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Thinking like a trader – Trading Psychology

July 22, 2020

Thinking like a trader – Trading Psychology

Many of us start trading Options or stocks because we want to break free from the rules of life and the traditional norms that everyone else has to deal with. We want to do what we want, when we want to, but in trading, the very rules and boundaries we hope to one day escape are actually the most essential to long term success. To make it as a trader, you have to be highly disciplined. That’s why the psychology behind trading is such a pivotal topic to consider, and one of the most important skills for you to hone.

Many of us start trading Options or stocks because we want to break free from the rules of life and the traditional norms that everyone else has to deal with. We want to do what we want, when we want to, but in trading, the very rules and boundaries we hope to one day escape are actually the most essential to long term success. To make it as a trader, you have to be highly disciplined. That’s why the psychology behind trading is such a pivotal topic to consider, and one of the most important skills for you to hone.

What rules do you live by?

It goes without saying that within a society we must adhere to certain conventions. Behaviours and actions are influenced by our upbringing, our societal traditions, our education and religion and even popular culture. We are all motivated and influenced by different things, however it’s often the expectations of others or our concern on how we will be perceived that regulates our behaviour.

If you start to make strange decisions, or not meet the standards set by others, you get called out. If you decide not to turn up to work, remove your shirt on public transport or if you watch Game of Thrones at your desk, you will probably get questions, strange looks or some sort of disciplinary action against you.

As a trader, you certainly use history to pick a direction, but you have to set up your own rules and follow them with discipline.

Traders must set up their own rules

Trading is like playing singles tennis. You are responsible for your own achievements. No one looks weirdly at you if you make weird decisions. In fact, your advisors may even cheer you on as you go down a wrong path, because they will make money off it. In the world of trading you have to be self-directed.

That’s why it’s so important to create rules for yourself as soon as you start trading.

You wouldn’t start a business without a business plan. In the same way, you wouldn’t start trading without a system – although many do.

Anyone could give you a set of rules or disciplines to follow, but for you to have success, those have to become your rules. You have to own those rules. They have to become who you are, what you do and how you behave and that’s one of the most challenging things about trading.

Why Trading Psychology is so important

The concept of trading psychology is pivotal. It’s tempting to follow your instincts when trading, instead of trading mechanically, especially if the market suddenly changes unexpectedly. But it’s important to control your behaviour. It doesn’t matter if you’re right in the moment. What matters is that your trading system will make you money over time, and that’s why you need to stick to it.

As a trader, your mindset is essential to your success. It’s essential to understand how probabilities work, and how your mindset can set you up for success in the long run.

Four important rules that you should internalise

  1. Anything can happen. The next event in the market is going to be random, no matter how high the probabilities are.
  2. You don’t need to know what is going to happen next in order to make money.
  3. There is a random distribution between wins and losses for any given set of variables that define an edge.
  4. An edge is nothing more than an indication of a higher probability of one thing happening over another.

We often apply these four rules in real life, but forget to apply them when we trade. If you had a shop, for example, you won’t know if people are going to come in today and spend money. You don’t know if you’ll be able to make a profit on that particular day. But based on your knowledge of your business and the markets, you are confident that if you keep opening the doors every day, in the long run, your business is going to be profitable. That’s how you have to approach trading as well.

You have to have your system in place before you place the trade that allows you to turn up to do your trade, while knowing that not all trades will be winning trades. If you don’t set up these rules beforehand, it becomes very difficult to think rationally as soon as there’s money at stake.

Thinking like a trader

Thinking like a trader can be a challenge. If you follow these four steps you can set yourself up for success by training your mind and your confidence to trade by your rules, no matter what happens:

  1. Build the self-trust necessary to operate in an unlimited environment.
  2. Learn to flawlessly execute a trading system
  3. Train your mind to think in probabilities
  4. Create strong, unshakable belief in your consistency as a trader.

How to become a consistent winner

Many traders say they’re good at technical analysis or at analysing the market. But another very important skill is to be able to take a hit. It’s essential to be able to do what you have to do in the moment and take the occasional loss without losing confidence or changing your system, and to be able to control behaviour when things don’t go the way you wanted them to go.

These five behaviours can help you become a consistent winner:

  1. Objectively identify your edges
  2. Predefine the risk of every trade
  3. Completely accept the risk or be willing to let go of the trade
  4. Pay yourself as the market makes money available to you
  5. Continually monitor your susceptibility for making errors
  6. Understand the absolute necessity of these principles of consistent success and therefore never violate them.

 

The concept of trading psychology is pivotal. Every time you lose confidence or don’t follow your own rules, you will pay the price for it. It’s very tempting to break your rules in times of weakness, if you for example have a lucky streak or if the market is suddenly doing something different. But it’s important to control your behaviour. It doesn’t matter if you’re right in the moment. What matters is that your trading system will make you money over time, and that’s why you need to stick to it.

We recently ran a special webcast about trading psychology where I and professional trader Ivan Tchourilov shared our key insights and rules that help us manage our own “trading psychology.” Watch it here.

 

Past returns do not reflect future returns. 

Trading options is not suitable for everyone. There is a risk that you can lose more than the value of a trade or its underlying assets. You should only trade if you are confident that you fully understand what you are doing. If you are thinking about acquiring a financial product, you should consult our Financial Services Guide (FSG) at www.reachmarkets.com.au first. 

 


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