The importance of good trading psychology cannot be emphasized enough, but what exactly is it safeguarding against?
Based on one of my favorite trading books “Trading in the Zone”, here are some of the core problems that prevent traders from performing well and how to address them:
1. Resistance to creating and following rules
Author Mark Douglas explains that rules and boundaries are needed in order for us to operate effectively in a seemingly random trading environment.
Even casinos and other forms of gaming have built-in structures that limit risk, determine wins and losses, or define when the play ends… So why shouldn’t trading be the same?
While most serious traders have a pretty disciplined approach that adheres to strategies and plans, resistance to rules may manifest in a more subtle manner.In fact, it might be this very process of instilling structure that has wound up repressing natural impulses when feelings like greed, frustration, guilt, or disappointment come up.
Now when these happen all at the same time in the heat of the market battle, it can be disorienting for a trader to figure out how to properly react to the situation. Douglas writes:
The need for rules may make perfect sense, but it can be difficult to generate the motivation to create these rules when we’ve been trying to break free of them most of our lives.
He suggests that there may be a need to break down the source of this resistance, be it through some form of therapy or psychoanalysis of one’s upbringing and life experiences. This way, one is able to fully understand and be on top of negative emotions that threaten the ability to stick to trading rules.
2. Inability to take responsibility
Since there’s no shortage of unforeseen events in trading, it can be easy to pin the blame on the random nature of the financial markets when one is not performing well.
However, this runs the risk of traders not being able to accept responsibility for their decisions and the outcomes.
More often than not, traders find it easy to take credit for plays that turn out profitable because they followed the strategy but at the same time have a hard time feeling accountable for trades that didn’t turn out as planned because of a market surprise.
The problem with this line of thinking is that it could abandon the pursuit of trading consistency and blame it on the randomness of market events. To address this, it helps to remember that:
Even though the outcome of each individual [market] pattern is random, the outcome of a series of patterns is consistent (statistically reliable).
3. Addiction to rewards
There’s no denying that scoring a big winning trade or a series of wins comes with a huge dopamine hit that feels very, very good.
Of course, this feeling can be addicting to some, which can lead a trader to keep chasing highs, even at the expense of deviating from trading rules. Douglas writes:
The problem with any addiction is that it leaves us in a state of “choicelessness.” To whatever degree the addiction dominates our state of mind, to that same degree our focus and efforts will be geared toward fulfilling the object of that addiction.
In other words, a trader can wind up only practicing proper risk management only when he or she feels guaranteed a win. On the flip side, when one feels powerless when it comes to affecting the outcome of a trade, there’s a tendency to do whatever it takes to satisfy the addiction.
4. Losing external and internal control
For most of us, our social upbringing and environment have enabled us to figure out ways to put situations under control.
When arguments are getting heated, we have our own strategies for keeping our cool and possibly convincing others to do the same. When facing plenty of uncertainty, let’s say when traveling to a new city, we instinctively determine what we can plan ahead or research.
Of course, as any trader worth his salt knows, it is virtually impossible to manipulate or control every single thing that the market does. This challenges the trader’s ability to make the external environment conform to his or her internal state.
The truth is that we can still control our perception and interpretation of information, as well as our own reactions.For instance, your flight can get canceled due to bad weather (an external factor out of your control) but you can either throw a fit or just walk around the airport to look for a snack (an internal reaction within your control).
When market events don’t go your way, do you keep a cool head while figuring out your next steps? Do you take time to digest the fresh information and consider making adjustments? Or do you throw all caution to the wind and scramble to make up for your losses?
Keep in mind that all information is neutral and that the market isn’t out on a mission to get you. It’s your own mental framework that determines how you perceive things and whether or not you can enter an objective state of mind that’s conducive to taking advantage of whatever the market is offering.