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The 4 Major Psychological Traps and How to Avoid Them
• There are 4 major psychological biases that all human beings have a natural tendency to display. When these biases interact with the world of trading, disastrous outcomes often occur. Being aware of the biases is a major step towards avoiding the traps that they create for you in your trading.
• Outcome Bias: Using hindsight to judge our decisions based on the outcome, rather than the strength of the decision given the information we had. o If we make a decision to take a trade and it turns out to be a loss, we tend to think that it was a bad decision. If it turns out to be a profit, we tend to think it was a good decision. The reality is that the outcome of the decision is irrelevant, and thinking that it’s relevant is the outcome bias in action. The only relevant thing is the information you had before the outcome became known, and you can’t let later information bias your judgment regarding the strength of your decision. o Thinking in this manner, a mistake becomes defined not as a loss, but as any instance in which you don’t follow the rules of correct trading process that you’ve learned. If you break the rules and it results in a good outcome, that’s nothing to be proud of because you’re picking up bad habits that will degrade your edge in the long run. If you see all the makings of a good trade and take it, it’s something to be proud of even if it ends up being a loss. And this applies to decisions regarding profit exits too.
• Loss Aversion Bias: The tendency to strongly prefer avoiding losses to acquiring gains.
o The solution to this bias can be found in the “Your Trading Framework” section in the sessions titled “Understanding the Hidden Psychology of Losses” and “Overcoming the Hidden Psychology of Losses”.
o This bias tells us that we will feel much worse when we lose than we will feel good when we win. The intensity of the bad feeling associated with losing is much larger than the good feeling associated with winning. As such, when you fall into the trap this bias sets up, you’ll start trading not to lose versus trading to win. But you’re not in this to just protect your capital. Otherwise you could have just kept your money in the bank. You’re in this to make money, and therefore you cannot let this bias keep you trading scared.
o A related effect that comes forth from this bias is “The break-even effect”. Because people hate losing so much, they’ll do anything to get back to break even when they’re trading. Whether in a particular trade, or in a day, or a week etc., they’ll take larger risks and worse risks just to get back to break even so they don’t experience losing. Experiments have proven this to be true, which is why you need to be aware of the greater propensity to take risks when you’re down money and not let yourself fall into that..
• Sunk Cost Bias: Making decisions based on already incurred costs or losses instead of future incremental benefit.
o To understand sunk cost bias it helps to look at an example. If you bought a $500 ink jet printer that you plan to use extensively for the next 3 years, and if the ink costs $100 per month, then you should be willing to throw out this new printer and buy another $500 one that is now on the market with $20 per month costs in ink. This is the rational decision because you will save $80 a month and your savings in 3 years will be $2,880, which greatly outweigh the $500 new cost. But most people will incorrectly factor in that old $500 cost to their decision and feel like they can’t throw that away. In reality, even if the old printer cost you $3,000 you should STILL throw it away (assuming it can’t be sold) because that cost is in the past and is irrelevant now. The only relevant thing is how much you’ll be saving from this point forward with the new printer versus the old one. The $3000 you spent is already spent whether you throw away or use the printer. It’s a sunk cost and is irrelevant for any decision you make now.
o Sunk cost bias shows up in trading when you’ve lost money on a trade and the thought comes into your mind that you can’t exit now because you’ve already lost this much and so it makes sense to risk a bit more to get it back. But the reality is that the loss is irrelevant. The question is would you be taking this trade right now if you hadn’t been in from before? And if not, you should be exiting. Another way it shows up is in thinking about lost time. You may be in a trade for hours and think that you can’t exit now because you’ve already invested so much time and energy in the trade. But again, the past is a “sunk cost” and is irrelevant for making a decision on the trade. Finally, this bias can also show up when you’re in a drawdown (whether intraday or longer) and you start making decisions based on your losses. You may think “what’s another few hundred dollars?” and take risks that you shouldn’t. The reality is that what you’ve lost is irrelevant to the decision to enter any trade going forward.
o To spot sunk cost bias and avoid its trap, simply ask yourself if you would make a different decision if you hadn’t lost anything on the trade, day, week etc. If the answer is yes, you know you’re falling into sunk cost bias and you should make the decision you would make assuming no previous losses.
• Recency Bias: Giving more weight to recent results or events than they deserve.
o You can see one aspect of this bias in action when you base your market outlook based on the latest price action, while greatly decreasing the value placed on all that came before it and the general context. A strong down bar makes you feel “sure” that the market is going to go down. A strong up bar makes you think it’s going to fly up. The most recent price action keeps taking precedence even though it is just one small piece of the puzzle.
o The other aspect of this bias comes when looking at our results. We ascribe more weight to the last few trades than to the big picture equity curve of our trading. We fail to realize that if the last 3 trades are losing ones that this doesn’t mean anything about our trading and there’s nothing more significant or special about these trades just because they just happened. They don’t deserve extra weight, attention, or worry in our mind.
o The way to deal with this bias and avoid its traps is to just be aware of it. Be aware of it when you’re reading the market and be aware of it when you’re looking at your results, and just watch this tendency arise without judging it. Doing that will allow you not to fall for it, and not to project forward just based on the latest events or results.
Achieving a State of Confidence at Will
• Confidence is of utmost importance to all traders, but the first thing to realize about confidence is that it is primarily not an issue of psychology, but one of abilities and skills. If you want the highest level of confidence that can be maintained, then dedicate yourself to improving your market reading abilities and your trading skills. Many traders complain about a lack of confidence when in reality they shouldn’t be confident given their lack of skill and real edge in the market. So once again, it’s about the foundations, and they come first.
• Assuming you’re diligently working on those foundations but you want a way to feel instant confidence during times when it may be low, there are a couple specific techniques that can help you achieve this. • Technique #1: The Personal Highlight Reel. Just like athletes have highlight reels of their best plays in their sports, you can create your own mental highlight reel of your best trades. To do this simply recall your best trades from the past, close your eyes, and visualize them as if you were making them now. To be most effective, use as many modalities (senses) as you can, so it really feels real to you. But the most important part is to focus on the feeling of confidence evoked at the time you took those trades. Relive it. Feel it as if it’s happening right now. You can stack one trade after another and just visualize how you took it, and fast forward to the exit and the result and feel that feeling of confidence. 1 – 2 minutes is more than enough time to do this, and you can do it each morning and midday. You don’t have to wait for confidence to be down to employ this technique; it will add to any confidence you currently have.
• Different people visualize in different ways, so you may see yourself sitting at your screen taking the trade, or you may just see the screen, or it may feel as if it’s all just a blur of quick images and you just sense it all. There is no correct way to do this. Just go with what works for you.
• Technique #2: Creative Visualization. The unconscious mind cannot differentiate between visualization and reality. That’s why just thinking about something can cause very real reactions in your body and emotions. You can use this power to conjure up confidence at will. Simply visualize the day ahead, and visualize making great trades and following your trading plan correctly, and ending up with a great overall result. To do it most effectively, focus on both winning and losing trades and draw confidence not only from results, but from correct trading process. You might want to visualize a winner, followed by a loser, followed by a great winner. And even with the loser, feel confident that you took a good trade and you cut your loss short and you bounced back quickly. This would mimic real life and bring forth more authentic confidence that will be maintained during the trading day. The side benefit of visualizing great execution of your trading plan is that you’ll be more likely to actually achieve this in real trading. If you’ve already seen yourself entering correctly, and holding the trades correctly and sticking through correct process despite emotions (which will also be felt during visualization) , then you are much more likely to be able to do it in the trading day.
• As a general principle, you should look to derive as much confidence as possible from correct trading process as opposed to just bottom-line results. You don’t want your confidence going down with every equity curve drawdown, and focusing on correct process and feeling confident when you do things right will be the best way to maintain confidence on a consistent basis. And you should feel confident when you do the right things, because most traders don’t do them, and if you build up these habits your chance of trading success rises dramatically. Also, if you make mistakes, draw confidence from your ability to quickly learn from and bounce back from mistakes. Everything can be used to increase your confidence if you look at it from the right perspective. Of course we can’t be too idealistic here. We all know that you’ll be the most confident when you actually have good trading results, but the point is to not let that be your only source of confidence.
Achieving Peak Performance Through Mental Modeling
• One of the best ways to instill new habits, beliefs, and traits, is to model someone who has them. We can do that in trading to make it easier to apply all of the psychological principles and techniques.
• Modeling A World-Class Trader:
o Can be a real person or a mental construct. You can either choose a top notch trader that you know, have read about or have heard of, or you can create a mental image of what a world class trader would be like.
o Model their beliefs about trading. You’ve already learned all the beliefs you need to trade at an optimal level throughout this training. You’ve learned beliefs about the nature of trading, adversity, mistakes, emotions, entries, exits etc. Now you can simply take these beliefs and attach them to the mental image of this trader that you’re modeling.
o Model their thinking habits and ability to deal with emotions. For example you would model their great mental state control, and their ability to accept emotions with selfawareness, and their positive grateful attitude, and you would mentally attach all this to their image too.
o Model their body language and demeanor. What do they look like when they’re at the trading screens? How confident do they look? What is their posture like? Imagine how they would look after taking a string of losses, or when they have a big winner on and are letting it run.
• When you’re trading, you want to pull up this image of this trader in your mind, and you want to keep it in the background of your thinking throughout the day. Look at this trader as your role model and draw inspiration and motivation from them. Think their thoughts, believe their beliefs, and posture yourself in the way they would. Doing this will end up acting as the fuel or kick you need to actually apply all the techniques you’ve learned in the heat of the battle.
o To really take this to the next level, you can also envision yourself as the trader you want to be. When you do this, even if you feel like you’re just acting, you will start doing the things that are consistent with being this great trader. Even if your results aren’t yet consistent with the thought that you already are this great trader, it’s all about process. And the more you trade with correct process, the more positive reinforcement you’ll receive in the form of better results. Gradually, what used to be an act will become the natural way you do things. We become what we think about. Think of yourself as already being that great trader and your progress towards your goal will be greatly accelerated.
Channeling the Harsh Realities of Trading Into a Psychological Edge
• The world of sports psychology can often offer great insights that can be used to improve your trading. An excellent book that does just this is “Golf is Not A Game of Perfect” by Bob Rotella. It talks about how at the top levels of golf, everyone can hit the ball well and everyone is very skilled, but what separates the great from the good is their ability to handle adversity and all of the imperfections of the game.
• When we transfer these insights over to the world of trading, we realize that trading is not a game of perfect. From one side, this means that it is futile to seek perfect entries, exits, and numerical values for any indicators. There’s no perfection possible; there will always be ambiguity; and we should strive simply for close approximations so as not to become frustrated from expecting unreachable perfection.
• The other side of this statement is that trading is a game that is won by those who can best deal with frustration, disappointment, and adversity. Since trading has harsh realities full of losses, missed opportunities, drawdowns, and unforeseen events, those who can best deal with these things will perform the best. When things go right it’s easy to be disciplined. It’s when things go wrong that our psychology is truly tested.
• Most traders are simply coping with the harsh realities of trading as best they can. But the key to having great psychology and outperforming, is to embrace the realities of trading and make it your priority, challenge, and goal, to handle adversity and frustration well. Instead of coping with it, you want to THRIVE on it. You want to embrace it and make it your very purpose. Your purpose is no longer to make money. That will take care of itself when you do the right things. Rather, your purpose is to thrive on adversity and handle all the imperfections and frustrations so well that you will be able to do the right things consistently.
• And you do this by proactively preparing for it. You expect adversity during the trading day, and you prepare your mind for it by actually looking forward to it. This seems strange and unnatural, but no natural way of thinking will make you a great trader. And you can look forward to adversity simply because you know that your ability to handle it well is your purpose, and you want to fulfill your purpose. And you know that fulfilling this purpose is what will separate you from most traders. When you think about it in this way, it’s not so strange anymore to actually look forward to the chance to prove yourself and do the very things that will bring about great performance. Losses, missed opportunities, drawdowns, and unforeseen events are no longer looked at some unfortunate incidents that are happening to you, but rather as your biggest source of edge, because you know that handling them well is what will separate you from the pack. They’re going to happen whether you like it or not, so instead of cursing them decide to embrace and thrive on them.
Overcoming The 3 Hidden Obstacles to Good Profit Exits
• There are 3 major obstacles to being able to execute profit exits well, with the first one of those obstacles directly influencing the other two.
• Obstacle #1: The myth that it’s wrong to let a winner turn into a loser.
o This is a common piece of trading “wisdom”, and yet it’s one of the most harmful pieces of advice out there. The traders who originally said it failed to explain its true meaning, and as often happens it got misinterpreted and now stands as a trading myth that most traders unfortunately believe in.
o The belief in this myth means that most traders mistakenly think that any time they have a decent profit it’s wrong to let it turn into a loss. But thinking in this way will create very bad trading habits because most trades (especially in rotational markets like the stock indices) will have decent retracements as they move to your objective. And if you’re always worried about letting a “winner” turn into a loser, you’ll be too quick to move to break-even or scale out and this will hurt your bottom line greatly.
• Obstacle #2: The fear of regret and your own negative self-talk.
o As a result of believing that it’s wrong to let any winner turn into a loser, you will naturally feel great regret when you do. You’ll feel bad about yourself and think of yourself as a bad trader, and you will often blame yourself and beat yourself up emotionally and psychologically.
o The obstacle arises not so much because of the regret and negative self-talk themselves, but rather due to your fear of them. You’ll intuitively know that you’ll beat yourself up if you break this supposedly sacred rule of not letting a winner turn into a loser, and you know you don’t like that feeling of being harsh on yourself. Given this, you’ll unconsciously want to avoid it. And what’s the way to avoid it? Simply by avoiding that which gives rise to it. And so you make it your goal to never let a winner turn into a loser, and in doing so you trade scared and do all the things that will hurt your bottom line, like scaling out too often and too fast and moving your stop to breakeven too quickly.
• Obstacle #3: The fear of losing something you have acquired.
o This draws back to loss aversion bias, but now affects you in the realm of profits. Missing out on a point of profit doesn’t hurt nearly as much as losing a point of profit you already had. So there’s always a natural tendency to want to lock profits in and not lose them even when the potential reward that is left in the trade is much larger than the current profit.
• Solution #1: Change the rules of the game.
o The great traders weren’t wrong- they just didn’t explain what they meant very well. You need to change the rules of the game to get back in synch with what they really meant. And to do that it’s necessary to define what a winner truly is. A winner is not simply a profit. Rather, it is a trade where the market has moved enough in your favor that if it were to return to your entry point it would be indicating that your market view is now no longer valid. If you have such a winner, then it’s wrong to let it turn into a loser.
o Another way to change the rules of the game is to only look at things from the market’s perspective. Your P&L doesn’t determine whether it’s wrong to let a trade turn into a loss; the market does. For example, it would be wrong if you are in a trade with a profit and the market is now displaying strong signs that your directional view may no longer be correct. In that instance it makes sense to take profits, or scale out, or move your stop to break-even.
o In both of these points, we do not exit a trade simply in fear of letting a “winner” turn into a loser. There is no blind belief in a trading adage. We only protect profits when we have a true winner and when the market tells us to. And this becomes our new rule, and now we don’t feel bad when any random profit turns into a loser. We only feel bad when we break this rule. And we feel proud when we uphold it. In this way, the game gets redefined to our benefit, and we even overcome obstacle #2 because now we have nothing to feel bad about unless we truly break the real rules which we won’t be inclined to in the first place since they’re very logical and are based on how the markets actually work. The new rules literally change our psychology.
• Solution #2: Practice self-awareness.
o Solution # 1 takes care of the first two obstacles. This second solution takes care of obstacle #3. Being aware that you’ll have a great tendency to not want to lose the profits you’ve acquired (even when the correct trading process is to let your profits run), you’ll catch yourself when you start thinking such thoughts as “a bird in the hand is worth 2 in the bush”. That may be true in life when opportunities rarely repeat themselves, but in trading we get trade after trade after trade. All we need to do is the correct thing regardless if it yields profits on this particular trade or not. And so being self-aware will allow you to catch these thoughts as they arise so you don’t let them cause wrong trading behaviors.
Proven Methods & Techniques for Handling Emotions
• Before you can hope to have good trading psychology and the mindset of a professional trader, you have to have certain foundations in place. These foundations are:
o Thinking in probabilities
o Having correct risk management
o Having a strategy with a real edge
• The reason the psychology section comes at the end of this training is that if you don’t know how to think via long-term odds and probabilities, and you don’t control your risk properly, and you don’t have a strategy built on a robust market framework that can provide a true edge, then you are naturally going to lack confidence and be filled with fear, and all the psychological techniques in the world will do you no good. These foundations are the very things that allow you to trade with an objective and confident mindset to begin with.
• Once you have these foundations in place, the key to a great trading mindset becomes selfawareness. Scientific research has shown that the vast majority of people are completely non-selfaware. That is, most people are going through life thinking that they’re making decisions and leading an intentional life, while in reality they are being run by conditioned responses and repeating mental and emotional patterns. The external environment contains events that trigger these programmed patterns, and predictable behaviors follow. Something triggers a conditioned response, and we act automatically without our conscious awareness. Our mind then rationalizes it a few milliseconds later and convinces us that we made the decision consciously. But without practicing self-awareness in the moment, we are not in control and any seeming control is an illusion.
• The #1 trading psychology myth is that you have to trade without emotion. The great traders know this is not true, and what they really mean by it is that you should not let your emotions make trading decisions for you. But often they have no better way to articulate it and it gets misinterpreted to mean that you have to shut off your emotions and not let yourself feel strong emotions when you’re trading. If you’ve been trying to do this, you may be relieved to know that the reason you’ve failed is because it’s impossible to trade without emotions. In fact, it’s impossible to shut off emotions altogether, so don’t waste your time in trying.
• The question then becomes: how do you sever that link between an emotion and the automatic negative trading behavior it causes? And the answer is to accept / welcome your feelings, which is the #1 trading psychology method when it comes to emotions.
• To understand why this is the case, you have to realize that the alternatives you have for dealing with emotions lie on a continuum. On one end of the continuum is repression, where we try to shut off our feelings, push them down, and act like they’re not there. This ends up hurting us because the feelings don’t actually go away; they’re still there and they continue to build up in our unconscious. And since the unconscious mind is largely what drives behavior (as mentioned above), these repressed feelings will end up greatly influencing your future trades negatively without your awareness. This is one reason you continue to break your trading rules and keep doing things you promised you’d never do again. Repressed feelings and experiences are still there unconsciously driving your trading behaviors.
• On the other end of the spectrum we have expression. When you express your feelings automatically (which is how most people express them), the feelings take control over you and leave you powerless. Your judgment becomes highly clouded and remains impaired as the energy of the feeling gets amplified and you give it more life. This energy keeps lingering even after you’ve “calmed down”. But the real consequence comes in the midst of the expression, as we often do things we later regret because we’ve let the emotion take over us. Those that say expressing your feelings is good don’t mean that you should be a slave to your feeling and let them come out automatically to drive your behavior.
• In the middle of the spectrum lies the third alternative: welcoming or acceptance. This is a way of handling emotions that most people are completely unaware of. They don’t even know the choice exists because it is highly counter-intuitive to welcome or accept feelings that we judge to be bad and that make us uncomfortable. But the essence here is to realize that you’re human and that feelings- whatever they may be- are natural. So the only healthy thing is to acknowledge, accept, and even welcome them. When you welcome something you’re saying it’s okay. And when you make it okay, you don’t have a reason to push it away. And you also don’t make it too big of a deal and give it a power that it doesn’t have by letting it take over you and control your actions. You simply let it be there, and you feel it and welcome the feeling. And if you feel a strong resistance to welcoming it, you recognize that resistance itself is just a feeling and you welcome that too. And when you do that, both the feeling- and the resistance to the feeling- quickly decrease in strength, and often even disappear. That’s because you’re not keeping them alive by repressing or expressing, which are both forms of holding onto them tightly. When you welcome and you accept, it actually serves to let them go. It’s counterintuitive, but it works- often like magic.
• For anyone who wants a highly extensive workbook that teaches in-depth ways to welcome and release feelings in every area in life, for improved relationships, finances, health, and anything else, the book “The Sedona Method” by Hale Dwoskin is a great resource.
• To be able to reside in the middle part of the continuum, you need to understand two key psychological principles:
o There’s no such thing as a bad feeling. It’s useless to judge your feelings and to judge yourself for having them. Society has given us labels for ‘good’ and ‘bad’ feelings, and our parents often told us that having certain feelings (like anger for instance) is wrong. When you realize no feeling is bad or wrong, and that in and of itself it’s just neutral, it becomes much easier to accept or welcome it.
o Through self-awareness, the link between feelings and actions can be severed. Most people think that some feelings like anger, fear, hate, jealousy etc. are bad because they’re thinking about the consequences of the actions that those feelings often cause. But when you realize that the link between feelings and behavior doesn’t have to remain intact, and that through self-awareness it can be severed, then you realize that feelings are not something that need to be avoided in and of themselves, and they don’t have a power of their own. It’s only the unconscious link they have to actions that is the problem.
• There are three good techniques that can be used to welcome / accept your feelings. Of course if you can do it naturally based on all of the above (i.e. simply by welcoming feelings), that’s great. But if you need some help, you can use one or a combination of these three useful techniques:
o Watch them as an independent observer. To practice doing this, simply visualize watching yourself as someone else would be watching you, whenever you have a strong emotion. Doing that allows you to see that the emotion is not one with you because YOU are aware of it. Without this form of self-awareness it often feels that the feeling is us. It literally takes over and we can’t make a distinction between it and us as we feel it in every part of our being. But watching yourself as you feel the feeling allows you to see it from a different perspective and separate yourself from it in a sense. You just watch yourself with awareness, and watch yourself feeling the emotion, and you acknowledge it without repressing or automatically expressing. This, by its nature, means that you are accepting and welcoming the emotion. You’re letting it be there without acting on it or trying to get rid of it. This instantly decreases its power and often you’ll feel it leaving your body as a wave of energy release.
o Use Questioning to draw out the root cause of the feeling. To practice this, you’ll need to ask yourself questions immediately when you experience a strong emotion which you know can negatively affect your trading. Keep asking why until you get to a root cause. You may feel fear of taking a loss, and instead of letting it keep you from missing a good trade you quickly ask yourself why you’re afraid. And then when the answer comes back you ask why again and so on until you reach what you feel to be a final deep answer. Often when we hit this root level the feeling just releases on its own because its no longer unconscious. It’s been brought to the surface and in the light we see that it’s not that terrible. We won’t die if we feel it (even though it makes us feel like we will), and whatever it is making us afraid of won’t kill us either.
Another form of questioning is to simply ask yourself, can I welcome this feeling? And if the answer is no, then ask if you can welcome the resistance to welcoming the feeling. And keep asking until you feel a wave of release as the feeling decreases or evaporates. It seems very simple, and it is. It’s us that complicate feelings. But we can learn very simple, proven, and effective ways for dealing with them that greatly decreases their negative effects on our trading.
o Transfer your feelings onto paper. This technique allows you to not repress your feelings while simultaneously severing the link between them and action. The action becomes writing them out. When you verbalize them in this way and put them onto paper, you take any negative action that might have resulted in the market and hurt your account, and you place that energy into writing. And the key is to do this from a place of non-judgmental acceptance and awareness. This is not an excuse for stewing in your juices and being one with the feeling and letting it take over. Just acknowledge it and be okay with it, while verbalizing it.
• Experiment with combining these techniques. You may find it helpful to use the questioning process through writing for instance. Or to combine it with being an independent observer. There is no set way. Try out different things and stick with the technique that works for you. Often no specific technique is needed if you can just learn to welcome the feeling by visualizing yourself opening up and letting it in with a sort of embrace.
• And realize that ‘failure’ is part of the process. In fact it’s not really failure because no one can do this perfectly. Just do the best you can and continue to get better and better. At first you may be only able to do this with the less intense emotions. But if you continue practicing, with time you’ll be able handle the majority of emotions quite readily. At the very least, you’ll have a process to go through to keep you from just acting automatically and making trading mistakes.
Proven Methods & Techniques for Mental State Control
• Most traders, when asked what trading discipline is, will answer that it is all about cutting your losses short and not risking too much of your account on any given trade. i.e. They equate discipline with good risk management. While this is certainly a key part of discipline, it is by no means an exhaustive description. And it’s also the part of discipline that should be a given if you’re at all serious about trading. You should respect the market far too much to do risky things.
• So then, what is discipline? Our definition is that trading discipline is the ability to control your state of mind to allow for optimal trading performance. This definition does not limit discipline to certain behaviors. Rather, it’s an internal state of mind that consistently produces correct trading behavior. And the correct trading behaviors which fall under this realm of discipline are not limited to correct risk management. In fact, here are some other effects of having weak discipline, showing that discipline extends to every aspect of trading:
o Overtrading: Letting frustration, lack of patience, or anger, allow you to take too many trades, get chopped up by the market, trade in places and at times you shouldn’t be trading, and take trades that are not part of your strategy or trading plan.
o Under-optimizing exits: Letting fear and doubt allow you to not hold the trade to your target, scale out too often and too quickly, and consistently take small profits.
o Skipping trades after a string of losers: Letting lack of confidence and fear allow you to skip perfectly good trades that could make up for some or all of your losses, thereby degrading the long-term edge of your strategy.
o Failing to aggressively capitalize on good conditions: Letting yourself be complacent, satisfied, and fearful of losing profits, thereby not accepting good risks during high conviction days and greatly under-optimizing their profit potential.
o Stopping trading once you’re up a certain amount: Letting the gratification of booking a profitable day and the fear of losing profits allow you to stop prematurely even when conditions are conducive to further profits.
• In all of these mistakes, the trader focuses on their profits & losses for the day, instead of focusing on correct trading process. He or she allows their negative state of mind to control their trading behaviors. Even when such a thing doesn’t lead to outright losses, missed or under-optimized opportunities end up greatly degrading the bottom-line results. Discipline is all about consistent mental state control to achieve to as close to optimal trading performance as possible. Given two equal traders in terms of strategy and skill, the one with the better and more consistent mental state control is the one with more discipline, and he or she will be the one that will make more money.
• There are various techniques for controlling your state of mind, and this is really the flip side of the coin to handling emotions. Your thoughts cause your emotions, and how you handle your emotions affects your thoughts. So it’s all intertwined and interrelated. The first technique is Cognitive Reframing, and to understand what this technique is all about, you have to first understand the nature of reality.
• What you view as reality is simply a product of your interpretation based on your beliefs and experiences. This creates your frame of reference, and your frame of reference is your reality. There is no objective reality “out there”. Rather, each person’s reality is a product of their state of mind and their frame of reference. And this frame of reference not only determines how we view the world, but it literally shapes our lives and what happens “to” us. Based on our beliefs and thoughts, we act in certain ways, and given a different set of beliefs and thoughts in the same situation, we would act in different ways and cause a whole new sequence of events in our life that can dramatically change our path and everything that happens. Our minds literally create our realities. We are not victims of chance or circumstance.
• All of this points to one simple, yet powerful conclusion. You are responsible for your life, and if you can change your mind and thoughts, you can change your reality. It’s a matter of choice, and all that is needed is to take 100% responsibility for it. Make that commitment now to take 100% responsibility for creating the reality that you want in trading and in life.
• Technique #1: Cognitive Reframing. This simply means to change your frame of reference by ascribing different meaning to something or looking at it from a different perspective. Here are some trading examples:
o You take a loss on a trade that you shouldn’t have taken:
I’m a bad trader. That was so stupid. → I can’t learn if I don’t make mistakes.
o You take a loss as part of your strategy:
The market is out to get me. → This is a game of odds and losses are a natural part of my edge.
o You take a string of losers in a row:
I’ve lost my trading ability. I can’t make money anymore. → Any good strategy will have strings of losers and this is to be expected even when I’m doing the right things.
o You miss a great trade that you should have caught:
I’m such an idiot. A good trader would not have missed that trade. → Even good traders make mistakes and what defines a trader is how well they bounce back from mistakes.
• Through cognitive reframing, you can take something that would normally be a negative thing, and flip it completely around so that not only does the negative aspect get taken away, but it becomes a total positive. The key is to continually monitor your self-talk and any time you find it slipping towards something negative, even if that comes in the form of an innocent question (eg. how could this have happened?), to look for the positive within it and focus on that. A mistake can be turned into an empowering challenge. A loss into pride for following the rules correctly. And so on.
• To help you with cognitive reframing, make sure to practice what you learned about handling emotions. The negative thoughts are often so quick and automatic that by the time you notice them the feelings they cause may already be overwhelming you. So to even be able to reframe it, you may need to quickly deal with the emotions first. Often the strong emotion coupled with the intensity of the situation will cause you to feel apathetic. i.e. You’ll notice your negative thoughts but you won’t even want to do something about them because you get into the “I don’t care attitude”. This is normal and is simply a form of resistance. The way to get through it is to welcome it instead of fighting it, as unnatural as that may feel. Usually it’ll quickly dissipate and you’ll once again have the will and desire to change your state of mind.
• As an important side note, always finding the positive in any situation does not mean ignoring the lessons that your mistakes and losses can offer you. You should be learning from everything and not being blindly and naively positive. You should always be looking to push yourself to get better and find weaknesses in your trading. But those things are best suited for after market hours. During the trading day, your goal and priority should be to stay in an optimal state of mind- not to critique and pick apart your trading. You can jot down quick notes during the day, but keep your focus on staying positive and maintaining your state of mind. That is what will serve you best when you’re actually trading.