins and losses regardless of their strategy and system. Much like in sports traders don’t succeed on every trade just like baseball players don’t hit every pitch and basketball players don’t sink every basket. Trading is a game of win rate and positive expectancy through bigger wins than losses on average. New traders are surprised at the emotions that become involved with trading real money that was not present during system development. How you manage your psychology and discipline in trading will determine your success even after you have a system with an edge.
Here are seven key trading psychology rules to help you manage your emotions during your losing trades and maintain discipline.
1. Never let a losing day cost you more than your average winning day.
Your winning days should be bigger than your losing days. A key to getting and staying profitable is keeping your losses small and not allowing them to grow out of hand and become bigger than your wins. You can think of your risk/reward ratio in time as well as dollars and you should spend more time in your winning trades than losing trades. A losing day should not be bigger than an average winning day if you’re using stop losses and proper position sizing.
2. Quantify your stop loss level before you enter a trade.
You must know where you’re getting out of a trade before you ever get in. You must define the price level where your trade should not go if the trade is correct. Once that level is reached you must accept the loss to keep it small. Asking other people what you should do in a losing trade is a sign you have no trading plan. Quantify your risk at the start to define your risk/reward ratio.
3. Don’t engage in revenge trading.
Revenge trading is the irrational desire to win back your losses from the same market, chart and stock that you lost money in.
Revenge trading is commonly triggered by the ego feeling beaten by a stock and wanting to get even with the chart by making their losses back in new profits. A trader can become obsessed with making the money back on the same chart that they lost it on to feel a return to even for trading it. They can feel they are better or won against an imaginary adversary or the market.
This is a big mental weakness for people that are very competitive, hate to lose, and always want to prove they were right.
The simple solution for this is to not take any loss personally, follow a system with a diversified watchlist and move on to the next trading opportunity. With proper position sizing and risk management each trade should just be one of the next 100 trades and not engage the ego in battle against a chart they lost money on.
4. Accept responsibility for your trading results.
The blame game will destroy a trader’s ability to create the right mindset for positive trading results. In the end we chose our trading system, we did the research, we entered and exited the trades, we own the outcome. While we don’t control the market price action, we control our own actions and must accept both the success and losses.
Blaming the market, other people, the Federal Reserve, or politicians for our losses and losing streaks creates no constructive value to our trading. Accepting the outcome of following our strategy as our own, in the short-term can lead to long-term success is continuing to learn and adjust to the environment and not repeat mistakes.
We can only take responsibility for following our trading system with discipline and consistency not for what the market does. In the long-term our positive expectancy model should play out with profits, in the short-term anything can happen.
5. Only trade when your edge is present in the markets.
Only trade when your signals are triggered and your edge is present. Not every day and every market environment is conducive to your own strategy and system. Know when you should be trading and when you should be waiting. When there is nothing to do in the market, have the discipline to do nothing. Every trading system should have cash signals and when to be out of the market. Traders don’t get paid for activity; they only get paid for the correct activity.
6. Every trade should have the proper position sizing.
Base your position sizing in your trades on the maximum amount of capital you want to lose on a trade. Losing more than 1% on any one trade can become dangerous. If I am trading with a $100,000 account, I don’t want to lose more than $1,000 in a losing trade. A stop loss level has to start at the price level that you know you are wrong, and work back to position sizing. If the support level on your trade is $105 for your entry and you set your stop at $100, then you can trade 200 shares with a stop at the $100 price level. 200 X $105 = $21,000 position size for 200 shares. This is about 20% of your total trading capital with about a 5% stop loss on your position that equals a 1% loss of your total trading capital.
- A 20% position size of your total trading capital gives you a potential 5% stop loss on your position to equal 1% of total trading capital.
- A 10% position size of your total trading capital gives you a potential 10% stop loss on your position to equal 1% of total trading capital.
- A 5% position size of your total trading capital gives you a potential 20% stop loss on your position to equal 1% of total trading capital.
The average true range (ATR) can give you the daily range of price movement and help you position size based on your time frame and your stocks volatility. If your entry is $105, your stop is $100, and the ATR is $1, then you have a five days worth of movement against you as a stop.
Start with your stop loss level and volatility to give yourself your position size. The more room you want on your stop determines how big of a position size you can take.
If you only risk losing 1% of your trading capital when you are wrong, then every trade can become just one of the next 100 with little emotional impact. Ultimately, you can survive losing streaks and increase your odds of trading success.
Focus on your trading system execution and not the outcome of any one trade.
If you focus on trading your system with discipline and focus, in the long-term results will take care of their self. Your focus must be on the positive expectancy of your system, not the results of any one trade. If you position size right, each trade should be seen inside the context of just one of your next 100 trades.
Trading too big or wanting to be right about a trade can put a trader on tilt causing them to lose the ability to think clearly, stay emotionally balanced, and execute their trading plan with discipline. Focus on your process, not short-term results. One trade can have a random outcome but 100 trades is a filter you can use to profit from your edge. Focus must be on the big picture and not just one trade. These rules can be powerful to add to your trading plan parameters.