8/19/2010 - The Winning Traders Mindset

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Plutchik’s Wheel of Emotions

As you know by now, psychology is a secondary interest of mine, after reading charts and tarot cards, of course. For this week, I decided to cover the “trader’s mindset” and the most common psychological issues that all traders deal with.

How does someone know that they reached the trader’s mindset? Here are a few characteristics:

1. No anger whatsoever.
2. Confidence and being in control of the self
3. A sense of not forcing the markets
4. An absence of feeling victimized by the markets
5. Trading with money you can afford to risk
6. Trading using a chosen approach or system
7. Not influenced by others
8. Trading is enjoyable
9. Accepting both winning and losing trades equally
10. An open mind approach at all times
11. Equity curve grows as skills improve
12. Constantly learning on a daily basis
13. Consistently aligning trades with the market’s direction
14. Ability to focus on the present reality
15. Taking full responsibility for your actions

Developing the trader’s mindset takes time.

Let’s take 100 traders using the same trading system or approach. It is highly likely that two of them will not trade a system exactly the same way in all aspects. Why is this? Because our mindsets, beliefs, and understandings are unique. It is no surprise that most traders fail and the reason why is because they lack the trader’s mindset.

There are two parts to fixing any psychological problems:

1. Recognizing that it exists
2. Accepting it so you can move on

In trading, this is where it’s so crucial to take responsibility for your own actions because it induces change and you can start making improvements. If you don’t recognize and accept a problem, then you won’t get anywhere!

What are some of these issues that I speak of? Here are a few along with their causes and/or effects (these 15 issues are not meant to perfectly coincide with the above 15 mindset characteristics):

1. Anger over a losing trade – Traders usually feel as if they are victims of the market. This is usually because they either 1) care too much about the trade and/or 2) have unrealistic expectations. They seek approval from the markets, something the markets cannot provide.

2. Trading too much - Traders that do this have some personal need to “conquer” the market. The sole motivation here is greed and about “getting even” with the market. It is impossible to get “even” with the market. Trading too much is also indicative of a lack of discipline and ignoring set rules. This is emotionally-driven.

3. Trading the wrong size – Traders ignore or don’t recognize the risk of each trade or do not understand money management. There is no personal responsibility here. Typically, aggressive position sizes are used, however if risk is not contained, then it could spiral out of control. Usually, this issue comes from traders wanting to make a huge killing. Maybe they do win, but the point is that a bad habit emerges if a trader repeats this behavior.

4. PMSing after the day is over – Traders are on a wild emotional roller coaster that is fueled by a plethora of emotions ranging throughout the spectrum. Focus is taken off of the process and is placed too heavily on the money. These people are very irritable akin to the symptoms of premenstrual syndrome (something I wouldn’t know about personally).

5. Using money you can’t afford to lose – Usually, a trader is pinning his/her last hopes to make money. Traders fear “losing” the “last best opportunity”. Self-discipline is quickly forgotten but the power of greed drives them, usually over a cliff. Here, the rewards are given more attention and overall personal financial risk is ignored.

6. Wishing, hoping, or praying – Do this in church, but leave this out of the market. Traders do not take control of their trades and cannot accept the present reality of what’s happening in the market.

7. Getting high after a huge win – These traders tie their self-worth to their success in the markets or by the value of their account. Usually, these folks have an unrealistic feeling of being “in control” of the markets. A huge loss usually sobers them up pretty quickly. It’s important to maintain emotional restraint after wins, just as you would for losses.

8. Adding to a losing position – Also known as doubling, tripling, quadrupling down, typically, this means that the trader does not want to admit the trade is wrong. The trader’s ego is at stake and #6 comes into effect as the trader is hoping the markets will “work in their favor”. If you are wrong, you have a near 0% chance of making a full recovery.

9. Compulsive trading – Similar to #2, except these traders have an addiction to trading and quite possibly gambling issues. They need to constantly trade, even if there is no rational reason to do so. They are always excited whether they win or lose. These traders will trade in all environments and usually trade when it’s advisable to sit out.

10. Afraid of “pulling the trigger” – This usually means that the trader does not have a system or approach already in place. They have not calculated risk/reward and many times, these trades are unplanned. This also comes after a string of losses. They don’t want to be “wrong again”. There is no trust from within and an obviously lack of confidence.

11. Over-thinking or second guessing – Similar to #10, but these people are usually looking for a “sure thing”, when they clearly don’t exist. Losing is not recognized as a normal part of trading and the risks and unknowns of trading are not fully accepted. These traders cannot make decisions in the face of the unknown.

12. Limiting profits or getting out too early - These traders do not have a plan. There is a direct effect from believing that profits were undeserved…a typical reason for giving them up. Usually a trader is stressed over a trade for some reason and closing the position quickly eliminates the anxiety. Usually, there is a fear of “giving back” those gains.

13. Fear of being stopped out – Traders fear failure and the pain from taking losses is great. Here is another instance where the ego is at risk. They must always be correct or suffer a feeling of “let down”. Don’t forget that your stop loss is your last line of defense.

14. Not following your system – This is a trust and follow-through issue. Perhaps the trader didn’t test it enough, or it recently produced a string of losses, casing some doubt. Your faith in the system is broken. Not only do you not trust the system, you can’t even trust yourself with picking one that works for you. Find and stick with one that is consistent and ‘fits’ with your personality and style.

15. Following other traders (indiscriminately) – These traders do not have a system. They are also limited in trading knowledge. They feel that they will become winners if they simply “follow” someone. These trades are usually impulsive. It’s too dangerous to follow without cause.

The key to all things is creating balance. Remember, it takes time and discipline. The important thing here is to recognize the issues and learn to seriously accept them and take responsibility for your actions. When you finally recognize and accept each of these common pitfalls, you’ll be well on your way to acquiring the trader’s mindset.