Psychology of Investing
- Thread starter Jett_Star
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Try www.innerworth.com
I have been getting the daily email for 2 yrs...recomended
Not sure how to sign up for it now but worth a try
Cheers
To successful trading
I have been getting the daily email for 2 yrs...recomended
Not sure how to sign up for it now but worth a try
Cheers
To successful trading
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Never fall inlove with a stock
Trade with your mind, not with your eyes
my 2cents
Trade with your mind, not with your eyes
my 2cents
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I just uploaded a new smilie you might find useful in the future:profithunter said:
ghotib
THIMKER
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Do you mean psychology of investors - as in what on earth was I thinking? - or psychology of markets - as in WTF is going on this time?
Maybe it's the same thing.
Ghoti
Maybe it's the same thing.
Ghoti
WaySolid
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Jett_Star said:Is anyone elsed interested in the psychology of investing?
Know of any good sites?
Have any wise words for us all?
Hi Jett,
I found the following site fascinating. Travis has many wise things to say: http://www.travismorien.com/FAQ/psychology.htm
VanTharp covers the psychology of trading well in his book "Trade Your Way to Financial Freedom"
I consider pyschology to be a crucial area for investing and life.
WaySolid
RichKid
PlanYourTrade > TradeYourPlan
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Hi,
There's a book by David Cohen (psychologist) on the psychology of markets (sorry I can't recall the title). Lots of other titles too, a classic is- 'The Madness of Crowds' or something that sounds like that, sorry I've forgotten (check out Amazon.com) on contrarian investing.
Also, Safety in the Market (www.sitm.com.au) has a free email newsletter (trading tutors) that has a regular column on the mental perspective of investing. I don't use the SITM system (too expensive and complicated for me) so I don't recommend it but the email is informative (it's easy to subscribe to it but they'll also send you spam advertising their products).
Finally, Louise Bedford's trading books explain possible reasons for certain trends using market psychology.
I basically reckon that if you know yourself, you'll be halfway to achieving everything else! But that's just me being philosophical.
Hope this helps.
RichKid
There's a book by David Cohen (psychologist) on the psychology of markets (sorry I can't recall the title). Lots of other titles too, a classic is- 'The Madness of Crowds' or something that sounds like that, sorry I've forgotten (check out Amazon.com) on contrarian investing.
Also, Safety in the Market (www.sitm.com.au) has a free email newsletter (trading tutors) that has a regular column on the mental perspective of investing. I don't use the SITM system (too expensive and complicated for me) so I don't recommend it but the email is informative (it's easy to subscribe to it but they'll also send you spam advertising their products).
Finally, Louise Bedford's trading books explain possible reasons for certain trends using market psychology.
I basically reckon that if you know yourself, you'll be halfway to achieving everything else! But that's just me being philosophical.
Hope this helps.
RichKid
At the risk of looking like a "plug", here is a chunk of my course:
INVESTOR PSYCHOLOGY
THE TRADERS MINDSET
So you want to become a share trader. You have probably talked to someone else who has done it, and told you it was easy, a part time job with high pay and low stress. Or perhaps you picked up one of those trading books where they promise you wealth, freedom and happiness if you just follow their methods. “You can trade anywhere in the world, work two hours a day and live carefree”. Right, so then, why aren’t you trading from a tropical island instead of writing books for a living? I have read a lot of trading books, and the majority only tell you what you want to hear, because if they told the truth and said “trading is hard work, stressful, and 95% of traders go broke” nobody would buy their book would they? People aren’t interested in the truth if the truth is painful. They want to be inspired, they want every new experience to be a positive one. They want to get rich quick, and what better way than doing it yourself?
Trading as a business.
If you decide to trade full time, you will need to treat trading the same as any other business. Long hours are sometimes required, it can be very stressful, and your financial fate rests on your ability to operate the business successfully. In most endeavors, you have peers that guide and advise you, keeping you on the rails. Failure is less likely when you have people following your progress. Trading is a solitary occupation.
If you have a bad day you do not get the sack, you lose money. If you are incompetent or slack off you will lose money. There is nobody to hold your hand. If you mess up, nobody tells you to stop and nobody offers advice. You and only you are solely responsible for every action and inaction alike.
Experience
When things are going well, nobody stops and asks why. They just accept it, using the ‘if it ain’t broke, don’t fix it’ mentality. If a listed company is making huge profits, shareholders are unlikely to request an investigation into their business practices. People only look for causes of failure after the event.
The definition of experience – learning from a great number of mistakes. If you only ever succeed, you will never know failure, and therefore will not be prepared for it when it comes. Some of history’s greatest achievers only got to the top by facing massive failure along the way. Billy Joel for example, struggled to make it big, and contemplated suicide. Colonel Sanders from KFC fame was rejected 1099 times before someone agreed to buy his chicken. Many famous traders went broke 3 or 4 times before they found success. “Experience is knowing you have made the same mistake before.” Are you prepared for this kind of suffering?
Discipline is the most important trading skill, but luck, timing, deep pockets and inside info can sometimes outweigh the discipline weakness. I know a lot of traders who simply double down when they lose, and assuming you have enough capital you can eventually win that way, but it’s a dangerous strategy, if you can call it that. Fund managers are the experts. They are never wrong. If they are, they flood the market until they overpower it. But for the rest of us, we have to rely on skill.
Bearing these things in mind, whom should you learn trading skills from? Remember that we only look for causes of failure after things go wrong. Our hotshot trader is an egomaniac, he never loses. Do you think he would spend 18 hours a day reading books to become more knowledgeable? Success is not a measure of knowledge, but knowledge is a measure of success. Why would the hotshot waste his time teaching you anything anyway, he prefers the market to be full of idiots that he can take money from, and his time is better spent watching the market than writing books.
I have spent many years looking for the cause of my own failure as a trader. This quest has seen me read many books, talk to many traders, go to seminars and complete formal education in finance. I now have a much greater knowledge of the trader’s mindset and the mechanics of the market. I used to read trading books and think ‘if you are such a good trader, why do you spend your life writing books?’ Now I know the answer. It takes a special person to be a successful trader. Perhaps one day I will master my discipline and become a great trader.
I find it easier to give up the trading and look for other ways to make money in stocks. After a lot of research and number-crunching, I found I was making more money using strategies that make money when a stock does anything, not just go the way I had hoped. Yes, I am a failed trader. I am a statistic. I am not the one in twenty who succeeds. Do you wish to learn from my experience of throw away thousands of dollars making the mistakes for yourself? I don’t need to trade anymore. I make my money writing options. “Be a buyer of despair and a seller of hope”. Isn’t that what an option trader does? Writing calls to the hopeful and writing puts to the desperate.
Have no illusions, it is unlikely you will be a successful trader. It is widely reported that 95% of traders go broke. If by the end of this course you are deterred from trading (as opposed to investing), possibly because you feel you have a weakness that may result in your financial implosion, then the cost of this course is money well spent. I remember the first month I spent trading. I did not bother to learn anything, I considered it a waste of time and money, there were opportunities I was missing, damnit! Within a month, I had lost a few thousand dollars. In hindsight, that money would have been better spent on education. What we as traders must realise, is that the market is a closed loop, a finite amount of capital is there at all times. In order for someone to make money, someone else has to lose it. This is known as a ‘zero sum game’. However, it is not quite accurate. Many people rely on the stock market for employment. Think of all the brokers, the newsletter writers, the magazines, the fund managers, the data providers……the list is endless. Think of the Internet and computer you bought just to trade shares. Think of books like this one you paid for, which you would not require if not for the market. All of these people take their salary from the market indirectly. Therefore, the market is a NEGATIVE sum game, and it requires constant re-inflation through injected capital just to stay afloat. Luckily retirement schemes worldwide ensure this.
Greater Fool
You can only make money in the market by taking it from someone else, while they are trying to take it from you. It is a race. If you have no knowledge or experience, and everyone else does, who is going to win? The least experienced players always sell at the bottom and buy at the top. This is known as the ‘greater fool’ theory. If you are buying an overpriced stock, you are expecting to sell it for a profit, which means you think there must be someone (more foolish than you) who will buy it at the higher price. After all, why would you sell if you thought it was going to go up more? When the market is rising, as it did during 1999-2000 in the dotcom era, everyone wants to jump on the bandwagon. New, inexperienced traders flood the market with cash, pushing the market up more. They will make money for a while, as there are always fresh buyers for them to sell to.
When everyone is making money, it seems easy, and nobody bothers to become educated. Eventually the music stops when the supply of new buyers runs out, and there is a mad scramble to the exit. The top of the market occurs when the most conservative punters finally succumb to greed, having watched the market climb and climb, kicking themselves for not getting in earlier.
These are the ‘greater fools’, they are the last to buy, and they are reluctant to sell and lose money, instead hoping things will get better. As the market falls, the ‘not quite the greatest fools’ start to lose money, some are smart and pull out, some watch their paper profits erode, followed by their starting capital. Eventually most will pull out in disgust, while others just go broke. There is a pattern emerging. As the market falls, the fools leave. Remember, we only make money as a trader by taking it off those with less experience. As the market falls, the I.Q of the market increases. Eventually, there are no fools left in the market, and we are left to compete against professional traders and fund managers. What do you think your odds of winning are now? If you stay and play, it is financial suicide. Congratulations, you are now the ‘greater fool’. It is like a 4-ft midget taking on a 7-ft wrestler. Sure, maybe you might get a punch in, but there’s no way you are coming out of the ring victorious. But alas, lured by the 30% a day returns from yesteryear, some just cant bring themselves to leave. When you go from making 30k a year to 3k a day, the real world can seem hard to go back to.
The confidence cycle
The trader without discipline goes through various stages, which form a cycle. When a trader has a win, he feels empowered and brilliant. His confidence rises with each winning trade. Sometimes a trader can experience a period where every trade is a success. This growth in confidence begins to affect how the trader thinks. He gains a feeling of invincibility, and throws caution to the wind. Losing trades and the pain associated with them are a distant memory. The balance between fear and greed has shifted. He asks himself why he should continue to place small bets when he could have compounded the small profits into a very large one had he had the courage. Suddenly he begins to place larger bets, while also using less caution. He bends the rules for entry, and finds the lamest reason for taking a trade. When the trade goes wrong, he hesitates to take the loss quickly because he has seen many recent losses turn into large profits. He sees no reason to panic and watches the trade go against him. Eventually panic creeps in, and he tells himself he will take the loss on the next bounce. If the bounce comes, he argues that the fall was just temporary and stays in the trade hoping for a complete recovery. The trade then slips back and regret sets in. He promises himself that he will get out if only he can have another chance. No second chance ever comes however, and the losses stack up.
He has been in this position before. Last time he had a big loss, he sold at the exact bottom in disgust. He won’t make the same mistake this time. He is going to hold on until it turns around. He knows that if he sells here, the market will rally just to spite him. Eventually all this negativity eats away at him, and he decides to try a new position. He thinks he can wipe the slate clean and start fresh. He is unhappy about the loss he just suffered, and vows to make it up on the next trade. He figures that the odds of a similar thing happening again are low, and that the market owes him a good trade because of the law of averages. Nevermind the fact that he had 7 or 8 good wins followed by one loss, he wants a win to balance out the previous loss. This time he bets even bigger, and when the trade goes bad he refuses to act because the large position size together with the small percentage loss result in a large chunk of capital lost. He searches for a reason to delay acting, hoping for a recovery in the stock which never comes.
By this time his confidence is in free-fall along with his account balance. It is quite normal for a trader to base his confidence level on his account balance. This is a subconscious association, but it is incredibly reliable. If you were to ask the trader about his confidence level at the end of each day and plot the information, you would find it mirrors the chart of his account balance almost exactly. I realised this early on, and deliberately did not look at my account balance during the day. At the end of the day I would note my confidence level, and then check my account balance. Many times my performance for the day was a lot different than I thought, and the result changed my confidence level immediately. Unfortunately it is rarely possible to ignore your account balance, especially when margins are involved. Some wealthy traders have a buffer of several hundred thousand dollars, and could easily ignore their account balance if it would help them regulate their confidence. Something tells me though that if they have reached this level, they have already mastered their confidence fluctuations.
Our amateur trader has had his confidence and account devastated. The majority in this situation will accept defeat and quit trading altogether. Some while search for a new system, buy new software, or trade different stocks. Very few will take a good hard look at themselves, try to figure out what they did wrong, and learn from the experience. Some pretend that it was just bad luck, or that the market has it in for them. They make excuses for their own failure. Everyone and everything is to blame except themselves. Some blame their broker, their computer, the report they read or the tip they were given. These people get back on the horse and do things exactly the same way, expecting a different result. With their confidence shot, and their account a fraction of its former glory, they begin to trade again. Fear is now the ruling emotion. This promotes caution, which in turn makes the trader less likely to take a silly trade. He waits like a sniper for an opportunity with good odds of success. When it comes, he bets small. The trade goes well, and money is made. With each passing trade, confidence grows with the account balance. Sure enough the trader is back to the beginning, and the cycle repeats over and over.
Discipline
Gambling is an addiction, caused by a mental illness. It is not a chemical dependency issue like drugs, smoking or alcohol, but rather one we can control if we so desire. Similar to chemical addictions, certain parts of the brain are stimulated when we gamble. When we win, we begin to think of the happiness that lies ahead. These positive thoughts release dopamine in the brain and adrenaline in the body, giving us a ‘buzz’. Our heart rate, blood pressure and breathing increase. The dopamine in the brain stimulates the regions that control mood and motivation. We feel very happy and very alive. When we lose, only adrenaline is released. Since we lack the dopamine effect in the brain, but still have the increased heart rate, blood pressure and breathing, this enhances a feeling of fear. It is a primitive instinct, common during a fight for survival. Think fast, react fast, and survive. The increased heart rate, blood pressure and breathing cause a large amount of oxygen to accelerate the normal brain activity, forcing the decision making process to be sped up. Neurons do not have time to ‘consult’ parts of the brain controlling logic and reason, and bypass them. This is the early stage of panic. Placed bets during this stage are seldom logical or rational, and a self-destructive cycle emerges.
A trader may face the same problems, if they treat trading as a source of excitement. The trick for a trader is to operate void of emotion, so that the decision making process remains stable. When trading itself provides no ‘buzz’, it is less likely a trade will be entered for the wrong reasons. It is important that you do not allow yourself to celebrate a win, nor moarn a loss. It takes time to develop this emotional detachment, and it is a form of discipline in itself. Few traders I know have mastered this.
Discipline is the most important trader skill. In order to master discipline, we must first understand and define it. Many people confuse discipline with will power, in fact they are quite different.
Will power vs discipline.
Discipline:
1. Training expected to produce a specific character or pattern of behavior, especially training that produces moral or mental improvement.
2. Controlled behaviour resulting from disciplinary training; self-control.
3. 1. Control obtained by enforcing compliance or order.
2. A systematic method to obtain obedience: a military discipline.
3. A state of order based on submission to rules and authority: a teacher who demanded discipline in the classroom.
4. Punishment intended to correct or train.
5. A set of rules or methods, as those regulating the practice of a church or monastic order.
Will power - The strength of will to carry out one's decisions, wishes, or plans.
Source: dictionary.com
Discipline is something that is learned, while will power is something you either have or do not have. Perhaps it is genetic. Will power is the emotional form of discipline. Discipline is an autonomous thought process, while will power is an emotional response. Emotions are hard to modify. However it is possible to compensate for a lack of will power by developing strong discipline. We avoid using will power as a tool in trading, as emotional thoughts are seldom logical.
The decision making process
For every choice we are faced with, we evaluate both possibilities then decide to choose the one that will cause us happiness, or avoid pain. Every trade contains multiple crucial decisions, and making the wrong decision results in certain financial and mental pain. You have a choice right now. You can keep reading this course to the end, or you can put it down now. You will evaluate both choices. On the one hand, you will think that you need to keep reading this course because knowledge will lead to money, which provides happiness. On the other hand you will also think that reading is boring, and watching TV is so much easier. Now you have associated pain with the decision to keep reading, and happiness with the decision to go watch TV. Still here? You have not allowed short-term happiness to over-ride long term happiness or short-term pain. Well done. You have some discipline.
I now make decisions I never used to make. I spend a little more time evaluating the pros and cons of each decision now that I know how to process them more accurately. I now find myself doing things that I would normally dismiss as ‘too hard’ or ‘not in MY interest’. Understanding the decision process has helped me become a less selfish, more productive person, but most of all, a more disciplined trader.
A smoker has a choice. I am going to use smoking as an example, as there are more smokers than alcoholics or gamblers. It is important you understand why we decide what we do. If you have never been a smoker, surely you know someone who has tried to quit. Do you think you would be able to quit? If you are already a trader, substitute nicotine for the trading buzz.
Nicotine stimulates the adrenal glands and results in a discharge of epinephrine (adrenaline). The rush of adrenaline stimulates the body and causes a sudden release of glucose as well as an increase in heart rate, blood pressure and breathing. Nicotine causes a release of dopamine (feel good chemical) in the brain, affecting regions that control motivation and mood. It is little wonder the addiction is so hard to kick, the short-term happiness argument has a head start and an unfair advantage. There is no opportunity for the decision process to work without bias. The brain evaluates this choice, and decides that the long-term pain from bad health and cost of cigarettes do not over-ride the short-term pain of going cold turkey.
An incredible amount of will power and discipline is required to overcome the habit. Most try the will power approach first, and most fail. Those who try the discipline method with conviction will break the habit.
Everyone has weaknesses. What are yours? Maybe you are overweight, maybe you smoke, perhaps you do not exercise enough, or maybe you gamble or drink too much. What leads you to these actions? Where does your decision process break down? What inaction’s do you take and why? Do not just read that and think, “I do not need to do that”. Show some discipline! Write the questions down on a piece of paper NOW. Then answer the questions truthfully.
So how do we overcome an addiction? We cannot avoid the decision making process, so we must use it against the habit. We must trick our mind into re-evaluating the pain and happiness components. In the smoker’s case, they need to associate pain with the decision to light up, and happiness with the decision to throw the pack out.
When you feel an urge to smoke, force yourself to think of pain associated with the cigarette, and happiness with not smoking it. Follow these steps:
Step 1, consider the short-term pain first. Think of how disgusting the smoke tastes, how it makes your breath stink which makes your partner not want to kiss you and think of the time wasted.
Step 2, consider the long term pain. Think of the damage you are doing to your health, think of all the money you wasted on cigarettes and the extra you pay for insurance. Think of how smoking has affected your partner’s view of your attractiveness, consider the health of others you smoke around, think of your teeth going yellow and think of the wrinkles around your mouth.
Step 3, associate short term happiness with the decision to not light up. Think of the time that could be spent doing something else you enjoy. Think of the money you could save. Think of how fresh your breath will smell and the smile on your partners face after they kiss you.
Step 4, long term happiness. Think of how much cheaper life and health insurance will be. Think of the money you will save on cigarettes. Invest that money! Consider how much more attractive your partner will find you. Think how much longer you will live. Think of your nice white teeth and wrinkle free mouth. Think of how many people will admire your courage and do the same.
Achieving Discipline
One thing I noticed about trading books in general is that they were big on demands. “You must do this, you must do that” e.g. “you must be disciplined” well that’s great. Just how exactly do I do that? It’s one thing to say, “get disciplined, stupid!” and quite another to show people how to achieve it. How many people even know what discipline actually is? How can they possibly achieve it if they don’t know what it is?
The mind can be improved the same way the body can be. If you train and condition your mind, it will respond with great efficiency and effectiveness. The brain, especially the subconscious, can be easily conditioned. The subconscious mind can be a great ally or a great enemy, and we are only just beginning to understand its workings. If you think something often enough, even if it is not true, your subconscious mind will come to believe it. Throw in some controlled body language and you can make your brain do anything you want. Try it now. Fold your arms and legs, tilt your head down, breath shallow, frown, and say “I am a bad person” ten times. How do you feel? Miserable! Now uncross your legs and arms, lift your head right up, hold a smile, take a deep breath and say “I am a good person” ten times. Better? Isnt it amazing how easily you can control your mind!
Discipline is a major benefit to those involved in martial arts. It would surely be easier to learn discipline using both mental and physical stimulus, from those who have thousands of years experience in mind conditioning and discipline, therefore any type of martial arts training is likely to improve your skills as a trader. The military have developed their own discipline system.
There are five steps to achieving discipline.
1. Motivation. Short-term reasons for taking action. These can be invented and programmed into the subconscious. Set minor goals, and devise a strategy to achieve them. As a trader our minor goals are to enter trades with good odds, while maintaining risk control and money management.
2. Incentive. Long-term reasons for taking action. These must be either genuine beliefs or convictions. Set major goals, and devise a strategy to achieve them. Our major goals are consistent profits and increased experience.
3. Visualization. Picture yourself achieving the minor goals one by one. Then visualise yourself achieving the major goals. This supports the belief system. See yourself pulling the trigger when a stop is reached. This will make it easier when you need to actually do it.
4. Belief. Tell yourself that you can achieve the minor goals. Be repetitive. Realise that achieving all the minor goals results in achieving the major goals. Capital preservation is everything. Keep the losses small and let the winners run. Realise that it is possible to succeed as a trader if you maintain discipline.
5. Focus. When your mind is constantly analyzing your activity or thinking about many different things, it distracts you from your awareness and performance of what you are doing in the moment. Your mental power is strained and the decision process can easily be corrupted. Mental discipline requires focusing your attention fully on the task at hand. When trading, minimise all other thoughts. Take action to ensure interruptions do not affect your trading. Be organised and prepared.
“Whether you think you can or think you cannot, you are always right”
“I think, therefore I am.”
Three decisions
Now we understand and respect the decision making control we have, there are no excuses. In trading, discipline should be used at many points in a trade. First, we decide on an entry. We should always be considering the pain possibilities in this process, many people focus only on the happiness part, ie ‘how much will I make?’. Before we enter the trade, we have two other decisions to make. One is our stop-loss. We need to do all 4 steps for the stoploss, then decide on an exit strategy using the 4 steps again. It sounds like a lot of work, but in time you will do it subconsciously and quick. “Plan the trade and trade the plan”. This means know what you will do before you need to do it, and cover every scenario. Your mind is unreliable when it has to make decisions in a hurry. Make the decisions when you are calm and have time, enact them when need be without thought. This ensures clear, calm, stress-free thinking and no mistakes.
Emotion is your worst enemy. Fear and greed easily replace pain and happiness in the decision process when inaction is taken, but with less control. Fear especially is uncontrollable, so keep control in the decision making process by acting before fear (or greed) become a problem.
Let us go through an example trade. Assume RIO has been in a downtrend, and we see there is support at 2900.
Entry. We think RIO will provide us with short-term happiness if we buy RIO at 2900 and it rallies. Our short-term pain is that RIO will fall under 2900, causing us to stop out, and then rally. Our long-term happiness is watching RIO go up and up for months. Our long-term pain would be if we bought at 2900 and did not stop out, and RIO kept falling, causing us a large loss. Lets assume we weigh these thoughts up and decide to take the risk.
Stop-loss. Support is 2900. Our trading rules tell us to buy on support and stop out if below support. This makes our decision easier, as there is a clear-cut difference between under or above support. The only decision we need to make is how much lower do we want the stop. Our short-term pain is that we set our stop too close. Our short-term happiness is we set it close and RIO breaks down. Our long-term pain is that we set it too far away and lose more than necessary. Our long-term happiness is we set it far away and RIO breaks down slightly then rallies, in which case we are safe. Lets assume then that we decide to set the stop at 2890.
Exit. We enter at 2900, and are taking a risk, so we should not aim for a low return. We could use one of a hundred exit strategies, such as a 10% gain, moving average cross or a count back line. Each will have its own pains and happiness, namely giving a return different to other strategies. The pain is choosing one that gives the lowest return, and the happiness is choosing the one that gives the best return.
Now we have our three decisions made, we enter the trade and trade the plan, calm and collected. We do not get excited when we win, and we do not get upset when we lose. If we cannot control our emotions and keep them well clear of our thinking, they will corrupt our decision processes. This is a skill that is learnt in time.
The Disciplined Trader Survey
I have access to a large trading community. I was able to ask around, and get a list of names of those who have great discipline, and those who completely lack it. I sent some of them several questions, and noted their replies.
Survey Results
Discipline perception
Many of the participants stated that they thought they had excellent discipline. Some of the participants gave themselves 7 or 8 out of 10. They then proceeded to state that they did not set their stop-loss or exit strategy before entry, if at all. They also broke their trading rules often, ignored or changed stops, and sometimes added to a losing position. They also took ‘punts’ because they were bored and could not find any trades with good odds. Obviously they are not as disciplined as they think. Many also stated that they started trading with low discipline, but multiple losses had forced them to improve.
Futures traders think differently to share traders.
The second observation I made was that the ‘disciplined’ traders were all futures traders. What’s more, these traders stated that they found it hard to stay disciplined when trading stocks instead of futures, and some said they ceased trading stocks altogether for this reason. Why is this? Further probing revealed that these traders perceived greater control when trading futures, as liquidity, hours of trading and risk management was thought to be better. There is no room for complacency with futures, as you cannot simply ‘put it in the bottom drawer’ and hope it comes right one day. Futures traders realise a loss is a loss NOW, the option of waiting for the trade to turn around is not there. Denial is a rare trait among futures traders, as you will be wiped out. A single act of denial or ignorance means you wont be around to tell us what went wrong. Another factor is futures are traded on a margin, and when losses build up, so does the margin. It reaches a certain point where the trader is unable to fund the position, and he faces a choice of closing out broke, or getting a margin call. Neither is an appealing option, as you cannot recover losses without trading capital. Basically you are finished if you let things get that far. Perhaps this is a subconscious thought they have when experiencing a loss. Perhaps it is the motivator they need to keep them in control.
But why do share traders act so complacent in comparison? There is a common misconception (more an admission of denial really) that a ‘paper’ loss is not a real loss until you exit. I find this confusing, as people are quick to celebrate a paper profit. Either it is real, or it isn’t. Another pearler is adding to a losing position. You made a decision to buy, and expected the stock to go up. Clearly you were wrong, and should take responsibility for this action. You were wrong once, what on earth would make you think you could not be wrong again? You are so afraid to take the small loss, and go into denial. You figure that you weren’t wrong at all, the market is. Soon the market will realise its mistake, and they will begin buying. So you buy more. Then the stock drops more. Your losses are exponential. Denial is now harder to break out of. A minor problem has now become a serious one. You have abandoned logic and reason at this point, and adopted hope and denial. To avoid this path of self-destruction, we must learn humility, accountability and control.
So what can we learn from the futures traders? They are masters of control. They cannot make excuses for staying in a bad trade, and they cannot wait for things to improve. They take quick, decisive action, and plan ahead like a good chess player. They learn these things quickly because the futures market is absolutely unforgiving. There are no second chances. There are many others who have been burnt, most likely coming into the market with no discipline, and denial issues. Learning the ropes by trading futures is an option, but an expensive one.
We must overcome these misconceptions that losses on shares are different to losses on futures. Shares can be margined, but usually they are not. Do we treat losses more seriously when margin is involved? We should hope so.
These are the new thoughts we must substitute for the old:
We will not enter a trade without planning, and certainly will not enter a trade because we are bored.
Good trades are very rare, but it is more profitable to wait for them than to accept lesser trades.
We must accept that a loss is a loss NOW, and indecision is not an option.
We should have already planned our trade, with stop-loss and exit strategy ready to implement.
Decisions should have already been made, as we do not want to make them under pressure. All that remains is to ‘pull the trigger.’
We must recognise the signs of denial, and be able to detect them in ourselves.
We must accept that the market is never wrong, only we are wrong.
When a loss is made, we are in error and must take action to correct the situation.
Hope is not a valid investment strategy, in fact it is a guaranteed loser.
A good trade is one where the rules are followed and discipline is kept, resulting in a profit or a loss.
A bad trade is one where the rules are broken and discipline is lost, resulting in a loss or a profit.
We will take a small loss now, and regroup. Accept defeat.
Why did we enter the trade in the first place? Analyse everything. Make a new trading rule. Enter it into our trading diary. Never repeat the same mistake.
We will not take a course of action, or inaction, that will lead to self-destruction.
While we are waiting and hoping for a losing position to turn around, we will probably miss 10 other opportunities. Even if we do get back to even, how much profit did we miss out on because our capital was tied up in a trade which ultimately made no money for all the time and stress involved?
So now we have purged some of the corruptive thought processes from our mind, and we now more closely resemble controlled, disciplined futures traders.
Traders cliches.
While some may consider cliches tacky and unprofessional, I believe they are a powerful learning tool. A cliché is an overused expression. They get to cliché status because they are effective at conveying the point. Cliches work!
When everyone agrees, no ones thinking
Zig when the lemmings Zag
If in doubt.. Get out
Winners hold onto their winners, losers hold onto their losers
The trend is your friend, but the trend must end
The market can remain irrational longer than you can stay solvent
There are old traders and bold traders, but there are no old bold traders
You can’t go broke taking a profit
Never fall in love with a stock
BIG genuine sellers do not sit in the depth.
Buy the rumour, sell the fact
If you’re not on the inside, you’re on the outside
Amateurs set the open, pros set the close
The past has no bearing on the future
The market will do what the least number of people expect
Do not catch a falling knife
Never fight the Fed
Up the stairs, out the window
But markets always go up long term.....don’t they?
A mistake on a short-term hold turns it into a long-term investment
Sell in may & go away
Buy in Gloom Sell in Boom
Be a seller of hope and a buyer of despair
INVESTOR PSYCHOLOGY
THE TRADERS MINDSET
So you want to become a share trader. You have probably talked to someone else who has done it, and told you it was easy, a part time job with high pay and low stress. Or perhaps you picked up one of those trading books where they promise you wealth, freedom and happiness if you just follow their methods. “You can trade anywhere in the world, work two hours a day and live carefree”. Right, so then, why aren’t you trading from a tropical island instead of writing books for a living? I have read a lot of trading books, and the majority only tell you what you want to hear, because if they told the truth and said “trading is hard work, stressful, and 95% of traders go broke” nobody would buy their book would they? People aren’t interested in the truth if the truth is painful. They want to be inspired, they want every new experience to be a positive one. They want to get rich quick, and what better way than doing it yourself?
Trading as a business.
If you decide to trade full time, you will need to treat trading the same as any other business. Long hours are sometimes required, it can be very stressful, and your financial fate rests on your ability to operate the business successfully. In most endeavors, you have peers that guide and advise you, keeping you on the rails. Failure is less likely when you have people following your progress. Trading is a solitary occupation.
If you have a bad day you do not get the sack, you lose money. If you are incompetent or slack off you will lose money. There is nobody to hold your hand. If you mess up, nobody tells you to stop and nobody offers advice. You and only you are solely responsible for every action and inaction alike.
Experience
When things are going well, nobody stops and asks why. They just accept it, using the ‘if it ain’t broke, don’t fix it’ mentality. If a listed company is making huge profits, shareholders are unlikely to request an investigation into their business practices. People only look for causes of failure after the event.
The definition of experience – learning from a great number of mistakes. If you only ever succeed, you will never know failure, and therefore will not be prepared for it when it comes. Some of history’s greatest achievers only got to the top by facing massive failure along the way. Billy Joel for example, struggled to make it big, and contemplated suicide. Colonel Sanders from KFC fame was rejected 1099 times before someone agreed to buy his chicken. Many famous traders went broke 3 or 4 times before they found success. “Experience is knowing you have made the same mistake before.” Are you prepared for this kind of suffering?
Discipline is the most important trading skill, but luck, timing, deep pockets and inside info can sometimes outweigh the discipline weakness. I know a lot of traders who simply double down when they lose, and assuming you have enough capital you can eventually win that way, but it’s a dangerous strategy, if you can call it that. Fund managers are the experts. They are never wrong. If they are, they flood the market until they overpower it. But for the rest of us, we have to rely on skill.
Bearing these things in mind, whom should you learn trading skills from? Remember that we only look for causes of failure after things go wrong. Our hotshot trader is an egomaniac, he never loses. Do you think he would spend 18 hours a day reading books to become more knowledgeable? Success is not a measure of knowledge, but knowledge is a measure of success. Why would the hotshot waste his time teaching you anything anyway, he prefers the market to be full of idiots that he can take money from, and his time is better spent watching the market than writing books.
I have spent many years looking for the cause of my own failure as a trader. This quest has seen me read many books, talk to many traders, go to seminars and complete formal education in finance. I now have a much greater knowledge of the trader’s mindset and the mechanics of the market. I used to read trading books and think ‘if you are such a good trader, why do you spend your life writing books?’ Now I know the answer. It takes a special person to be a successful trader. Perhaps one day I will master my discipline and become a great trader.
I find it easier to give up the trading and look for other ways to make money in stocks. After a lot of research and number-crunching, I found I was making more money using strategies that make money when a stock does anything, not just go the way I had hoped. Yes, I am a failed trader. I am a statistic. I am not the one in twenty who succeeds. Do you wish to learn from my experience of throw away thousands of dollars making the mistakes for yourself? I don’t need to trade anymore. I make my money writing options. “Be a buyer of despair and a seller of hope”. Isn’t that what an option trader does? Writing calls to the hopeful and writing puts to the desperate.
Have no illusions, it is unlikely you will be a successful trader. It is widely reported that 95% of traders go broke. If by the end of this course you are deterred from trading (as opposed to investing), possibly because you feel you have a weakness that may result in your financial implosion, then the cost of this course is money well spent. I remember the first month I spent trading. I did not bother to learn anything, I considered it a waste of time and money, there were opportunities I was missing, damnit! Within a month, I had lost a few thousand dollars. In hindsight, that money would have been better spent on education. What we as traders must realise, is that the market is a closed loop, a finite amount of capital is there at all times. In order for someone to make money, someone else has to lose it. This is known as a ‘zero sum game’. However, it is not quite accurate. Many people rely on the stock market for employment. Think of all the brokers, the newsletter writers, the magazines, the fund managers, the data providers……the list is endless. Think of the Internet and computer you bought just to trade shares. Think of books like this one you paid for, which you would not require if not for the market. All of these people take their salary from the market indirectly. Therefore, the market is a NEGATIVE sum game, and it requires constant re-inflation through injected capital just to stay afloat. Luckily retirement schemes worldwide ensure this.
Greater Fool
You can only make money in the market by taking it from someone else, while they are trying to take it from you. It is a race. If you have no knowledge or experience, and everyone else does, who is going to win? The least experienced players always sell at the bottom and buy at the top. This is known as the ‘greater fool’ theory. If you are buying an overpriced stock, you are expecting to sell it for a profit, which means you think there must be someone (more foolish than you) who will buy it at the higher price. After all, why would you sell if you thought it was going to go up more? When the market is rising, as it did during 1999-2000 in the dotcom era, everyone wants to jump on the bandwagon. New, inexperienced traders flood the market with cash, pushing the market up more. They will make money for a while, as there are always fresh buyers for them to sell to.
When everyone is making money, it seems easy, and nobody bothers to become educated. Eventually the music stops when the supply of new buyers runs out, and there is a mad scramble to the exit. The top of the market occurs when the most conservative punters finally succumb to greed, having watched the market climb and climb, kicking themselves for not getting in earlier.
These are the ‘greater fools’, they are the last to buy, and they are reluctant to sell and lose money, instead hoping things will get better. As the market falls, the ‘not quite the greatest fools’ start to lose money, some are smart and pull out, some watch their paper profits erode, followed by their starting capital. Eventually most will pull out in disgust, while others just go broke. There is a pattern emerging. As the market falls, the fools leave. Remember, we only make money as a trader by taking it off those with less experience. As the market falls, the I.Q of the market increases. Eventually, there are no fools left in the market, and we are left to compete against professional traders and fund managers. What do you think your odds of winning are now? If you stay and play, it is financial suicide. Congratulations, you are now the ‘greater fool’. It is like a 4-ft midget taking on a 7-ft wrestler. Sure, maybe you might get a punch in, but there’s no way you are coming out of the ring victorious. But alas, lured by the 30% a day returns from yesteryear, some just cant bring themselves to leave. When you go from making 30k a year to 3k a day, the real world can seem hard to go back to.
The confidence cycle
The trader without discipline goes through various stages, which form a cycle. When a trader has a win, he feels empowered and brilliant. His confidence rises with each winning trade. Sometimes a trader can experience a period where every trade is a success. This growth in confidence begins to affect how the trader thinks. He gains a feeling of invincibility, and throws caution to the wind. Losing trades and the pain associated with them are a distant memory. The balance between fear and greed has shifted. He asks himself why he should continue to place small bets when he could have compounded the small profits into a very large one had he had the courage. Suddenly he begins to place larger bets, while also using less caution. He bends the rules for entry, and finds the lamest reason for taking a trade. When the trade goes wrong, he hesitates to take the loss quickly because he has seen many recent losses turn into large profits. He sees no reason to panic and watches the trade go against him. Eventually panic creeps in, and he tells himself he will take the loss on the next bounce. If the bounce comes, he argues that the fall was just temporary and stays in the trade hoping for a complete recovery. The trade then slips back and regret sets in. He promises himself that he will get out if only he can have another chance. No second chance ever comes however, and the losses stack up.
He has been in this position before. Last time he had a big loss, he sold at the exact bottom in disgust. He won’t make the same mistake this time. He is going to hold on until it turns around. He knows that if he sells here, the market will rally just to spite him. Eventually all this negativity eats away at him, and he decides to try a new position. He thinks he can wipe the slate clean and start fresh. He is unhappy about the loss he just suffered, and vows to make it up on the next trade. He figures that the odds of a similar thing happening again are low, and that the market owes him a good trade because of the law of averages. Nevermind the fact that he had 7 or 8 good wins followed by one loss, he wants a win to balance out the previous loss. This time he bets even bigger, and when the trade goes bad he refuses to act because the large position size together with the small percentage loss result in a large chunk of capital lost. He searches for a reason to delay acting, hoping for a recovery in the stock which never comes.
By this time his confidence is in free-fall along with his account balance. It is quite normal for a trader to base his confidence level on his account balance. This is a subconscious association, but it is incredibly reliable. If you were to ask the trader about his confidence level at the end of each day and plot the information, you would find it mirrors the chart of his account balance almost exactly. I realised this early on, and deliberately did not look at my account balance during the day. At the end of the day I would note my confidence level, and then check my account balance. Many times my performance for the day was a lot different than I thought, and the result changed my confidence level immediately. Unfortunately it is rarely possible to ignore your account balance, especially when margins are involved. Some wealthy traders have a buffer of several hundred thousand dollars, and could easily ignore their account balance if it would help them regulate their confidence. Something tells me though that if they have reached this level, they have already mastered their confidence fluctuations.
Our amateur trader has had his confidence and account devastated. The majority in this situation will accept defeat and quit trading altogether. Some while search for a new system, buy new software, or trade different stocks. Very few will take a good hard look at themselves, try to figure out what they did wrong, and learn from the experience. Some pretend that it was just bad luck, or that the market has it in for them. They make excuses for their own failure. Everyone and everything is to blame except themselves. Some blame their broker, their computer, the report they read or the tip they were given. These people get back on the horse and do things exactly the same way, expecting a different result. With their confidence shot, and their account a fraction of its former glory, they begin to trade again. Fear is now the ruling emotion. This promotes caution, which in turn makes the trader less likely to take a silly trade. He waits like a sniper for an opportunity with good odds of success. When it comes, he bets small. The trade goes well, and money is made. With each passing trade, confidence grows with the account balance. Sure enough the trader is back to the beginning, and the cycle repeats over and over.
Discipline
Gambling is an addiction, caused by a mental illness. It is not a chemical dependency issue like drugs, smoking or alcohol, but rather one we can control if we so desire. Similar to chemical addictions, certain parts of the brain are stimulated when we gamble. When we win, we begin to think of the happiness that lies ahead. These positive thoughts release dopamine in the brain and adrenaline in the body, giving us a ‘buzz’. Our heart rate, blood pressure and breathing increase. The dopamine in the brain stimulates the regions that control mood and motivation. We feel very happy and very alive. When we lose, only adrenaline is released. Since we lack the dopamine effect in the brain, but still have the increased heart rate, blood pressure and breathing, this enhances a feeling of fear. It is a primitive instinct, common during a fight for survival. Think fast, react fast, and survive. The increased heart rate, blood pressure and breathing cause a large amount of oxygen to accelerate the normal brain activity, forcing the decision making process to be sped up. Neurons do not have time to ‘consult’ parts of the brain controlling logic and reason, and bypass them. This is the early stage of panic. Placed bets during this stage are seldom logical or rational, and a self-destructive cycle emerges.
A trader may face the same problems, if they treat trading as a source of excitement. The trick for a trader is to operate void of emotion, so that the decision making process remains stable. When trading itself provides no ‘buzz’, it is less likely a trade will be entered for the wrong reasons. It is important that you do not allow yourself to celebrate a win, nor moarn a loss. It takes time to develop this emotional detachment, and it is a form of discipline in itself. Few traders I know have mastered this.
Discipline is the most important trader skill. In order to master discipline, we must first understand and define it. Many people confuse discipline with will power, in fact they are quite different.
Will power vs discipline.
Discipline:
1. Training expected to produce a specific character or pattern of behavior, especially training that produces moral or mental improvement.
2. Controlled behaviour resulting from disciplinary training; self-control.
3. 1. Control obtained by enforcing compliance or order.
2. A systematic method to obtain obedience: a military discipline.
3. A state of order based on submission to rules and authority: a teacher who demanded discipline in the classroom.
4. Punishment intended to correct or train.
5. A set of rules or methods, as those regulating the practice of a church or monastic order.
Will power - The strength of will to carry out one's decisions, wishes, or plans.
Source: dictionary.com
Discipline is something that is learned, while will power is something you either have or do not have. Perhaps it is genetic. Will power is the emotional form of discipline. Discipline is an autonomous thought process, while will power is an emotional response. Emotions are hard to modify. However it is possible to compensate for a lack of will power by developing strong discipline. We avoid using will power as a tool in trading, as emotional thoughts are seldom logical.
The decision making process
For every choice we are faced with, we evaluate both possibilities then decide to choose the one that will cause us happiness, or avoid pain. Every trade contains multiple crucial decisions, and making the wrong decision results in certain financial and mental pain. You have a choice right now. You can keep reading this course to the end, or you can put it down now. You will evaluate both choices. On the one hand, you will think that you need to keep reading this course because knowledge will lead to money, which provides happiness. On the other hand you will also think that reading is boring, and watching TV is so much easier. Now you have associated pain with the decision to keep reading, and happiness with the decision to go watch TV. Still here? You have not allowed short-term happiness to over-ride long term happiness or short-term pain. Well done. You have some discipline.
I now make decisions I never used to make. I spend a little more time evaluating the pros and cons of each decision now that I know how to process them more accurately. I now find myself doing things that I would normally dismiss as ‘too hard’ or ‘not in MY interest’. Understanding the decision process has helped me become a less selfish, more productive person, but most of all, a more disciplined trader.
A smoker has a choice. I am going to use smoking as an example, as there are more smokers than alcoholics or gamblers. It is important you understand why we decide what we do. If you have never been a smoker, surely you know someone who has tried to quit. Do you think you would be able to quit? If you are already a trader, substitute nicotine for the trading buzz.
Nicotine stimulates the adrenal glands and results in a discharge of epinephrine (adrenaline). The rush of adrenaline stimulates the body and causes a sudden release of glucose as well as an increase in heart rate, blood pressure and breathing. Nicotine causes a release of dopamine (feel good chemical) in the brain, affecting regions that control motivation and mood. It is little wonder the addiction is so hard to kick, the short-term happiness argument has a head start and an unfair advantage. There is no opportunity for the decision process to work without bias. The brain evaluates this choice, and decides that the long-term pain from bad health and cost of cigarettes do not over-ride the short-term pain of going cold turkey.
An incredible amount of will power and discipline is required to overcome the habit. Most try the will power approach first, and most fail. Those who try the discipline method with conviction will break the habit.
Everyone has weaknesses. What are yours? Maybe you are overweight, maybe you smoke, perhaps you do not exercise enough, or maybe you gamble or drink too much. What leads you to these actions? Where does your decision process break down? What inaction’s do you take and why? Do not just read that and think, “I do not need to do that”. Show some discipline! Write the questions down on a piece of paper NOW. Then answer the questions truthfully.
So how do we overcome an addiction? We cannot avoid the decision making process, so we must use it against the habit. We must trick our mind into re-evaluating the pain and happiness components. In the smoker’s case, they need to associate pain with the decision to light up, and happiness with the decision to throw the pack out.
When you feel an urge to smoke, force yourself to think of pain associated with the cigarette, and happiness with not smoking it. Follow these steps:
Step 1, consider the short-term pain first. Think of how disgusting the smoke tastes, how it makes your breath stink which makes your partner not want to kiss you and think of the time wasted.
Step 2, consider the long term pain. Think of the damage you are doing to your health, think of all the money you wasted on cigarettes and the extra you pay for insurance. Think of how smoking has affected your partner’s view of your attractiveness, consider the health of others you smoke around, think of your teeth going yellow and think of the wrinkles around your mouth.
Step 3, associate short term happiness with the decision to not light up. Think of the time that could be spent doing something else you enjoy. Think of the money you could save. Think of how fresh your breath will smell and the smile on your partners face after they kiss you.
Step 4, long term happiness. Think of how much cheaper life and health insurance will be. Think of the money you will save on cigarettes. Invest that money! Consider how much more attractive your partner will find you. Think how much longer you will live. Think of your nice white teeth and wrinkle free mouth. Think of how many people will admire your courage and do the same.
Achieving Discipline
One thing I noticed about trading books in general is that they were big on demands. “You must do this, you must do that” e.g. “you must be disciplined” well that’s great. Just how exactly do I do that? It’s one thing to say, “get disciplined, stupid!” and quite another to show people how to achieve it. How many people even know what discipline actually is? How can they possibly achieve it if they don’t know what it is?
The mind can be improved the same way the body can be. If you train and condition your mind, it will respond with great efficiency and effectiveness. The brain, especially the subconscious, can be easily conditioned. The subconscious mind can be a great ally or a great enemy, and we are only just beginning to understand its workings. If you think something often enough, even if it is not true, your subconscious mind will come to believe it. Throw in some controlled body language and you can make your brain do anything you want. Try it now. Fold your arms and legs, tilt your head down, breath shallow, frown, and say “I am a bad person” ten times. How do you feel? Miserable! Now uncross your legs and arms, lift your head right up, hold a smile, take a deep breath and say “I am a good person” ten times. Better? Isnt it amazing how easily you can control your mind!
Discipline is a major benefit to those involved in martial arts. It would surely be easier to learn discipline using both mental and physical stimulus, from those who have thousands of years experience in mind conditioning and discipline, therefore any type of martial arts training is likely to improve your skills as a trader. The military have developed their own discipline system.
There are five steps to achieving discipline.
1. Motivation. Short-term reasons for taking action. These can be invented and programmed into the subconscious. Set minor goals, and devise a strategy to achieve them. As a trader our minor goals are to enter trades with good odds, while maintaining risk control and money management.
2. Incentive. Long-term reasons for taking action. These must be either genuine beliefs or convictions. Set major goals, and devise a strategy to achieve them. Our major goals are consistent profits and increased experience.
3. Visualization. Picture yourself achieving the minor goals one by one. Then visualise yourself achieving the major goals. This supports the belief system. See yourself pulling the trigger when a stop is reached. This will make it easier when you need to actually do it.
4. Belief. Tell yourself that you can achieve the minor goals. Be repetitive. Realise that achieving all the minor goals results in achieving the major goals. Capital preservation is everything. Keep the losses small and let the winners run. Realise that it is possible to succeed as a trader if you maintain discipline.
5. Focus. When your mind is constantly analyzing your activity or thinking about many different things, it distracts you from your awareness and performance of what you are doing in the moment. Your mental power is strained and the decision process can easily be corrupted. Mental discipline requires focusing your attention fully on the task at hand. When trading, minimise all other thoughts. Take action to ensure interruptions do not affect your trading. Be organised and prepared.
“Whether you think you can or think you cannot, you are always right”
“I think, therefore I am.”
Three decisions
Now we understand and respect the decision making control we have, there are no excuses. In trading, discipline should be used at many points in a trade. First, we decide on an entry. We should always be considering the pain possibilities in this process, many people focus only on the happiness part, ie ‘how much will I make?’. Before we enter the trade, we have two other decisions to make. One is our stop-loss. We need to do all 4 steps for the stoploss, then decide on an exit strategy using the 4 steps again. It sounds like a lot of work, but in time you will do it subconsciously and quick. “Plan the trade and trade the plan”. This means know what you will do before you need to do it, and cover every scenario. Your mind is unreliable when it has to make decisions in a hurry. Make the decisions when you are calm and have time, enact them when need be without thought. This ensures clear, calm, stress-free thinking and no mistakes.
Emotion is your worst enemy. Fear and greed easily replace pain and happiness in the decision process when inaction is taken, but with less control. Fear especially is uncontrollable, so keep control in the decision making process by acting before fear (or greed) become a problem.
Let us go through an example trade. Assume RIO has been in a downtrend, and we see there is support at 2900.
Entry. We think RIO will provide us with short-term happiness if we buy RIO at 2900 and it rallies. Our short-term pain is that RIO will fall under 2900, causing us to stop out, and then rally. Our long-term happiness is watching RIO go up and up for months. Our long-term pain would be if we bought at 2900 and did not stop out, and RIO kept falling, causing us a large loss. Lets assume we weigh these thoughts up and decide to take the risk.
Stop-loss. Support is 2900. Our trading rules tell us to buy on support and stop out if below support. This makes our decision easier, as there is a clear-cut difference between under or above support. The only decision we need to make is how much lower do we want the stop. Our short-term pain is that we set our stop too close. Our short-term happiness is we set it close and RIO breaks down. Our long-term pain is that we set it too far away and lose more than necessary. Our long-term happiness is we set it far away and RIO breaks down slightly then rallies, in which case we are safe. Lets assume then that we decide to set the stop at 2890.
Exit. We enter at 2900, and are taking a risk, so we should not aim for a low return. We could use one of a hundred exit strategies, such as a 10% gain, moving average cross or a count back line. Each will have its own pains and happiness, namely giving a return different to other strategies. The pain is choosing one that gives the lowest return, and the happiness is choosing the one that gives the best return.
Now we have our three decisions made, we enter the trade and trade the plan, calm and collected. We do not get excited when we win, and we do not get upset when we lose. If we cannot control our emotions and keep them well clear of our thinking, they will corrupt our decision processes. This is a skill that is learnt in time.
The Disciplined Trader Survey
I have access to a large trading community. I was able to ask around, and get a list of names of those who have great discipline, and those who completely lack it. I sent some of them several questions, and noted their replies.
Survey Results
Discipline perception
Many of the participants stated that they thought they had excellent discipline. Some of the participants gave themselves 7 or 8 out of 10. They then proceeded to state that they did not set their stop-loss or exit strategy before entry, if at all. They also broke their trading rules often, ignored or changed stops, and sometimes added to a losing position. They also took ‘punts’ because they were bored and could not find any trades with good odds. Obviously they are not as disciplined as they think. Many also stated that they started trading with low discipline, but multiple losses had forced them to improve.
Futures traders think differently to share traders.
The second observation I made was that the ‘disciplined’ traders were all futures traders. What’s more, these traders stated that they found it hard to stay disciplined when trading stocks instead of futures, and some said they ceased trading stocks altogether for this reason. Why is this? Further probing revealed that these traders perceived greater control when trading futures, as liquidity, hours of trading and risk management was thought to be better. There is no room for complacency with futures, as you cannot simply ‘put it in the bottom drawer’ and hope it comes right one day. Futures traders realise a loss is a loss NOW, the option of waiting for the trade to turn around is not there. Denial is a rare trait among futures traders, as you will be wiped out. A single act of denial or ignorance means you wont be around to tell us what went wrong. Another factor is futures are traded on a margin, and when losses build up, so does the margin. It reaches a certain point where the trader is unable to fund the position, and he faces a choice of closing out broke, or getting a margin call. Neither is an appealing option, as you cannot recover losses without trading capital. Basically you are finished if you let things get that far. Perhaps this is a subconscious thought they have when experiencing a loss. Perhaps it is the motivator they need to keep them in control.
But why do share traders act so complacent in comparison? There is a common misconception (more an admission of denial really) that a ‘paper’ loss is not a real loss until you exit. I find this confusing, as people are quick to celebrate a paper profit. Either it is real, or it isn’t. Another pearler is adding to a losing position. You made a decision to buy, and expected the stock to go up. Clearly you were wrong, and should take responsibility for this action. You were wrong once, what on earth would make you think you could not be wrong again? You are so afraid to take the small loss, and go into denial. You figure that you weren’t wrong at all, the market is. Soon the market will realise its mistake, and they will begin buying. So you buy more. Then the stock drops more. Your losses are exponential. Denial is now harder to break out of. A minor problem has now become a serious one. You have abandoned logic and reason at this point, and adopted hope and denial. To avoid this path of self-destruction, we must learn humility, accountability and control.
So what can we learn from the futures traders? They are masters of control. They cannot make excuses for staying in a bad trade, and they cannot wait for things to improve. They take quick, decisive action, and plan ahead like a good chess player. They learn these things quickly because the futures market is absolutely unforgiving. There are no second chances. There are many others who have been burnt, most likely coming into the market with no discipline, and denial issues. Learning the ropes by trading futures is an option, but an expensive one.
We must overcome these misconceptions that losses on shares are different to losses on futures. Shares can be margined, but usually they are not. Do we treat losses more seriously when margin is involved? We should hope so.
These are the new thoughts we must substitute for the old:
We will not enter a trade without planning, and certainly will not enter a trade because we are bored.
Good trades are very rare, but it is more profitable to wait for them than to accept lesser trades.
We must accept that a loss is a loss NOW, and indecision is not an option.
We should have already planned our trade, with stop-loss and exit strategy ready to implement.
Decisions should have already been made, as we do not want to make them under pressure. All that remains is to ‘pull the trigger.’
We must recognise the signs of denial, and be able to detect them in ourselves.
We must accept that the market is never wrong, only we are wrong.
When a loss is made, we are in error and must take action to correct the situation.
Hope is not a valid investment strategy, in fact it is a guaranteed loser.
A good trade is one where the rules are followed and discipline is kept, resulting in a profit or a loss.
A bad trade is one where the rules are broken and discipline is lost, resulting in a loss or a profit.
We will take a small loss now, and regroup. Accept defeat.
Why did we enter the trade in the first place? Analyse everything. Make a new trading rule. Enter it into our trading diary. Never repeat the same mistake.
We will not take a course of action, or inaction, that will lead to self-destruction.
While we are waiting and hoping for a losing position to turn around, we will probably miss 10 other opportunities. Even if we do get back to even, how much profit did we miss out on because our capital was tied up in a trade which ultimately made no money for all the time and stress involved?
So now we have purged some of the corruptive thought processes from our mind, and we now more closely resemble controlled, disciplined futures traders.
Traders cliches.
While some may consider cliches tacky and unprofessional, I believe they are a powerful learning tool. A cliché is an overused expression. They get to cliché status because they are effective at conveying the point. Cliches work!
When everyone agrees, no ones thinking
Zig when the lemmings Zag
If in doubt.. Get out
Winners hold onto their winners, losers hold onto their losers
The trend is your friend, but the trend must end
The market can remain irrational longer than you can stay solvent
There are old traders and bold traders, but there are no old bold traders
You can’t go broke taking a profit
Never fall in love with a stock
BIG genuine sellers do not sit in the depth.
Buy the rumour, sell the fact
If you’re not on the inside, you’re on the outside
Amateurs set the open, pros set the close
The past has no bearing on the future
The market will do what the least number of people expect
Do not catch a falling knife
Never fight the Fed
Up the stairs, out the window
But markets always go up long term.....don’t they?
A mistake on a short-term hold turns it into a long-term investment
Sell in may & go away
Buy in Gloom Sell in Boom
Be a seller of hope and a buyer of despair
Wow! Thanks for sharing crashy.
Agreed...
RUMOUR
Become a share trader ..... A part time job with high pay and low stress.
FACT
trading is hard work, stressful, and 95% of traders go broke
The definition of experience.
How did you get into this particular subject?
Do you follow your own teachings when you invest?
Agreed...
RUMOUR
Become a share trader ..... A part time job with high pay and low stress.
FACT
trading is hard work, stressful, and 95% of traders go broke
The definition of experience.
How did you get into this particular subject?
Do you follow your own teachings when you invest?
wayneL
VIVA LA LIBERTAD, CARAJO!
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Crashy,
Finally set aside some time to read this.
As always I can find things in your writings to argue with:chainsaw:
But I won't, because you have done some really good work here and you have spoken from your own experience...worth ten times more than all the postulations that you normally read in trading/investment books...and some really useful stuff.
Cheers
Finally set aside some time to read this.
As always I can find things in your writings to argue with:chainsaw:
But I won't, because you have done some really good work here and you have spoken from your own experience...worth ten times more than all the postulations that you normally read in trading/investment books...and some really useful stuff.
Cheers
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Crashy, that is a fantastic report - terrifyingly pessimistic, but fantastic.crashy said:
The BEST book for investing as well as the related psychology is:
Benjamin Graham - The Intelligent Investor
Good Luck!
Benjamin Graham - The Intelligent Investor
Good Luck!
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And people want to trade for a living thinking like this.
