Top 3 Trading Psychology Lessons

The wrong trading psychology is one of the biggest things that cause people to fail in trading the financial markets. No trading system will work, no matter how good, if a trader can’t follow it with discipline and focus over a long period of time. It is emotions and ego that usually cause a trader to abandon good risk management parameters and trade too big, with too much risk, and destroy their accounts regardless of past success.

While emotions can never be completely removed from trading as we are humans and not machines, emotions can be managed to allow us to feel them, understand them, and still make the right decisions on the actions we take. We can act more like business managers and not like gamblers in our trading once we learn the right mental management techniques.

Here are the Top 3 Trading Psychology Lessons I Leaned In 30 Years (Emotions = Mistakes)

How to Reduce Trading Stress

Treat each trade as only one of your next one hundred trades. 

If you manage your position sizing correctly based on a chart’s volatility, then no one trade should mean much by itself and just blend into the results of your next one hundred trades.  If your risk of loss is only 1% of your total trading capital if your stop loss is triggered based on your position sizing mathematically it is only one of your next one hundred trades.

The primary causes of trading stress are uncertainty, lack of confidence in your strategy, trading too big, and taking on too much risk at one time. If you know your trading strategy has an edge based on your back testing, chart studies, or risk/reward ratio then trading smaller is the solution to all the problems traders face with stress.

Stop trading so damn big, this simple principle changed my trading psychology immediately. Trade big enough to be meaningful but not so big it puts you on tilt.

Here are my position sizing guidelines for total trading capital.

20% position size for regular index ETFs.

10% position size for big cap stocks.

5% position size for leveraged ETFs and small cap growth stocks.

1% position size for option contracts.

How do you get rid of ego in trading?

Focus trading your strategy not your opinions or predictions. 

Ego is a person’s sense of self-esteem or self-importance. The ego is a mental construct that can be both on a conscious and subconscious level. An ego is the self concept that a person tries to protect and keep safe from pain, destruction, and embarrassment. A trader must trade the their trading strategy and abandoning signals and their trading plan in favor of their own ego because they don’t want to admit they were wrong comes from stubbornness, self delusion, and big losses.

The trader is the weakest part of any trading system as the ego can take over and lead to terrible decisions all in an effort to save face.

Most market predictions are ego based. A trader wants to be able to say they called a top or a bottom or had a great stock pick. Signal and system based trading is a path that removes the need to predict, you simply quantify and react. You can’t control what happens on a chart after you take a position. All you can control is what you do. A good trade is one where you followed your entry and exit parameters to create a good risk/reward ratio not whether you made money of lost money, the market decides that.

Stubbornness is an emotion that flows from the ego as it does not want to be proven wrong. Many times this leads to letting a losing trade continue to run against a trader. Egos have trouble taking stop losses because they hate to be wrong. Right and wrong should be changed to good trades and bad trades and determined by long-term discipline not short-term results.

Egos lock into being bullish or bearish and let their opinions do their trading. Following the actual price trend creates better odds of success than having an opinion on what should happen next.

You should not let trading consume your entire life. The markets should be only one of several things you do in life. A diversified life outside the markets with friends, families, hobbies, learning new things, and staying healthy will help you keep your perspective during losing streaks and drawdowns in trading capital.

A profit and loss statement can not define your self worth. Your profits are more of a reflection of whether the price action is conducive to your method’s success currently, not whether you are a good trader or not. Your self worth has to be determined by whether or not you followed your trading system with discipline, consistency, and risk management.

Opinions and predictions outside the context of an edge is a delusion of the ego. Trading a quantified strategy with an edge based on systematic parameters is the mark of a profitable trader. Trading should be a way to make money, find your validation elsewhere or connect it to your ability to execute.

How to Manage a Trade

Execute a predetermined trading plan instead of trying to decide what to do once in a trade.

 Instead of trying to figure out what to do after entering a trade, your predetermined trading plan should already be written before you ever enter a position. A trading plan explains how you will manage a trade inside the context of your trading system. Where you enter and where you exit based on signals.

A trading plan is used to express the actions you will take to express your trading system in the market through entries, exits, and position sizing. A trading plan sets the parameters for executing your signals with real capital in the markets based on predetermined signals. A trading plan is created when the market is closed to be used when the market is open.

A trading plan must be structured to minimize losses when wrong and maximize gains when right about a trade. It should express your signals specifically so they can be executed quickly with no hesitation.

Stop losses and proper position sizing minimize losses. Profit targets and trailing stops can maximize gains. Never trade so big that your emotions or ego become too loud to execute your trading plan.

Your trading plan must be based inside the context of your system using your watchlist, time frame, risk tolerance, and return goals to express your strategy in an actionable way.

A trading plan redirects your decision-making process from your ego and prevents errors from becoming emotional when a trade moves against you or for you in a big way. A trading plan is where you turn to for the right decision when fear, greed, or ego want to take over. Independent traders still have a boss, their trading plan.

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