Pin-ball ricocheting through the trading universe of gurus, systems, literature and hype I’ve been repeatedly irritated by everyone’s inability to define two persistent concepts. You’ll hear these tropes over and over…
- You need an edge
- Trading is 90% psychology
Well thanks you great and ponderous genii but what in heavens name do you actually mean?!?! You may as well be describing clouds to a fish for all the good knowing this will do.
Did I mention this ‘godlike pronouncement from on high’ nonsense irritates me? Oh and by the way, the definitions (when they do appear) don’t necessarily agree with each other. Brilliant eh? #facepalm
I’m feeling quite combative so in this post I will be sticking my neck way out there and proposing some proper definitions.
Let’s take a step back and roll out a big concept… To trade successfully you basically need these three things squared away.
Don’t risk more than you can afford to in each trade. Don’t trade an amount that has a negative impact on your ability to manage the trade or think rationally. If I have to explain to you why this is important we’re basically in deep s**t already.
A large part of the issue around risk seems to be un-realistic expectations which I’ve addressed elsewhere. Summary? Don’t trade like you know what you’re doing. This can be fatal. I will re-visit this in detail in another post and try to remember to post the link back here.
You have an edge if the trades you take over a statistically relevant period of time have a net positive expectancy. In other words… How you trade needs to make money over weeks, months and years. Your indicator diarrhea based, extensively back-tested blah-blah-blah is of no use if the execution is appalling. Does how you execute, manage and evolve as a trader net you profit over time?
Hand wringing about how you detail or characterise your ‘edge’ is pretty much a waste of time because all you need to know is whether you have one or not. To do this all you can do is look at your results.
If you make money then you have an edge. It is likely that this is the result of a ridiculous amount of study, losses, perseverance, pain, irritation, despair etc. then at some point this becomes familiarity, belief, success, euphoria, process orientation and ultimately boredom.
You should then be able to show/teach another person how you trade. You really know how to do something when you can teach it to someone else so clearly they can pass it on successfully to a third party you’ve never met.
At this point the student/teacher process breaks partly due to issues around risk but mainly because of the third leg of the stool…
Psychology Arousal Control
We make crappy decisions under conditions of emotional arousal or stress. Putting your wang in some random ’cause you’re horny and then giving your girlfriend an STD is an example of arousal leading to making a crap decision.
I’ve crossed out psychology and labelled it ‘arousal control’ because (again) no-one really relates to what ‘psychology’ as a word means in this context. Hopefully everyone has experienced what arousal is at one point or another but please don’t send me emails with examples. Thanks.
Arousal is when our focus narrows and our rational decision making goes completely out of the window. It’s when our monkey brain starts screaming like something trapped in a cage from 28 Days Later. It’s gibbering and throwing poop. Monkey mind needs to STFU because: -
- If you manage your risk
- as well as having a trading process that is statistically profitable over time
- with a mind this is in an un-aroused state
then with these three things in line you have every chance of taking money out of the market in the form profits. With just one of these legs missing your stool will fall over.
So here’s the point of this post.
I used to be worried about my psychology with respect to trading and it would drive me nuts ’cause it’s such a huge topic. You read about it literally everywhere with trading, psychology, psychology, psychology AAAAARGH… I had literally no idea where to begin ‘sorting out my psychology’ and found this very demotivating.
Apologies in advance if the next part comes across as somewhat glib cause you’re not there just yet. It’ll take practice but what I’m going to suggest is very do-able I’m not special in this regard.
If you want to sort out your ‘psychology’ with respect to trading then you need to concentrate on removing the aspect of your response which leads you to make mistakes. It’s okay to have emotions, just not emotions that lead to you to make bad decisions. Even asking yourself simple questions when you are about to make a trading decision can have a huge impact at each stage. Take the arousal out of the equation by whatever means works for you.
The emotional part of your brain (when aroused) is a terrible trader so you need to practice managing it when engaged in this activity. This is why gurus and the trading literature keep banging on about following rules. Ironically having rules and being discretionary cannot logically fit into the same box – hence discretionary trading is hard to teach.
Having been able to observe what I do/did and then dial back the monkey/arousal part of my brain when I see it kicking in means you’re now seriously tipping the odds in your favour.
How have I managed to actually do this?
You can’t change a behavior till you know it from every angle in order to combat it. It will seek to continue doing it’s job because there is a reason for it’s existence – just unfortunately when trading it’s not useful.
The job of this part of the brain is to hyper focus in case of danger or ’cause you’re going to have to fight someone else for the chance to mate. Your job is to trick this part of your brain to back off so your more rational/experienced/conscious and process driven thinking can help you make the most of the
dice roll trade.
Which is where the other two legs come back in. If your risk isn’t in control this is very hard to do. If you haven’t got a clue how/why your trades make money then quieting the monkey will be extremely difficult if not impossible. Let’s assume you’ve got these two parts sorted though… What else can you do to help re-frame what you’re doing?
- Rinse as much emotion as possible out of the event you’re engaged in. What happens next must have absolutely no bearing or impact on your life, self esteem, emotions, hopes, fears or dreams. Win/loss or whatever means nothing. Consciously think about this when looking at getting into or managing a position. Breath deeper if you need to.
- Really treat this experience as an opportunity to learn more – especially at a physiological level. With practice you can observe/feel your mind and it’s almost like trying not to go over the edge (ahem… you know what I mean). If you going to make a knee-jerk reaction based on your mind running about then STOP and don’t do anything till you’re sure you are going on something you can justify – a proper REASON has to exist for you to take action
- Do not engage in the mental gymnastics associated with chains of events. You may have taken three losers (or winners!) in a row. Taking or managing this trade has completely bugger all relationship to anything that went before. Don’t fall into this trap. Events that follow each other are NOT correlated at all in any way. I can’t overstate how important this is.
- Do not look at your P&L – if you want to mess yourself up emotionally by 200% then feel free to do this. This is partly related to point 3 above of course. You’re involved in a one off single and unique event – stop dreaming about the Ferrari
- Breathing – like any stressful event just breathing and being an observer is a very effective way to ‘step back’ from what you’re looking at. In the end though (like everything) it takes practice over and over again. Keep practicing keeping your mind in check.
Having finally realised this I’ve stopped worrying about my ‘psychology’ and have been focusing on dialing back my emotional knee-jerk reactions when executing and managing trades. This has meant I’ve actually been looking at what’s happening, following my rules (edge), managing risk and taking the emotion out of each event.
In some ways the fact I’ve previously meditated regularly and still do this (not as often as I should) gives me an advantage because I can usually take a few breaths and step back from the ‘omfg it’s going against me I’m a terrible human being I’m never going to make it why did I get into this position what am I doing with my life‘ insanity. After all, it’s only a trade and I didn’t bet my house/car/self-esteem on it.
Practice taking a step back, looking objectively at the trade as a single, un-correlated event and things begin to sort themselves out. Practice this 100 times and it begins to be less of an issue.
Update: +22 | +2 | -2 | +0 | +24 | -10 | – 8 | +10
My particular problem right now? I’ve not had enough practice doing this when my trades are in the green ’cause that last one should have been +30 ;)