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Always trade with you, never against you

EDUCATION CENTRE

3 July 2020

Trading Psychology

There is no doubt that trading is stressful and that the psychology of a trader hugely influences their profit and loss profile. There are a plethora of books and articles on this subject with many claiming to give ways to "beat the market" so let's debunk that one from the start and accept the age old adage that the Market is always right. That is not to say however that understanding one's own personality and having rigorous trading discipline won't result in greater profitability.

It is said the market has no emotion, conscience or memory. That is true literally but, when you consider that pivot points are usually established by historic congestion or trading decisions, whole figures are often support or resistance levels and that markets can move on optimistic predictions or dire warnings without the backing of solid current economic figures, you can see that market traders do in fact imprint their emotions and memories on the market.

Traders cannot be expected to totally change their personalities but an understanding of the strength of the various personality traits that one possesses will help mitigate some of the main biases that afflict traders:

The naturally optimistic trader is probably the most abundant of the trading 'types' as we humans are innately optimistic and as a trader has to be optimistic that they will make money to actually place a trade. 'The trend is your friend' is often thrown around and that is true, however a trend by definition is a prevailing inclination or tendency and thus will have an end. Traders must ensure that they don't get married to a profitable trade and let it run when targets have been met or breached. Discipline, sticking to targets and stop losses will minimise this risk.

An overconfident trader who is convinced that they have 'the strategy' to win may fail to continually understand the relevance of the strategy whilst also missing out on new opportunities that the market offers. "If it's not broke don't fix it" could be the motto when a trader has had success with a strategy and continues to repeat it. The problem with this is that the market and the influences on it are always in flux and the adopted strategy may become irrelevant. Recognising this and continually monitoring the trading environment will make sure that the trading strategies are relevant.

A pessimistic trader or one lacking confidence in their research and strategy may be reluctant to place a trade or will close out potentially profitable trades when a small setback occurs. One has to remember that the market is not performing correctly if it is offering a risk free trade. Such anomalies only occur when a market is imperfectly priced and are thus rare and fleeting. Thorough research, and the resulting confidence in that research, acknowledgement of what has gone right in a strategy whilst maintaining trading rigor by sticking to stop losses are useful methods in mitigation.

A person new to trading or a less confident trader may seek out news or opinion that backs their decision. There is no doubt that research and analysis is imperative for a sensible trading strategy but equal weight must be given to the news and analysis that challenges the trading idea as to that which supports it. Having said that one must always be careful to sort fact from rumour and unsubstantiated claims from reasoned opinion.

In short, these biases or personality traits can be bundled up into the terms Greed and Fear, which makes perfect sense when one considers that a price results from a battle between buyers and sellers and a price movement only occurs when one side prevails over the other. So simplistically all a trader needs to do is predict who will win that battle. However, this is usually easier said than done.

There are a few things a trader can do to help them navigate the markets:

  • Identify your personal traits: Be aware of which of your personal characteristics will affect your trading and balance your approach with those in mind.
  • Understand your risk appetite: Being aware of your personal risk thresholds and trading within them will help you with your trading discipline.
  • Research and analysis: Do the homework, research the product and the market, read analysis and opinion from all perspectives, determine the relevant quality of information sources.
  • Develop and follow a trading plan: Put take profit and stop loss targets in and abide by them unless something occurs which makes the original plan fundamentally out of date.
  • Keep a trading log: Use your previous successes and failures, along with the associated emotions, as a learning tool for what works for you.
  • Be adaptive and open minded: Whilst maintaining the courage of your convictions and faith in your analyses, continue to look for other opportunities and new information that may affect your strategies.
  • Be thoughtful about your trading targets: There is a tendency to view whole integers as support/resistance or pivot levels, that being the case place your target prices just inside those integers as otherwise you stand the chance of missing your target as the market pivots just shy of your target.
  • Be disciplined: Do not get married to trades. Do not ignore your target prices, do not fall foul of the common trading error of running losses and closing profit too early through lack of discipline. Do not hedge a losing position unless the analysis has been done to ensure that this hedge is short-term, the original decision is still correct and that it should not be scrapped. Do not jump into a new trade just in the hope of recovering the loss of the last trade, be ready to step back from trading, review what went wrong with the loss making trade and then return to the markets armed with that knowledge.
  • Seek informed opinion: Read analysis and opinion but also seek the advice and experiences of more seasoned traders. Brokers such as USG UK offer a personal account manager and although these are not permitted to offer investment advice they are experienced traders and can educate traders in how to adopt sensible trading disciplines and practices.

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