There are many trading methods available on the internet, as well as in books and in trading courses. Some methods may work well, while others only work intermittently and depending on market conditions. Advanced traders, for example, may use Elliot Wave counts, as well as Fibonacci Retracement levels to establish the next “wave" or trend. Many traders use various technical oscillators such as the Stochastic and MACD indicators, including support and resistance levels, as well as trend lines to establish whether a share is overbought or oversold and then try to anticipate the share price's next move up or down.
For most traders the task of outperforming the share market is not difficult; it the job of beating ourselves that proves to be the challenge. By 'beating ourselves', we mean mastering our emotions and attempting to think independently, as well as not being influenced by those around us. Trading success based on an emotional response to market conditions is due to chance, and chance does not help us attain consistent results. Objectivity is not easy to achieve because all humans are subject to the emotions of fear, greed, pride of opinion, and all other excitable states that prevent rational judgement. All the information and market knowledge available in the world will be useless without the ability to put that knowledge into action by mastering our emotions.
Many novice traders naively believe that with minimal knowledge, experience, effort and time, they can make a quick killing. They believe that if they just use a simple trading method such as a moving average crossover, they will be successful! This is an unrealistic expectation. Trading is not that easy and it does require much more thought and attention. Like any successful business enterprise, experience is slowly and steadily built up through hard work and careful planning. There is no rapid road to riches.
Beyond the price pattern
Changes in price occur due to buying and selling pressure. As buying pressure (i.e. demand) exceeds selling pressure (i.e. supply), the price moves up. And as selling pressure (i.e. supply) exceeds buying pressure (i.e. demand), the price moves down. As a trader, you strive to "see" where the price pattern is headed and place your trades accordingly. If you were to determine that a certain pattern is in a downtrend, you would naturally perceive a probability that the pattern would continue downward (unless you determine that the downtrend is coming to an end). And similarly, if you determine that a price pattern is in an uptrend or trading range, you expect that the pattern will continue that way until you see some signal that indicates otherwise.
It would therefore be beneficial for you to be able to determine the underlying trend of a given price pattern. At this point in analysis, many traders are confounded by issues of mixed or improper perspectives and the involvement of emotions. For instance, looking at a price pattern for the last hour may indicate a clear uptrend, but looking at the last eight hours may indicate that the last hour's movement was an insignificant correction and that the true trend of the price pattern is a downtrend. The key in determining the underlying trend of any price pattern is to look beyond the pattern. Every price pattern forms because of change, and change is a result of buying and selling pressure. This pressure is a result of the decisions investors (primarily institutional investors) and traders make in terms of what they anticipate. Ultimately, a given price pattern is the result of the actions of investors and traders. These actions are based on analyses and opinions of how the price pattern will form. And here, of course, there is somewhat of a cycle because investors and traders are forming opinions about what other investors and traders think and will do.
Price patterns are a reflection of market sentiment. They partly reflect what investors and traders actually think will happen and what they think other investors and traders think will happen. In this regard, price patterns are driven by cyclical motivators. And the more extreme the different opinions are at varying times, the more volatile the price is. As you analyse price charts in preparation for your trades, it is very important that you keep in mind what exactly the charts represent.
You are an excellent trader - you maintain your focus, execute winning trades quickly and effectively...You are so involved in and dedicated to what you do that you find yourself taking the same type of mental approach and using the same decision-making skills in situations that have nothing to do with your trading. Over a period of time, your continued success causes you to energetically seek further and greater success, but you stay within the boundaries of your risk capacity and have excellent discipline and emotional control. However, without you being aware of it, your psychology slowly begins to transform...
In trading and sports, it is known as being "in the zone." Psychologist Mihaly Csikszentmihalyi calls peak experiences "flow." People experience "flow" when they spend time in enjoyable activities, activities they find enjoyable for their own sake. During a flow experience, one performs above and beyond expectations. Flow is a Zen feeling. It is similar to meditation or intense concentration. It is an ego-less state, when all your actions become automatic. You may see that if one trades in a state of flow, he or she will attain a high level of trading performance.
Dr. Csikszentmihalyi scientifically studied many samples of people who engaged in a wide variety of activities. His goal was to describe the components of flow experiences, and determine how individuals could put themselves into a state of flow. He found that some activities produced more flow experiences than others. Flow was more frequently experienced in work activities, when one is trying to solve challenging problems, and in hobbies and home activities, such as cooking, sewing, photography, or singing. Sports were also very conducive to experiencing flow. What do these activities have in common? First, they require a focused and ordered state of consciousness. One has to be completely focused on the task and not allow any distractions to breakup consciousness. Rock climbers are likely to experience this type of focused attention. A rock climber must devote all attention to climbing and not be distracted by thinking of how high one is climbing or whether one will fall. Second, these activities involve an equal amount of skill and challenge. If a challenge is too great compared to one's skill, it causes worry, anxiety and a breakup of consciousness. On the other hand, if the task is too easy, it is viewed as boring.
How can trading be transformed into a flow experience? Make sure that you set up conditions to
make trading fun and enjoyable. Trading certainly is a challenge, but some traders are overwhelmed, and this is not conducive to flow. The trick is finding a happy medium between trading strategies that challenge your skills, but do not exceed them. If one tries to put on big trades or use strategies and methods that are beyond one's ability, for example, flow will not be experienced. When this happens, traders feel worry and anxiety. They cannot focus complete attention on monitoring their trades. So if you want to experience flow and perform at your highest potential, the key is to set appropriate goals. Manage your risk. Develop a well-defined trading plan based on your current understanding of the markets. Do not make trading more complex than you can understand right here and right now. Do not trade beyond your abilities. As you trade according to your current abilities and make small amounts of progress, you will experience trading as enjoyable. You will be able to focus on trading the markets with a high level of focused attention, in the same state of mind that an athlete experiences when playing sports, a dancer feels while dancing, or an artist experiences while creating art. Soon, your skills will develop even more, and you can face even more challenging trading goals. With greater and greater experience, you will find trading more enjoyable, experience greater levels of flow, and continue to hone your trading skills. Flow is an optimal state for traders. It is worth learning how you can experience more flow while trading.
Urges to follow
One of the most difficult things for a trader to learn is when to restrain his or her urges, and when to give them free rein. The reason is that most of your urges come from gut feel, and have little to do with the cold, calculating reasoning that forms the basis for most good trading decisions. But every once in a while, you get an urge that you ought to follow, because it represents the sum total of everything you have learned about trading successfully, and it offers an angle on obtaining a major gain that most other traders have not yet seen. Here are some guidelines to help you discriminate between urges to ignore, and urges to follow:
- If it makes sense: Emotional urges tend to fly in the face of reason. They are like betting R1 000 on a single spin of a roulette wheel where they certainly may come up winners, but chances are they would not. Yet other urges emerge from more rational mental processes that you may not even be aware of, but which are nevertheless valid. When you examine your urges in more detail, you find that some of them accurately take into account the tiniest details of what you know, and conform to your deepest understanding of how the market operates. In short, while all your urges may contain a special kind of inferential leap, there are some that contain reasoning in which you cannot punch any holes.
- If it follows your method: The bulk of emotional urges come out of left field, and would be a major departure for you to act on. But a few of your urges actually fit within your trading method. These are worth considering, because they offer the opportunity to tap into a different level of knowledge and awareness without compromising the elements of trading - such as consistency and favourable conditions that are essential for success.
- If it is low risk: Many emotional urges are of the "Damn the Torpedoes" variety - if they turn out poorly, the penalty can be extremely high. These are the kind of urges you will do well to resist. But other urges fully incorporate your established risk management and money management strategies. Because there is no extra downside if one of these urges turns out to be wrong, they may be worth testing.
Changing your personality to suit your trading lifestyle
Many successful traders have entered trading after a successful career in another field. However, achieving success in the markets is quite different from achieving success in other occupations. The markets do not necessarily reward the personality traits that are developed and rewarded in other occupations. Do you have personality characteristics that have gotten you ahead in the world, but may not get you ahead in the markets? If you do, you may have to work on changing some of these traits to be a successful trader.
Let us review some of the personality traits that may not be conducive to trading. Take conformity, for example. When working your way up the corporate ladder, it is vital to be able to perceive how you fit into the organisation. One must accurately perceive what his or her superiors view as the direction for the company, regardless of whether one agrees with this direction or not. Conformity is often rewarded over independent thinking and independence. If you have worked in a corporate setting, you are probably aware of how everyone seems to dislike the person who is always questioning group decisions and seems to self-promote his own ideas at the expense of the group. In contrast, conformity is a limitation rather than an asset when it comes to trading. Ideally, traders look only within themselves for the ultimate answers. They do not rely on the opinions of others, are sceptical of prevailing opinions, and continuously try to find a new trading plan before everyone else, so they can beat the crowd, rather than follow them.
Related to conformity is sociability. In many occupations, people work with other people. They must get along with others, perceive their needs, and sometimes yield to the needs of others at the expense of their own needs. Successful traders, in contrast, are rugged individualists. Many times, sociability and trading do not mix. A trader must make independent decisions, which again, means looking within themselves to find the right answers. It may also mean spending a great deal of time alone studying the markets and preparing for trades, rather than spending time with other people (which is also true of some other occupations). Traders must find the right balance between fulfilling the need for social contact and finding the time to spend alone to focus on one's trading passion.
Traders are creative people, who take personal risks, think independently, and intensely focus on trading problems to develop innovative solutions. Creativity requires independent thinking, non-conformity, and social isolation. In many occupations, such traits are not viewed as desirable, so you may not have developed these traits. But, if you trade full time, it is useful to develop some of these traits to some extent.
The market as an unstructured entity
Because the market has no real time limits (perception of value changes constantly in the human mind), it remains, to a major degree, unstructured. That presents a challenge! We humans like structure. We like to take a certain action with the assurance that it will produce a certain result. We understand limits, borders, and finite situations. As most of us find out the hard way, the market does not work on that principle. Market volatility creates erratic moves based on emotion rather than logic, so the market "changes its mind" constantly. Constant change brings on a mixed brew of possibilities, some rational, some that defy our sense of logic.
How can we traders, as humans who thrive on structure, order and boundaries survive in a mercurial market? We survive by creating our own limits. We survive and thrive by bringing our personalised structure, meaning that our own definitions, rules, and criteria, along with us. First, we gain all the knowledge we can, and we add more every day. Next, we study our own psychological reactions to market movement and situations, and strengthen our weak points. Then, we can draw up a set of guidelines that structure each trade. These guidelines define our own personal structure, limits and boundaries. Finally, we impose these onto the market. Now you are in command of your actions. The game is being played by your rules. And that is what it is all about, is that not it?
The bottom line
Should I buy? Should I sell? Many traders often focus their efforts on identifying buy and sell signals. The research and analysis they do are geared towards reaching the goal of getting that "bottom line" directive to guide their actions. Any successful, experienced trader will tell you that although properly identifying buy/sell signals is important, it is not the key to being successful. Instead, the way you manage each trade is what will determine your success. Traders who take the bottom line approach tend to believe that the success of their trading activity is dependent on following the right buy/sell signals at the right time. Clearly, it is important that a trader be able to understand the process of generating signals and to use the methods involved. Realistically though, almost any trader can find a way to generate signals (whether using technical methods already out there, coming up with their own system, or using their trading platform's automated signal generation tools).
Any successful, experienced trader will tell you that your trade does not begin and end with a buy or sell. There is a trade management process involved. For each trade you make, you are making a group of decisions. The way you manage and time those decisions is what will determine the success of your trade. Suppose two traders get the same trading signal at the same time and act on it. One's trade may result in profits while the other's results in losses. This could occur because each trader made a combination of additional decisions throughout the process of the trade. These decisions might include scaling in and/or out of the trade, using trailing stop losses, setting profit objectives, waiting, etc. The trader who made the more effective overall combination of decisions will have the better trade results in the end.
It is very important to regard trading as a process, and to understand that a trader's efforts need to be focused on the activity of trading itself, as opposed to getting a quick bottom line answer. Because there are many aspects involved in making your trades successful, it is essential that you educate and train yourself in all the different areas. Learn how to develop better trading plans and analysis methods, and then learn how to apply what you have developed to the process of making a trade from the original impetus to enter or stay out of a trade to the psychology of managing that trade.
Goal setting - do not set performance goals too high
Sam started trading almost three months ago. He has read that it is important to set specific goals and try to reach them. He thinks, "I have got to set my expectations high, otherwise I would not try hard enough. I think I will try to shoot for a 20% profit per month. I have got big dreams, and if I do not strive to reach them, I will never achieve them." Big dreams can be a powerful motivator, but there is a huge difference between lofty unrealistic dreams and specific ambitious goals that one strives to achieve with a methodical and detailed plan.
Industrial psychologists have studied goal setting. They have found that high performance goals are not always the best goals. Here is why. One may not have the experience or skills to reach a goal that exceeds one's abilities. For example, would you try to run a half marathon if you cannot even run one kilometre? Of course not. So why make such high and lofty trading goals until you have the requisite knowledge and skills? Regardless of the job task, many novices make the mistake of setting their goals too high. It is understandable in a way. Ambitious people are taught to set high goals. If one does not even consider achieving an ambitious goal, then one may not even try to achieve it. It is vital that we set high standards for ourselves and go out and do whatever it takes to reach them. But psychological studies show that it is the way one goes about achieving a high level goal that matters.
When novices set high goals that exceed their skills, they usually fail, feel discouraged, and give up. So if you are a novice trader, like Sam in our example, it may not be a good idea to immediately strive for a 20% profit per month, at least not yet. It is useful to distinguish performance goals from learning goals. When we set goals, we usually think of setting performance goals; that is, we think about a specific percentage a month we should achieve. But for novice traders, it is more useful to consider setting learning goals rather than performance goals. A learning goal is more modest and can be achieved more easily. It involves breaking down the larger goal into specific steps that are doable, and rewarding oneself after each step is accomplished. For example, a learning goal may be stating, "I am going to study for 30-hours a week to learn a new trading technique." The specific goal will not immediately lead to the larger goal of making a 20% profit per month, but it is easy to achieve, will lead to personal satisfaction upon completion, and in the long run, will contribute to the long term goal of becoming a seasoned trader.
So if you are a novice trader, set yourself up to win. Do not set overly high performance goals; set high and realistic learning goals. Break the bigger goal down into specific steps, and reward yourself after you complete each one. When you become a seasoned trader with advanced skills, you can set out to achieve those high performance goals. But right now, it is in your best interest to focus on skill building, rather than high performance.
A healthy approach to trading success
Successful traders follow their passion. One often hears traders say, "I love trading so much that I would do it for free if I could." Indeed, when one looks into the backgrounds of top traders, the story seems to be the same. They all tried to get a job in the trading industry as soon as possible, any job as long as it involved trading in some way. They were fascinated by the markets and the challenges it offered; the money was either secondary or not an issue at all. However, ask a typical non-trader what he or she thinks of traders, and the impression is quite different. Many think that traders are out to make big bucks, achieve high status, and show it all off with luxury cars and nice homes. These may be the side benefits of trading, but they are not the primary motivators. Successful traders love the challenges the markets offer and view their work as meaningful. In other words, they take a healthy approach to trading success.
In a study, psychologists Say Lim and Donnah Canavan showed that the advantages of taking a healthy, versus a conventional, approach to success. Taking a healthy approach to success entails pursuing goals that are intrinsically interesting and personally meaningful. A conventional approach to success, in contrast, is a preference for work that emphasises competition, financial reward, and high status (which is similar to the inaccurate stereotypical view that non-traders hold of professional traders). The advantages of taking a healthy approach to success are notable. Individuals who took a healthy approach to success were better adjusted and more satisfied with life, compared to those taking a conventional approach to success. They were also better able to control their ego; that is, they were able to accept their limitations, rather than have the tendency to exaggerate their abilities and deny their faults. They also put more effort into their work and achieved higher levels of performance.
These findings illustrate the advantages of a healthy approach to trading success. Those who find trading intrinsically satisfying, enjoyable, and meaningful will put in the necessary hard work and achieve high performance levels. So cultivate a healthy approach to success. Do not focus on the money and status that successful trading may bring. Enjoy the process of trading. Seek out challenges and the satisfaction of meeting them.
Turning a loss into a gain
John has had five losing trades in a row for a total loss of 25% of his trading account balance. He could feel defeated, pout, or get angry, but instead, he is excited about his future prospects. That is because he has decided to turn his loss into a gain. Professional athletes and seasoned traders know how to turn losses into gains. Rather than mull over past defeats, or trading losses, they use the setback as a motivator, an opportunity to hone their skills, grow, and improve. They examine what they did wrong, learn from their mistakes, and view the temporary setback as a launch pad from which to achieve higher future performance. Many successful athletes note that the baseball player, Babe Ruth, struck out over 1000 times on his way to setting the homerun record. Seasoned traders similarly note that winning traders, with proper risk management, can win as few as four trades out of a dozen and still come out ahead. In both cases, these winners could have been bogged down with self-doubt, regret, and defeat. But instead, they decided to use the "loss" as a motivator for change and improvement. They examined their past "losing" performance in scrupulous detail, discovered the factors that led to poor performance, corrected these factors, performed the task again, and honed their skills further until they eventually achieved lasting success.
As traders, it is crucial that you keep accurate records of all factors that may impact the outcome of your trades so that you can learn from your losses, improve your performance, and do better next time. From a psychological viewpoint, document factors associated with the loss, such as whether you were in a bad mood or acting on impulse rather than with a calm and relaxed trading style. Other factors, such as market conditions, trading strategy, preparation for the trade (such as back testing), or risk management strategy should also be noted. Armed with this knowledge, one can study a series of losing trades and identify the factors that led to the trades "going wrong." One can then change these factors in subsequent trades and monitor improvement. The key is to take an upbeat psychological approach. Rather than mulling over one's failure, it is more useful to view the past failure as an opportunity to grow and improve. Viewing a loss as a growing experience changes your perspective immediately. You will now focus on what you can do to achieve the bigger goal of becoming a seasoned trader, rather than mulling over the loss from a few of the many trades you will make throughout your career.
So try changing your viewpoint when it comes to losses. You will see your mood and mind-set change dramatically. It may not be pleasant to face failure and accept your limitations, but looking at these failures in a broader perspective can change your mood from hopeless depression to excitement and optimism. It is merely a matter of thinking of trading losses in terms of the broader perspective. You are human, and not perfect. You should expect to fail on a single trade more than succeed. But the key is to keep the bigger picture at the forefront. You will be a successful trader in the long run if you just keep honing your skills. In other words, you may strike out many times, but it is the shear number of wins that actually matters. The more times at bat, the more you will strike out, but overall, if you can learn from your past failures, your performance record will be impressive. By monitoring the factors associated with poor performance, and changing these factors in future trades, you can turn a loss into a gain, and be on your way to becoming a winning trader.
Enhancing performance through social support
Trading is a stressful business. When you are in a trade, your money is at risk, and you repeatedly face the possibility of losing substantial amounts of trading capital. If you are a novice trader, the stress is even greater, since you have not yet learned to trade consistently, and losing significant amounts of trading capital is the norm, not the exception. Managing stress is key to trading success, and maintaining a social support network is an important way of managing this stress.
Psychologists have studied social support critically. When extremely stressed people have a person, or persons, with which to vent their frustrations regarding stressors, they are able to better cope with the stressors. Oftentimes, merely expressing stressful emotions of anger, fear, and frustration can make one feel optimistic, empowered, and ready to tackle new stressors with renewed vigour. But not just anyone will do as a member of a social support network. Ideally, people in one's social support network should be good listeners; they should want to hear about your problems, support your feelings, and make you feel you can neutralise your emotions and come up with new ways of coping. Some relationships are uplifting, while others provoke frustration or anxiety, and can be yet another hassle, rather than uplifting.
An interpersonal relationship is uplifting when you gain emotional support, but it is a hassle when the relationship actually causes stress. This may be especially true of trading, since not everyone in a novice trader's social support network is supportive of trading activities. For example, suppose your spouse is not supportive of your trading plans, and frequently greets you at the end of the trading day with, "How much did you lose today?" or "I wish you would give this up and go back to your regular job." Such comments produce even more stress. Similarly, if you have conservative, risk-averse friends, they may not want to hear about your trading activities, or subtly express a sense of scepticism with every word. In these cases, such relationships are unsupportive at best or extreme stressors at worst. Thus, it is vital that you seek out the right kind of social support.
One of the best ways to build a social support network for your trading is to form a set of relationships with others who share your trading interests. Ideally, this should include senior members of the trading profession, or informal mentors, as well as traders at your own level of skill, especially if you are a novice. These individuals will have similar stressors and can help you cope more easily. They also need to form relationships with other traders who, like you, know the pitfalls of the trading field and support your motive to become a seasoned and consistently profitable trader. Social support is a proven method for neutralising stress, and the unpleasant emotions associated with it. It is an essential key to trading success, so go out and add a few traders to your social support network; you will find the journey to success a lot smoother.
John tells his friend, "I am fully committed to trading. I read The Business Day, The Business Report, every morning and the Financial Mail every week, and I sift through at least 100 technical charts at night, in the morning, and every break during the day." It sounds as if John is motivated, but is he working effectively or merely keeping busy? As writer Ellen Glasgow notes, "All change is not growth, as all movement is not forward." John intends to build his skills as a trader, but he may not be doing so in an efficient manner; he may actually be standing still despite his time and effort. You do not need to spend hours and hours reading about the markets if it does not directly lead to a profit. For example, most media coverage of the markets is for entertainment value, so spending hours reading or viewing it is a waste of valuable time. You need to work efficiently and make sure that the time you spend learning about trading and the markets does indeed pay off.
It is difficult to become a skilled and consistently profitable trader. Only an individual with rare talents can rise to the top 2% who make it as a top-notch trader. It does indeed take dedication and hard work. However, some make the mistake of thinking that trading is like a regular 40-hour a week job: "I put in my 40 hours and I get paid." This view is not pertinent to trading. Trading is more about accomplishing a specific target, making a profitable trade, rather than putting in a specific number of hours. For instance, if it takes only 15-minutes for a skilled trader to make enough profit to have a year's worth of living expenses, then so be it. Seasoned traders do not have to spend 40-hours a week to make a living, if they have the requisite skills (and novice traders may need to put in more time building up these requisite skills).
The point is that if you are a novice trader, you cannot work under the belief that everything you do will have a payoff. You must also consider that there are a fixed number of hours in the day that you can work, so you must spend that time efficiently. In John's case, he is likely to be using his precious limited time and energy reading about the markets and world events that have no direct bearing on the intra-day or intra-week prices of the shares that he wants to trade. Similarly, sifting through share charts that have no bearing on the shares one trades is also time misspent. You cannot be overloaded by information. You need to maintain focus and efficiency. Trade a few key shares, and know everything you can know about those key shares. Become an amateur specialist. Memorise the chart patterns, how the prices change during the day, and the factors that coincide with the price changes. Knowing about shares you do not plan to trade or about broader economic events that do not influence your key shares will take time that, realistically, you just do not have. Trading is a challenging profession, and you need to focus your psychological energy on what matters most. Do not be distracted by learning additional trading strategies that you will never use, or new indicators that are redundant with basic indicators of trend. And do not believe you must keep up with all the media hype. Focus, work efficiently, and in time you will build the skills you need to become a consistently profitable trader.
The dangers of anthropomorphising the market
Do not let creative journalists or analysts convince you into thinking about the market as a marathon runner: "Every bull market has to pause and get its breath once in a while, before it sprints higher." Or a wild animal: "The claws of this bear market ripped right through the last shred of resistance, nothing can stop it when it gets its blood boiling!" All too often writers, including or especially financial writers, wax poetically as they attempt to make their stories more interesting for their readers. Instead of saying the market advanced 50 points today, they will attempt to give the market mystical powers. "The market saw a chance to bolt through some resistance today and dashed for 50 large ones." The market has no eyes. It has no legs. It has no blood to boil. It cannot "see" or "bolt" or "gorge" or "claw." It just lies there like road kill until an amateur taxidermist happens to pick it up and drag it home.
Once you start ascribing human or superhuman characteristics to Mr. Market, it can really play havoc with your ability to make sound decisions. You begin to impose your thought process upon the market you are trading and project on to it a life of its own that does not exist. You begin asking yourself: What would I do if I were the market facing a truckload of negative news? If I had just battled my way past all kinds of downbeat pressure, I would be ready to take a breather and I would trade sideways for a few days. Please, the market never gets tired. It does not get depressed. How many times have you heard some pretentious fool talk about the market like this: "The All Share sure looks like it wants to move higher." "The Top 40 Index is determined to go back to the 26 000 point level no matter what we do!" Hold it right there, the JSE All Share Index does not want "to move higher" nor is the Top 40 Index "determined" to go anywhere. They have as much to say or do about where they close on any given day as an avalanche has about when it starts and where it stops.
What moves the market? It is traders and investors making informed and uninformed decisions. They use sophisticated technical systems, complex fundamental approaches, tips, hunches, guesses, bad information and even astrological signs to make their decisions to buy, sell, or stand aside. All the educated and uneducated conjectures are tossed in the pits and the market is pushed or pulled to a higher or lower close. It, meaning the market, has nothing to say about the daily results. That is why you must not anthropomorphise it. Take it for what it is; a dumb, inanimate blob. Do your very best to anticipate where it is headed, trade accordingly and keep a stop loss in place if you are wrong. The market is going to move, which way, for how long and at what speed, we do not know. For this reason, we take it for what it is and avoid empowering it with human or magical attributes.
Who is behind the curtain?
If you have not seen the movie "Wizard of Oz," you are in for a treat. It is a great movie on multiple levels. The climax occurs when the heroine, Dorothy Gale, reveals that the great wizard is only a common man pretending to be something much more than he really is. Does this remind you of any recent newsmakers and shakers? At the moment, the list of pretenders is long. The risk of deceit goes beyond mere mortals. As a trader, you must question virtually everything, even what appears at first blush to be hard, cold facts. It can even be doubted whether there are such things as "facts," unfettered by personal interpretations or prejudices. All information is analysed and interpreted. Interpretation gives information its predictive power, which, in turn, usually results in action. Action for us means trading, and trading brings us winners and losers.
Tradable facts, even with absolutely correct interpretations, do not automatically generate successful trades and profitability. A key ingredient, timing, is missing. Just to be safe, you might want to add a pinch of luck as well. But it is the elements of analysis and interpretation that we want to emphasise. The fundamental skill is the ability to discern the core truth from your inputs. Think for a moment what Norman Mailer once said about metaphors: "They often have more truth in them than truth itself." The reason is that metaphors are carefully contrived to make a specific point, usually morals or truths. Whereas what we call "facts" are actual occurrences; they are things that really happened. Since we know that they occurred, we give them high creditability, even to the point of accepting them without question.
Traders cannot be so naïve. The facts you deal with are the basis for your trades. If you blindly accept the facts that flow into your consciousness as truth, you will never become a successful trader or investor. As a wise old man once said: "Liars figure and figures lie." Meaning facts can be manipulated by just about everyone who touches them, particularly politicians, financial analysts and just about anyone trying to sell you something. And psychologically, even you can unconsciously manipulate so called facts. Consider something that is supposed to be completely straightforward, such as technical analysis; even it can be prone to subjective interpretations. Have you ever heard a gaggle of Elliot wave analysts argue about what wave a particular share or commodity is trading in? "This is the third wave!" "No, that is still part of the second!" Nothing is black and red in trading other than the final results. That is why you see so many trading styles and theories. And why you cannot simply mimic someone who is successful and be just as successful yourself. Trading is not a team sport nor is there any single way to become a superstar. You must forge your own way to the winner's circle. Part of that is finding out, for yourself, what is behind the curtain and how to analyse, interpret, and find the facts that are pertinent to your trading modus operandi.
Do not take it personally - objectify
Johan is a novice trader who is down R20 000 for the day. He thinks, "That is a lot of cash. I could pay my living expenses for the entire month with that. I need to win it back right now." Johan has made a fatal mistake: He has started to look at his profits and losses personally, and now his emotions are playing a role in his decision-making. He is now seeking "revenge" and such emotions have no place in trading. It is useful to cultivate a more objective, unemotional approach when examining profits and losses.
When it comes to managing your personal expenses, financial planners suggest using cash to pay all expenses rather than credit cards. When using credit cards, it is easy to forget that you are spending real money, and spending can get out of hand. Doling out the actual cash with each purchase, however, makes one see exactly how much money is being spent. It raises one's awareness. The money is less abstract. It is tangible. Watching the Rands slip away provides a strong motivation to cut back. But when it comes to trading, it is useful to do just the opposite: Look at the money as objectively and abstractly as possible, just as percentage points or ticks. Psychological studies have established the impact of taking an objective perspective. Research psychologists have studied this topic in a variety of contexts. There are times when taking an objective approach is dangerous. It is well documented, for example, that when a person views another person in a less human and objective manner, he or she can more easily harm that person. The other person is no longer seen as a fellow human being but as an abstract entity. Creating such psychological distance, however, can help one cope with upsetting events. When participants view distressing films, showing a surgical procedure for example, it is easier to fully process the information by objectifying the on-going action.
When it comes to trading, an objective approach is useful. There are a few simple things that you can do to maintain an objective view. Many say that when money is committed to a trade and the risk and potential loss is experienced, "objectivity goes out the window." Thus, anything one can do to minimise the feeling of risk and potential loss will nurture an objective mind-set. First, it is helpful to trade with money you can afford to lose. Trading is a profession where you should go in expecting to lose. If you cannot afford to lose the money you trade, it will be difficult to maintain objectivity. Deep down, you will know that you are risking money you just cannot afford to lose in a worst-case scenario. Second, it is also crucial to manage your risk. By carefully managing risk on any single trade, you call tell yourself, "I have got little to worry about. I can afford to take the loss." At first you may have to consciously remind yourself of this fact (again, make sure it is a fact), but over time it will automatically be in the back of your mind. You will be calmer, and can more easily cultivate an objective mind-set. Finally, view profits and loses in an abstract framework. Rather than focusing on concrete Rand amounts, try to focus on percentages, or just abstract, theoretical numbers. Do not think of the Rand amounts in terms of what can be purchased. Equating Rand amounts in terms of tangible terms, such as car payments or sought-after luxury items, will weaken your objective mind-set. You will be more prone to experience elation from big wins and disappointment from losses. So cultivate an objective mind-set. You will trade more profitably and consistently.
Rested, relaxed and ready for the market action
Sometimes success is a matter of making the most of a few key moments. Those hoping to gain acceptance to a prestigious university, for example, must perform well for a few key moments on a standardised test. Olympic athletes prepare their whole lives to perform at their best for a critical moment in order to win the Gold Medal. Trading can be much the same way. Though there are many opportunities, you must identify those specific opportunities where you can succeed, and be ready to take advantage of these opportunities and perform optimally. It is crucial to be at your peak during these key moments. You must be prepared and ready to take full advantage of the opportunity. Ideally, you should be fully rested, relaxed and ready for action. But people's personal physiology differs as well as their psychology. It is vital to ascertain your physical and psychological limitations, and work around them, so that you can be ready to capitalise on critical trading opportunities.
You do not need to perform at a peak performance state every minute of your life. If you are one of the few who can give it your all 24-hours a day, seven days a week, then you are blessed. The rest of us have human limitations. We can only work for a limited number of hours a day, and if we try to work in marathon stretches, it eventually catches up with us, and is shown by our weak performance. In the end, it is a matter of personally identifying how many hours you can perform at your peak performance state, and developing a specific plan to make sure that you have enough rest and relaxation to work in this optimal state when it is necessary.
So how does one operate at peak performance? How do you work "in the zone" and be ready to move in synchrony with the ebb and flow of the markets? Putting yourself into the right state of mind requires energy, both physical and psychological. From a physical standpoint, you must be rested. If that means that you need to get 12-hours of sleep a night, then by all means get it. If that means you can only trade for a few hours a day, for only three days a week, then by all means do it. The point is that you must know your own personal limitations and how to maximise your energy level. Do not view trading as a 9-to-5 job where you must put in the full 40-60 hour work week. If trying to uphold such a schedule wears you down to the point that you have little energy to trade at your best, then your effort will not be cost effective. You will put in more time than you will receive rewards. Indeed, you will likely put in a great deal of time only to fail in the long run. So figure out how much sleep, leisure time, relaxation, and exercise you need to maintain a high level of energy, allocate that time carefully, and maximise your energy level for when you need it.
Trading in a peak performance state is also a matter of maximising your psychological energy for those key moments when you need it the most. If you have a lot of psychological baggage in the back of your mind, you will spend a significant part of your precious psychological energy devoted to thinking about past conflicts and trying to find a resolution, whether you are conscious of it or not. Identifying any psychological problems and resolving them is crucial. It will free up the psychological energy you need to trade in a peak performance state. You may not have to resolve every single conflict, but again, you must develop a practical strategy for working around these psychological issues. For example, perhaps you find that you can concentrate for only three hours a day without your attention being compromised by thinking about personal psychological conflict or past upsetting events. If that is the case, plan on trading only for those three hours a day where you can trade optimally. Do not unrealistically think you can work longer than your personal limitations allow.
Part of trading profitably is the acknowledgement of your limitations and putting together sensible ways to work around them. Do not set yourself up for failure by trying to live up to expectations that you personally just cannot achieve (such as putting in 60-hours a week or going without enough sleep). One major component in trading profitably is cultivating the proper mind-set. And to do so, you must be rested, focused, and ready to put in extra-human energy to capitalise on those moments when ideal trading opportunities materialise.Traders often banter about letting preconceptions and so-called "conventional wisdom" unduly influence their ability to anticipate the markets. Market conditions are in constant flux, and forming an overly strong opinion, especially when it is oversimplified, can produce preconceptions that are hard to shake. That is why some traders steadfastly advise against forming a strong opinion. It is also wise to frequently question so-called "conventional wisdom," which is true only when a particular set of conditions is met. Flexible traders try to approach each day with a blank slate, so that they can "read and react" to the markets rather than erroneously allow their preconceived ideas of the market to bias their current perceptions. It is vital to remain open-minded, flexible, and ready to adapt to whatever the market is doing on a given day.
Buy on weakness; sell on strength - an example of a contrary approach
Many investment psychology books tout the virtues of thinking independently, and acting like a rugged individualist: "Do not follow the crowd. Be a contrarian." It is often useful to take such abstract ideas and make them more concrete with a specific example, even a basic, oversimplified example. It is vital to act as a rugged individualist in today's markets, since there are fewer amateurs trading the markets these days than in the late 1990s. In the "old days," some investors made nice profits by merely picking a popular share, waiting for new buyers to enter the markets, and selling when the share price hit the profit objective. Ironically, it was possible to be a conformist and just follow the crowd.
When there are many amateur participants, there are strong trends. As prices rise, the media reports on the optimism. Next, the confidence of the masses rises, and more and more enthusiastic buyers enter the markets. In such markets, the uncertain investor can wait for confirmation from positive news or the observation of a sudden buying spree. This conformist strategy works sometimes, but it is not a strategy that works consistently or very well today. These days, you cannot assume that when you "buy low," there will be an excess of naïve amateur buyers ready to push the share price up higher. If you wait too long, you will likely hit resistance, and it will be too late to profit from the move. These days, there is less certainty. You must gauge the phase that the market is in, anticipate what will happen next, and enter and exit a trade at optimal times. These conditions require a trader to depend on one's instincts, and rely on one's perceptions and opinions. Many times one must take a contrary position.
Trading as a contrarian is not merely doing the opposite of the masses. It is about thinking in reverse. Many traders, in contrast, only look at the obvious. For example, if one goes long on a share, it is natural to think that all you have to do is identify a share that is moving up, buy a few shares, wait for it to go up even more, and sell for a profit. But again, that only works when there are many buyers out there, which is less true today than in the late 1990s. It is more likely that one will encounter resistance. It is crucial to anticipate this turning point and make sure that you sell before the price goes down.
That is where thinking in reverse comes in. Instead of following the herd and buying when everyone else is buying, and selling when everyone else is selling, do the reverse. Buy when everyone else is selling, and sell when everyone else is buying. In other words, buy on weakness, and sell on strength. How does this work? Assume that share prices move in cycles. For mere illustrative purposes, pretend that market cycles, or waves, go down on Mondays, up on Tuesdays, and down on Wednesdays. If history were to repeat itself, and unfortunately it never does, you could buy low on Monday, wait for Tuesday, and sell at a higher price. Now if the cycle followed a reliable, consistent pattern, we guess that you would not need to be rugged individualist, a contrarian, or know how to use your intuition. You would know exactly what would happen and when, and trading would be easy. But in the markets "history only repeats itself" when it does; the rest of the time it does not, and no one knows for certain when it will or will not repeat. That is what makes trading a challenge. One does not know exactly where or when the cycle will repeat. In the end, it is just a matter of odds. You cannot wait for unswerving confirmation from the herd and merely follow them. Future prices are not certain, and so that is where thinking independently, like a rugged individualist is relevant. In the final analysis, you only have some fallible trading strategies and your own intuition to rely on. You have got to rely on you and no one else, and that is why it helps if you are a natural, rugged individualist, a person who is not used to looking toward others to see what to do next. A rugged individualist is used to taking chances, and using gut instincts to make decisions, and that is all one is doing in the markets: Making a good guess, taking a chance, and patiently waiting to see if it works out. If you want to follow the crowd, wait for a sure thing, or wait for group validation, you are not going to find it in complex markets like the ones we see these days. So nurture your individualist instincts, develop your intuition through experience, and look at the markets from multiple, and often contrary, perspectives.
Breaking away from the masses
All humans have a natural tendency to follow the crowd. There is safety and comfort in numbers. As the human race developed, it learned that its survival depended on banding together and working as a group. All humans inherited this legacy, and it is shown in the security we feel when we follow the crowd. It is adaptive most of the time. Although there may be vast individual differences on the extent to which people follow the crowd, with some conforming too much and others conforming too little, most successful members of society have seen the virtues in following the crowd. They have learned to look for rules to follow and to decide which standards to strive for. In school, for example, it was to our advantage to follow the rules. Blind obedience to authority may not be beneficial but compromise is. To be successful, it was vital to protect one's self interests yet also stay within the bounds of acceptable behaviour. It was also important to develop a clear and solid sense of personal values and to develop a clearly defined personal identity. Such a clearly defined view of oneself allows one to be self-sufficient. One can follow the crowd when appropriate, but effortlessly go his or her own way when it is necessary to protect self-interests.
Although you have been frequently warned about the pitfalls of following the crowd, it is important to acknowledge that it is adaptive most of the time. We strive to minimise unnecessary risk in our everyday lives, for example. We prefer to raise our children in safe neighbourhoods, and many prefer to live in homes that are unlikely to be destroyed in a natural disaster. And in the markets, it is sometimes useful to "follow the crowd" as well. For example, for long term investing, it is wise to put your money in shares that do not have a great deal of volatility and by all indications, have solid fundamentals that will push the share up consistently for several years. If a large enough "crowd" believes strongly that the company will produce profits for decades, it would be to your advantage to follow them, if you want a safe investment.
So following the crowd is not bad all the time, especially for those who do not like risk. On the other hand, if you are a trader, you are not looking for safe investments. You are looking for volatility, necessary risk, and a good chance for making a big profit. Most of the time that means going your own way. It requires that one think like a contrarian, guessing what the crowd will do next, and anticipating how the movement of the masses can benefit you as a trader. The key is to know when to follow the crowd and when to go against it. The crowd is usually right, until a turning point occurs. When virtually everyone has taken the position that the market is headed in a particular direction, there are few traders left to push the trend further. At that point, a countertrend initiates and moves the market in the opposite direction. The challenge is predicting when that turning point will occur, anticipating it, and developing a trading plan to capitalise on it. Now, this all sounds easy in theory, but in practice, it is difficult to implement a trading strategy to capitalise on this cycle. How can one predict the turning point? Some say it is almost impossible. All you can do is develop a sound method that works most of the time but also admit that it may fail. Whether you use technical indicators or you are lucky enough to use the media news to your advantage, you must temporarily believe in your method, put money on the line, and work under the assumption that overall, luck will be in your favour should you make enough trades. (And by all means, control your risk; otherwise you will be the victim of relatively risky trades, rather than the victor.)
Going against the crowd takes a special kind of person, a person who is not afraid of risk but does not seek it out, a person who looks inward only, and does not need reassurance from others. One must creatively study the markets and try to devise an innovative trading plan. It takes a great deal of experience and thought, but by using the proper perspective, gaining extensive experience, and honing your trading skills, you can break away from the masses, and trade consistently and profitably.
The holiday season - a time for psychological balance
Imagine that it is the holiday season. Whatever your religious preference: one way to look at the holiday season is as a psychological transition point at the end of one year and the beginning of another. It is an opportunity to look at where you've been and make plans for where you want to go. It is a time for contemplation and reflection. You can ask, "What went wrong? What went right? What do I want to do next year?" You can take some time off from trading to relax, re-energize, mobilize your psychological resources, and get ready for a new year of trading. It is also a time to cultivate psychological balance, which is a key element for maintaining psychological health and wellbeing. Cultivating a peak performance mind-set requires one to seek psychological balance: Make sure that your life is multi-faceted, rather than focused solely on trading. Make sure that you have fun in areas outside of trading. Enjoy spending time in fulfilling relationships, and enjoy life to the fullest. This time of year, Charles Dickens' character Scrooge, or a version of it, is portrayed in plays, television shows, and movies. Scrooge is an ideal example of a person who has no psychological balance in his life. He is all business and single-mindedly in pursuit of money. There is a lesson about peak performance and trading in Dickens' tale about Scrooge. Let us retell the story and provide our own psychological interpretation. (Let us also apologize now for telling the story in our own way and focusing on the specific parts of the storyline that illustrate key psychological points.)
From a psychological perspective, Scrooge is a businessman who has focused so much of his energy on making money that he has lost some of his humanity. He has lost his connection with people. In some ways, Scrooge has "repressed" his psychological and human needs because he is afraid to face them. He is afraid to admit his vulnerability, his fallible human nature. At the start of Dickens' story, Scrooge is alone in the world. His best friend and business partner has died, and his only living relative is his nephew, who Scrooge shuns. At first, we do not know why Scrooge acts the way he does, but when Scrooge is forced to re-evaluate his past by "the spirits," we are given a few revealing clues as to why he has become a misanthrope. For example, we discover that his father did not seem to like him. He sent him away to boarding school, and Scrooge often spent the holidays there alone. In the prime of his life, his unrelenting lust for money drove away his fiancée, and he never married. With age, he grew colder and colder, and less interested in his fellow humans. For example, when his business partner was near death, Scrooge escaped through his work. He stayed at the office, and barely had time to bid farewell to his old friend and colleague. After reviewing his life, Scrooge realized that he had been missing out on the enjoyable, social aspects of life. He had lost his psychological balance, and now he wanted to get it back. At the end of the story, he transforms his life by reaching out to others and living a more fulfilling life.
Many seasoned traders warn: "Do not forget to appreciate the advantages of working as a trader." Trading offers freedom, freedom to spend time with your family, friends, and loved ones. Trading provides the means to enjoy life. So regardless of whether you have had a profitable year or not, reward yourself by taking a nice, well-deserved break. One of the reasons you are trading is to enrich your life. It is important to remember that. It is important to celebrate what life has to offer. If you are not enjoying your life to the fullest, it will gnaw at you. In the back of your mind you will think, "Why am I spending my life trading?" Use this time to remember why you trade. Use this time to remind yourself about what really matters to you. Make sure that you have balance between working as a trader and the things that give your life a deeper meaning. If you ensure that you lead a balanced life, you will be able to cultivate the peak performance mind-set that is a key element to consistently profitable trading.
With every New Year, it is time to make plans for the future, and set exciting new goals. Goals can be motivating. When we think of where we want to go next in our lives, and when we formulate specific goals, the goals suddenly seem possible. We start thinking of various possibilities. The more we think, the more plans we make, and the more the possibilities seem realistic. We suddenly feel energized and ready to take on the world. But it is important to not get too carried away. Whether you are making plans for your personal life or setting new trading goals, you must set goals carefully. It is vital that you set realistic goals, goals that are challenging enough to take you to new heights, yet humble enough to match your actual available resources.
At the start of a New Year, it is tempting to be extremely optimistic. Why not shoot for the stars? Although high aspirations are necessary for one to achieve ambitious goals, "shooting for the stars" usually leads to unrealistic goals, and that usually leads to failure. For example, about 90% of the people who set New Year's resolutions fail. Most of these failures occur because people were too optimistic when setting their goals. They started to think, "anything is possible" if one "dares to dream." As inspiring as the "anything is possible" attitude is, it rarely proves true. You cannot merely think your way into success. It takes hard work and planning. And all the hoping in the world can't make one achieve the impossible. You must have the proper resources.
Most people set unrealistic goals when making a New Year's resolution. They think they can lose more weight than they really can lose. They tend to want to achieve personal projects that cannot possibility be completed with the resources they have available. And when it comes to trading, many novice traders plan on making more money than they can possibly make. (For example, one cannot hope to make a living with a R10 000 trading account.) Instead of setting goals that are difficult to achieve, it is essential to set realistic goals. Do not think that you can trade profitably if you are just starting out, for example. Give yourself some time to hone your trading skills. (Many seasoned traders say that if you have been trading for less than five years, you are still a newbie. Keep that in mind when you plan your trading goals.)
When setting goals, it is useful to make them specific, but not unrealistic. It is useful to distinguish learning goals from performance goals, and set both kinds of goals. A novice trader, for example, does not have the skills and resources to trade consistently or make big profits. Setting the goal of making a 40% profit in six months, for example, is difficult if one does not have the requisite skills. That is an example of setting an impossibly high "performance goal." Unrealistic performance goals usually lead to failure and extreme disappointment. This is when hopes are dashed, and most want to just give up. Instead of setting a high performance goal, novice traders should set high learning goals. A learning goal, such as spending 20-hours a week learning new strategies and putting on 10 practice trades (whether profitable or not), is easier to achieve. One will be likely to achieve success and meet the goal. Rather than feeling a sense of disappointment, one will feel accomplished, as if he or she has beaten the odds and triumphed. One will be energized and ready to move on to achieve even higher goals. The start of a New Year is a great time to set new and exciting goals. But be careful. Set realistic goals that you know you can achieve. For the New Year, many people set their sights too high, fail, and experience extreme disappointment. By setting realistic goals, however, you'll be more likely to achieve success, feel energized, and maximize your potential.
Developing new trading ideas
As any seasoned trader will tell you, the key to long-term profitability is a flair for devising innovative, new trading ideas. Winning strategies are hard to find. And after one goes through all the trouble of developing a lucrative trading strategy, it suddenly stops working. To stay ahead of the pack, it is necessary to find new strategies and opportunities; otherwise, you will see a noticeable decline in your overall profits. Here is a basic three-stage framework for generating and critiquing new ideas:
- Planning, and
- Playing devil's advocate.
In the brainstorming stage the goal is to create as many new ideas for trading strategies as possible. Be open and allow yourself to think freely. Do not hold back. Let the motto, "There is no such thing as a stupid idea," guide you. Think about what you would want to do if anything were possible. You may come up with some unrealistic ideas, but at this stage, the goal is to generate as many ideas as you can. You do not want to limit yourself. If you inhibit your creative juices, you may block an innovative idea from entering your consciousness. In the planning stage the goal is to refine your potentially innovative idea. It is time to move your idea from a vague impression to a concrete and practical plan. Try to work out every detail and think about how you will implement the plan. Think creatively, but think like a realist. What can you realistically do to implement your idea? What signs and signals suggest that market conditions are just right to implement your idea? What is a realistic profit objective for your idea? How will you limit your risk? What is your exit strategy? The more detailed the plan, the more easily it will be to follow. You will be able to evaluate its potential profitability more easily as well.
The final stage requires you to play devil's advocate. Now that you have outlined a reasonable plan, it is time to consider what is wrong with it. This is a key stage. It has been said that brilliant trendsetters are those who can distinguish a truly creative idea from a pipedream. It is vital to be a harsh critic. In this stage, it is useful to assume that most trading ideas are "bad ideas" and that you must entertain every possible problem with your plan. Even the most logically consistent idea may fail under actual market conditions. What basis do you have for believing that your strategy will work? What assumptions did you make when devising your plan? Are they reasonable? What is the worst-case scenario? A sceptical approach can prevent losses, so it is essential to find every possible flaw, and either fix the plan, or ditch it. By following this three-stage method of brainstorming, planning, and critiquing, you can devise innovative trading strategies that will keep you profitable under continually changing market conditions.
High personal standards are the hallmark of success. Unless one strives to move beyond one's comfort zone, he or she will never achieve greatness, and when it comes to trading, you are not going to make huge profits unless you set your sights high. That said, it is imperative to consider what it means to set "high personal standards." It is not as obvious as it seems, especially for trading aspirations. Depending on the context, setting extremely high personal standards, and meeting them, is sacrosanct. When one has a demanding job where even the best effort may not be quite good enough, it is necessary to comply with extremely high standards. Examples of such occupations include teachers who must ensure their students reach a prescribed level of mastery, a surgeon who must act flawlessly to save a patient's life, or a pilot who must fly a jet airliner carefully to ensure passenger safety. (And of course, it is also useful to take a similar stance when trading.)
Using the success history search to cultivate a winning attitude
Making profits is often a matter of thinking and feeling like a winner. In their book, "The Mental Edge," authors Kenneth Baum and Richard Trubo argue that tapping into your history of success can put you in a winning mind-set. When trying to maximise your performance, it is useful to set your sights high. "The more you expect from yourself, the more you will achieve. Modest expectations produce modest results," according to Baum and Trubo. The images that come into your mind dictate your expectations. A baseball player who tries for a homerun is more likely to do better than a player hoping to merely hit the ball to first base. Similarly, if you do not expect to see a profitable opportunity during the trading day, you would not. On the other hand, if you think optimistically, you will reach your potential: "If I study the markets carefully enough, I will find at least one way to make a profit today." As a trader, your goal should always be to reach your potential. That is not the same thing as unrealistically thinking you will make a 500% return on your money on any given day, if you are a novice trader, but achieving your peak performance, whatever it is, each and every day.
Not everyone has the same abilities. It does not make sense for an amateur golfer to think that he or she can play like Tiger Woods. And it is not realistic to think that an average trader can approach the success of a "Market Wizard." But whatever your skill level is, you should try to maximise it. For some, that may just mean putting on a few small trades a day to develop an intuitive feel for the markets. For others, it may mean making R10 000 a day. The main point is to maximise your performance. Try to achieve a level of performance that exemplifies the best that you can be.
When you strive to be your best, your confidence increases. Suddenly, you are enthusiastic and ready to achieve success. Baum and Trubo suggest using positive mental imagery to put you in the proper, optimal mood. They call this mental imagery task the "Success History Search."
Here's how it works:
- Close your eyes. Let yourself relax.
- Now think of a recent time when you have accomplished something important, a task you are proud of. It could be a recent winning trade. Or it could be an athletic event you won recently. Perhaps it is a big business deal that you closed, or even an A+ you received on a test in school or university. It could have happened yesterday or 10 years ago. The main issue, however, is that the event you remember should provide a clear image that inspires you, an event that makes you feel good about yourself, and makes you feel that you can do anything.
- Focus on the image. Try to remember the positive, optimistic thoughts that were running through your mind. Allow yourself to feel good about the experience. Remember how it felt like to win. Soon, you will find that you become optimistic, focused, and ready for action.
Use the Success History Search before you start the trading day or when you are about to execute a trade. If you find that replaying just one winning accomplishment is not enough, replay two or three until you cultivate a winning attitude. Images are powerful. By remembering vivid images of past successes, you will feel optimistic and ready to master the markets.
Media news and the behaviour of the masses
As a short-term trader, your goal is to stay ahead of the crowd and let their money flow from their pockets into yours. The better you can anticipate the behaviour of the masses, the better you will be able to capitalise on their irrational decisions. The masses are notorious for over-reacting to media news. In an innovative study, behavioural economist Dr. John Nofsinger studied how media coverage influences the masses. It is not as straightforward as you might think.
A popular theory in behavioural economics is that buying and selling by the masses is motivated by a powerful tendency to avoid regret and seek out pride. These emotional tendencies often lead to irrational investment decisions. Many investors, for example, hold on to a losing investment because they do not want to face feelings of failure and regret. Keeping losses on paper postpones the inevitable. Good news raises share prices, and when prices rise as a result of good news, most investors cannot wait to sell, take profits, and bask in the glory of success. Dr. Nofsinger's study, however, reveals that things may be a little more complicated. It may depend on the kind of news investors hear, rather than whether it is good or bad. He studied how investors reacted to two kinds of news, news about specific companies and news about the economy in general.
Good news, whether it is about a specific company or about the economy in general, increases share prices. And one would think that regardless of what kind of news raises a share price, the impact on the masses would be the same. But Dr. Nofsinger found that the kind of news does matter. If the good news is about the specific company, the masses tend to sell, but if the good news is general economic news, they hold on to their positions. Bad news about the economy similarly has little effect on what the masses do according to Dr. Nofsinger.
What are the psychological dynamics behind the behaviour of the masses? In their pursuit of pride and avoidance of regret, the masses continually monitor their positions and deliberate as to whether they have made a good or a bad investment. If the news is bad about a company, they tend to blame themselves for choosing the wrong company in which to invest. They tend to believe that they could have cherry picked a better company had they done their homework. When they hear good or bad economic news about a company, it bears on their original decision to invest in the company, and they react emotionally. On the other hand, it is hard to blame yourself for a poor economy. What could you have done? A poor economy impacts all shares, so the only thing you could have done was to avoid investing in the market altogether. It would not matter what company an investor decided to put their money in since all companies are affected by a poor economy. In this case, the masses forgive themselves, and do nothing.
The influence of emotions on the masses is powerful. By seeking out pride and avoiding regret, they allow their emotions to overpower their logic. As an astute trader, however, it is vital that you stay objective. Do not let your feelings of pride or regret influence you. Let the masses over-react. And when they do, capitalise on their irrational behaviour and profit from it.
Accepting the chaos
A butterfly flaps its wings …a hurricane strikes miles away. According to Chaos Theory, a seemingly irrelevant action can precipitate, and contribute to, a major event. The right set of factors comes together and a major event takes place. It is easy to imagine a fanciful chain of events that may initiate a market move. A housewife attends to her crying child who has tripped over the newspaper, and in doing so, leaves the fridge door open during an unseasonably warm day. It breaks down, and the family needs a new one. To get funds for a new fridge, she sells off a large chunk of Old Mutual shares that her parents gave her as a wedding present. By pure chance, at the moment that she sold the share, a specialist monitoring the action gets it in his head that the sale of a large chunk of shares means something, so he sells off his positions in the life assurance sector. Next, a financial reporter sees the sale and tries to interpret it. He reports that it reflects weaker than anticipated results and suggests investors unload their Old Mutual shares immediately. Many people follow his advice and a massive sell off takes place. Perhaps it seems a little unlikely that all of this can happen, but you get the idea. Just like how scientists claim, according to Chaos Theory, that a butterfly can start a hurricane, you can imagine that a few key seemingly minor events can start a major market move.
Many investors view the markets from a traditional long-term buy-and-hold strategy. They look at the markets in terms of fundamental variables, such as consumer confidence, demand, and general economic factors that impact a share price. If a company makes profits that are in high demand, the price goes up. Short-term investors, though, realise that many market moves are the result of psychological factors, such as opinions or emotions of fear and greed. In the short-term, anything can happen, and it is vital to keep this in mind.
Nothing is certain in the markets, but is this something to worry about? Not if you take precautions. Indeed, a potential chaotic event can be a good thing. The initial event that set off a market move is not important. Who cares why the masses buy or sell, for example, as long as you take advantage of the move? Some may view such moves as excellent opportunities to profit. On the other hand, if you have a swing trade that is ruined by an unexpected adverse event, the chaotic nature of the markets can be a hassle. But such events still are not worth worrying about. All you have to do is anticipate them and take precautions. By using a protective stop loss, for example, you can avoid losing trading capital when an adverse event unexpectedly occurs.
In the end, it is necessary to accept the risky nature of trading. Anything can happen, but it does not need to be a source of worry. Through careful risk management, you can protect your trading capital. And occasionally, an unexpected event can turn a mundane trade into a big winner. Worry can be the doom of many traders, but if you accept the fact that uncertainty and chaos are part of the inherent nature of the markets, you can account for it in your trading plan, and neutralise its potentially negative impact.
The cynic and the realist
In the trading business, it is prudent to take everything you hear with a grain of salt. Our field is full of false prophets who claim that they can make you rich quickly and easily. Realistic scepticism is healthy. For example, there are many traders who made huge profits in the late 90s, and now claim that they can help you live comfortably by trading a R10 000 account. How do you do it? It Is easy, they claim. All you have to do is buy 200 shares of a R50 stock, wait for it to go up 100c and make a R200 profit in as little as 30 minutes. That's R400 an hour, R800 000 a year. Is this realistic? It does not seem to be. Sure, you can invest R10 000 on one trade, pick a share that goes up 100c and make a R400 profit, but can you do that over and over again? Would there not be times when it went down 200c? What about those times where you try to sell off the position, but you can get the 100c increase for only part of your position? Can you make a winning trade hour upon hour, day after day, without fail? It is appealing. Who would not want to believe that it was true? But anyone who has traded the markets knows that it is hard to make winning trades over and over without making a few losers, at a minimum. You cannot pin all your hopes on one trade, and you cannot realistically believe that you will be able to repeat the process over and over again without fail. You must manage risk and constantly entertain the idea that you will hit upon a losing streak. It is better to take a more realistic, practical approach to trading. It is vital to be a realist.
What's a realist? Professor Joseph Badaracco of Harvard Business School draws an important distinction between realism and cynicism in his book, "Leading Quietly." "Realists understand that unpleasant surprises come with the territory. Caution, due diligence, and step-by-step planning are valuable, sometimes indispensable, but they do not guarantee smooth sailing," according to Badaracco. Realists do not look at the world through rose-coloured glasses, but they do not look at it through dark-tinted glasses either. Both over-optimism and fatalistic pessimism are distortions of reality. Realists find a balance between the two extremes. They are open, flexible problem solvers. The cynic takes the attitude, "you cannot fight city hall," but the realist believes there are times where you can work hard and do the impossible. It would not work all the time, but many times it will.
When cynics put on a trade that is ruined by adverse events, they pessimistically think, "I got a raw deal." Cynics are not ready for the unexpected. They view setbacks as evidence that the world is corrupt. They secretly believe that it is impossible to make money in the markets and they are looking for evidence to throw in the towel. Realists know that unexpected adverse events are commonplace when trading the markets. Nothing is completely certain. It is a matter of probabilities. While cynics view the challenges of trading the markets as a reason to find a new profession, realists are open to change. They expect things to go wrong occasionally, and they are ready to deal with them. The realist is ready to rise to the challenge and work around the problems. They manage risk. They are on the constant lookout for new trading methods, and they know that they cannot passively wait for trading opportunities to come to them. They search for them, and stay ahead of the masses.
So be a realist, not a cynic. Think positively, but do not distort reality. Do not fall for get rich quick schemes. Get quality training and build up rock solid trading skills. With enough persistence and effort, you can master the markets. There may be many setbacks, many losing trades, and endless dings to your ego, but if you are open to new experiences, and believe you can overcome any obstacle with hard work and persistence; then you will trade profitably and achieve enduring financial success.
Small things matter too
Ask many seasoned traders to describe their most profitable trade, and you will hear a fantastic story. It is usually purely serendipitous. For example, they may have been going long on a large position when suddenly a media reporter talked up the company for no good reason. The share price shot up as the masses heard the news, and they made a killing. These stories are thrilling. They inspire you to hone your trading skills and master the markets. Who does not want to be at the right place at the right time? But if you want to be a profitable, active trader, you cannot merely wait for a rare trading opportunity to present itself. Most of the time, trading is about making trade after trade to the point that it seems mundane. Rather than seek out the big, thrilling trade, it is important to remember that small trades matter a lot.
Influential advertising executive, Bruce Barton once observed, "Sometimes when I consider what tremendous consequences come from little things … I am tempted to think there are no little things." As stirring as big trades seem to be, it is the smaller trades that keep you in business. Many traders feel they reach a plateau when trading. They make trade after trade and little seems to happen. They do not suddenly find the trading Grail and achieve the great wealth and status of their dreams. Whether they realise it or not, however, they are still making progress. Each new observation of the market, each trade they execute, no matter how small, adds to their wealth of knowledge. They intuitively learn what to do and what not to do. They may see a slight variation of a classic chart pattern emerge and learn just how far the pattern can deviate from the prototype and still forecast the movement of the share price. On another day, they may learn a new way to place a protective stop so that they protect their risk, yet do not get stopped out prematurely. These small every day, seemingly insignificant experiences matter a lot.
Trading is challenging. Few people survive to trade over many years. The traders who do survive, however, know how to stay focused and patient. They do not go for quick thrills, and unrealistically huge profit objectives. They know that losing is easy and can happen in the blink of an eye, but building capital back up can require difficult work over many weeks. Instead of going for risky, exciting trades, they seek out high probability trade setups, take steps to protect trading capital, and execute the trade decisively, according to their trading plan. They may not have an exciting tale to brag about to their friends, but they take home a tidy profit. And when they make trade after trade, the small profits add up, and they end up with big profits in the end.
So when you feel that your earnings have reached a plateau, do not get discouraged. As long as you are making profits, and staying in the game, you are continuing to develop your trading skills. You are adding to your knowledge base. You are developing a more intuitive feel for how the markets operate. It may not seem like you are making the profits of a "Market Wizard," but if you keep at it, you will be one of the rare few that join the ranks of winning traders.
The power of positive imagery
Have you ever had those days, or weeks, where you just could not get on a winning streak? Perhaps you are a novice trader trying to break into the field, and wondering if you will ever become a full-time, active trader. Sometimes, it feels like you are just spinning your wheels. It is easy to feel like throwing in the towel. Whether you are feeling down and beaten or in a little bit of a slump, positive imagery can restore your optimism.
You can use a variety of positive images as a source of inspiration, and depending on your background and resources, some positive, motivating images are more realistic than others. If you are from a well-to-do and well-connected background, it may be motivating and realistic to imagine yourself becoming the next Warren Buffet. But if you're like most people, you would settle for becoming a skilled, profitable trader. Think of how great it would be. Imagine yourself having a wealth of market experience and being able to recognise a chart pattern intuitively and being able to react just as instantly. Every week, you have no problem identifying profitable trade setups and you have enough money in your trading account to take advantage of them in a major way. And then there are times when you hit upon a good run, and really make huge profits. Life is good. You enjoy the process of trading, and do not need to care about meeting your financial goals anymore. You just know you are having fun all day and sleep soundly at night.
Is that image not pleasing? Does it not motivate you to work harder to reach your goals? Anyone can dream, but what is the difference between a realistic dream and a pipedream? That is a hard question to answer. Only you know your abilities and what is realistic based on your background. It does not make sense to imagine the impossible, however. It may feel euphoric in the short term, but you will know that your motivating image is just a fantasy. If your dream is unrealistic, you will end up frustrated. You will set yourself up for failure because you can never attain the goals you have set. It is important to have a positive image that is motivating but also realistic.
How do you create a realistic, motivating image? Look for role models. There are numerous trading books with interviews of seasoned traders. Find traders who have similar backgrounds to yours. Learn how they made it. What were the market conditions? What did they do to prepare? Use their career as a roadmap for your career. Having a real person in mind as a role model can transform vague, quixotic images into a tangible, attainable reality.
Once you have a positive image in mind, it can only be motivating if you believe it is possible to attain it. It is essential to develop a clear plan for how you will reach your goals. If you do not have enough money to trade, for example, consider getting a second job. If you feel that you need more instruction, figure out how you will be able to find the time to get that instruction. If you are taking active steps each and every day to reach your goals, you will think of your positive, motivating image and feel inspired. You will take minor setbacks in stride and work tirelessly to reach your goal of becoming a profitable, master trader.
Cool and organised
Trading can be fast paced. As an active trader, you must sift through a barrage of information, from media reports to trading statements to unexpected national events. It is hard sometimes to make sense of it all, and to see which pieces of information actually impact the shares that you are trading in significant ways. What will happen next is never certain. Trading plans that you developed during off hours may not match current market action. When things do not click, and fall into place in the way that you had planned, it can be stressful, confusing, and frustrating, but in all the confusion, it is vital that you keep cool and organised. Rather than try to do too much with the little time and energy you have, it is vital that you stay focused.
The pressure to get things done in a short time can be a significant source of stress. And when your plans do not seem to be working out, there is psychological pressure to make difficult decisions quickly. Should you stick with your current trading plans, or look for new opportunities? There is a need to be careful. You do not want to make the wrong decision and miss out on a rare trading opportunity. When you feel that you have too much to do and not enough time to do it, it grates on your nerves. Suddenly, everything can seem unorganised, unstructured, and confusing.
One of the most effective ways to cope with the pressure to get more things done than you have time for is to change your time perception. Time perception is the degree to which people perceive their use of time as structured and as contributing to a specific goal or set of goals. When you are frustrated and unsure of what to do next, you can feel that you are moving aimlessly back and forth among alternatives and getting nowhere. It is as if you are out of control. At these times, it is necessary to return structure into your trading life. When you perceive that your time is structured and that you are working toward a specific purpose, you will feel calm and satisfied.
When frustrated by the markets, you can become an extreme perfectionist, afraid to make a mistake and unsure which path to take. To gain control, it is necessary to set clearly defined and realistic goals, and make specific plans for how to reach these goals. When you feel especially confused, it makes sense to pick a few trading plans, and focus on implementing them. Which should you pick? Pick the ones that seem to match the current market conditions, but do not get hung up on it. Many traders make the mistake of thinking that they must chose the one right plan or else they will miss out on an important trading opportunity. That may be the case. You may indeed pick a trading plan that was not the best, but you could be wasting more time deliberating among plans and trade setups than taking decision action, which can restore a feeling of control and direction. Once you implement at least one of the plans, you will naturally reward yourself, and feel that you have achieved a meaningful goal. You will feel back in control, and once again, enjoy the process of trading. Everything will start to feel as if it is coming together into a whole. When you perceive your time as structured, you will feel less stress and feel more satisfied with your overall trading experience. You will feel cool and organised, and trade more profitably.
Looking at your performance
How good of a trader are you? Everyone eventually must ask and answer this question. The answer may be unpleasant, but you have to face your limitations eventually. Some traders feed their trading accounts every month with additional funds to avoid looking at how poorly they are doing. It is natural to take such measures. We all want to be successful, and it can be devastating to discover that despite our best efforts, we just are not trading up to par. Sure, it takes time to hone your trading skills, but if you are losing money every month, you must be doing something wrong. Why not do something right and take home huge profits?
It is vital to monitor your trading performance on a trade-by-trade basis. Keep a trading diary. Record the trade setup, your trading plan, and how confident you felt about your plan. And more important, it is useful to keep track of your Rand-based win-loss ratio. There are many ratios that you could use to gauge your performance, but a win-loss ratio based on Rand amounts is a useful marker of performance. It is simple to calculate if you keep records. Always record the Rands won or lost on each trade, then divide the Rands won by the Rands lost. (You could use a simple win-loss ratio comparing winning trades to losing trades, but if you ignore the Rand amounts, it is possible to obtain a reasonable win-loss ratio, but still mount substantial losses.)
If your Rand-based win-loss ratio is 100% or lower, you are bound to blow out your trading account over time. In order to survive, you must increase the ratio. Seasoned traders tend to have a ratio of 200%, in other words, for every Rand they lose, they win R2. Some professionals have a ratio of 400%.
Why do some traders have low win-loss ratios? One of the reasons is that they do not look at the potential risk before they make a trade. They take trade setups that are overly risky and unlikely to produce a profit. Rather than take the trade, they would be better off waiting for a better trading opportunity, a trade setup that potentially could provide large profits and little risk. It is not easy. It takes patience, and a strong commitment to study the markets and identify good trade setups. But, in the end, it is worth it. If you carefully select high probability trade setups, you will trade more profitably and you will be more satisfied with your performance. A high probability trade setup corresponds to a price level where you perceive a clear advantage in that you are more likely to win than to lose if you enter into the market around this price level. Suddenly, you will find that you will get on a roll and your profits will increase greatly over time. By carefully monitoring your performance and managing your risk, you will see your profits reach new highs.
99% of a victory
Ever watch a hard-fought rugby or cricket or soccer game? When it is over, who is more tired? Who is more bloodied? Who is more used up? But who is more elated? At the end of the day, the raw effort required to win is not that much more than the effort required just to participate, and yet lose. Even more important, the rewards from the effort involved in achieving 99% of a victory are almost non-existent compared with the rewards you get from working just a little harder, and putting a "W" in your column. So if you are going to be tired, bloodied, and used up either way, is it not better to win? That is why successful traders are unwilling to curtail their efforts short of victory. They do not know, of course, whether a given trade will succeed or fail. But they do not want to allow for the possibility that it might fail just because they were a little lazy, or because they followed the easy way to make the trade, instead of the right way. Since the difference between winning and losing is so small, you can follow these suggestions to keep yourself more often on the winning side of the markets:
- Make The Right Choices: Many times there is only a subtle, small difference between having a winner or a loser, for example, a moment's doubt may be enough to force you to exit, only to see the trade work out right afterwards. That is why it is important that you try to make every decision as though it were the most important of your life. Part of that requires sticking closely to your plans. If you make the right choices as often as you can, you will collect far more winners than you otherwise would.
- Be Consistent: There are so many forces in the markets, acting in so many different directions, that varying your own approach and response to conditions only adds to the chaos. The best traders tend to be very consistent in what positions they put on, when they put them on, and when they take them off again.
- Sharpen Your Focus: The markets offer exceedingly diverse environments in which to make money. You cannot possibly master them all. That is why successful traders specialise very narrowly. This allows them to build their expertise and narrow their attention, to give themselves an edge, albeit in a very small area. This edge generally translates into profits.
The ultimate simulator
We at PSG Securities Ltd, offer our trading clients the ability to experience a simulated trading environment. Unfortunately, this simulated trading environment will never provide an environment that is realistic enough, even if we use historical market activity, down to the prints, as it happened when it actually happened. Why? In a simulated environment, you know you are not trading with actual money (no matter how much you pretend), and you know that none of it is real. The lack of reality significantly affects your emotional responses. If your success in trading did not rely so much on your emotional control and trading personality, such simulated trading environments might be more helpful. But as we have established before, your trading success does rely on your trading psychology.
The ultimate simulator, then, would put you in an environment where you are experiencing similar psychological situations and for which you do not have historical information you can look at. In other words, the end is not known. One of the best and easily overlooked activities that mirrors trading is driving in traffic. The analogy is detailed and in-depth. But to get you thinking about it, here is an example that highlights some key similarities. Suppose you are on the freeway in rush-hour traffic. You maintain control over your safety by anticipating what the cars around you are doing and will do. If you anticipate that the car in the adjacent lane is going to cut in front of you, you slow down and let them change over or you speed up past them to avoid any problems. In trading, you anticipate what other investors are doing and act according to your anticipations in an effort to prevent losses.
What the cars on the freeway do is completely dependent on driver psychology, just as what price patterns do is completely dependent on investor psychology. Because of this, you will see accurate examples of mass psychology and contrariness. For instance, when a certain lane is moving faster, most of the people who perceive it will tend to change over to that faster lane. Those who did not move over now find themselves in the faster moving lane, until everyone moves back over. In the end, each lane tends to move at approximately the same speed as its adjacent lanes, with slight differences (so that the right-most and left-most lanes have the greatest difference). Driving can help you monitor your proactive and reactive tendencies, emotional responses to the unexpected, and perceptions of mass psychology.
Seeking pride and avoiding regret
Jason has been holding a position in a particular share for the past month. It has been doing well so far, and earnings forecasts suggest profits, in part due to sales in new markets. On the other hand, economic figures seem grim. The business news is full of stories of company cutbacks, which can easily suggest lower sales for the company's widgets. Jason is stuck in a quandary. He is proud of his decision to buy the share, and he is hoping to make a profitable trade, but he wonders, "Am I trading on the news? Am I listening to the media and ignoring other more important economic indicators? Should I sell now or hold it a little longer?" He wants to make a profit, but on the other hand, he does not want his winning position to turn into a loser. It is one thing to make a wrong guess upon opening a position, it is quite another to let a winning trade turn into a loser. Inaction is a major cause of regret. Rather than face that possible regret, why not just sell now, lock in the profits and feel pride? The interplay between regret and pride influences many investment decisions. On the one hand, people prefer to experience pride, and bask in the glory of a winning trade, but on the other hand, "they need to let their winning trades run." Letting a winning trade run is hard to do. It is possible that it will turn around, and the inaction of holding the position may cause regret later.
According to behavioural economists, regret and pride are the two most pervasive and powerful emotions when it comes to investment decisions. Traders and investors seek out pride and avoid regret. Pride is experienced when we have accomplished an important goal. It results in a feeling of extreme pleasure. Regret occurs when we have made a poor decision. According to behavioural economists, the need for pride and avoidance of regret work together to make traders and investors prematurely sell off winning positions and hold losers unnecessarily. Here is how it works. Selling a loser forces investors to acknowledge that their trading plan was flawed. Instead of feeling pride, they feel ashamed, which is an unpleasant emotion. It is hard to face regret from making a bad decision, so such a decision is put off. By leaving the losses on paper, the feelings of shame and regret are avoided. On the other hand, selling a winning position allows for bragging rights. A person can feel the pride of making a big win, and bask in the glory of a good trade. What is wrong with this strategy? A study by Dr. Terrance Odean shows that winning positions are likely to remain winning positions. If a trader could hold onto the winning position, then it would have made additional profits. By selling it early, to feel a sense of pride, the investor feels good at the expense of a greater profit. In addition, since the position is usually held less than one year, capital gains taxes must be paid. Selling losing positions would be a much wiser move. Losing positions tend to fall even farther in the future, and there are tax advantages for closing them. Do not let regret and pride get the best of you. Sell your losers and keep your winners.
Doing it right is getting it right
People always have some opinion about where the markets are and where they are going. Most of these people are considered part of the masses or crowd. They believe that they have sound reasoning for what the market, or a particular share, will do in the future. Experienced traders know that such analysis is, for the most part, irrelevant. What separates professional traders from novice traders is not how well they analyse trade opportunities, but how much profit they make. When people think about trade "analysis", they are thinking about predicting or determining future price movement. Practically, we all know that none of us have the gift of predicting the future...No matter what kind of analysis we do and how well we determine the probability of what will happen, there is always the chance that what we think will happen would not happen. So if there is really nothing we can do to determine what will happen, we cannot use that as a valid way of evaluating a trader's performance.
On the other hand, the financial effect of an individual's trading activity is a concrete result that can be used to determine how well a trader is doing. Some traders make more effective winning trades than losing trades, resulting in financial profit over a period of time; these are the successful traders. Consider the following two statements:
- If a trade is a winning trade, then it will result in a profit.
- If a trade results in profit, then it is a winning trade.
Statement A is not true, because we can never identify that a trade is a winning trade until we know the end, and therefore the result, of the trade. In other words, if the "If" portion of the statement is true, the trade already resulted in a profit - not it will result in a profit. On the other hand, statement B is true. We can identify the type of trade once we know the result - if the result was a gain, we identify the trade as a winning one, and if the result was a loss, we identify the trade as a losing one. With this in mind, the best approach to developing your trading skills is not to concentrate your focus on your analysis skills, but to concentrate it on the entry/exit choices you make (which depend on your trading personality/psychology).
Traders often hear about the potential benefits of preparing actionable trade plans prior to the next trading day. The goal of such preparation is to make yourself immune to mental edge breakdown. One of the greatest threats to your mental edge is coming across something that is unexpected during the trading day. Seeing an unexpected price move (especially one you perceive to be a big move) is likely to stress and panic you and therefore cause your psychology to shift into an emotional, reactive state. An effective way to prevent this is to prepare with possibility mapping.
Possibility mapping is a process which will mentally prepare you to expect the potentially unexpected, and therefore will allow you to numb, in advance, any potential emotional responses. There are two major types of possibility mapping: Exact possibility mapping, which you would use if you tend to make your trade decisions the day before; and Price Pattern possibility mapping, which you would use if you tend to make your trade decisions while you watch price patterns forming. With exact possibility mapping, you first identify a trade you might make. You would then write out all possible scenarios of price activity following your entry. Yes, there are more scenarios than you could possibly define. However, you will be able to identify major groups of scenarios where each of the scenarios in a given group would ultimately result in the same signal. These groups are limited and can easily be defined. Then, in your objective state of mind, you decide how you would react in each case.
On the other hand, with pattern possibility mapping, you would define the several possible groups of general, overview patterns you might see and decide what actions you would take in each case. Over time, you will find yourself mapping possibilities faster and more accurately. You can also prepare further by defining what you might think the chances are of each scenario actually occurring. With such preparation, you have already "experienced" tomorrow's markets. Therefore, you virtually eliminate the chance of mental edge breakdown due to unexpected scenarios. Possibility mapping can also drastically improve the quality of your trading decisions and your recognition of certain patterns. In addition, reviewing and comparing your possibility mapping records with your trade diary will help you find key patterns in your trading, identify areas in which you might have a lack of preparation and ones in which you have strengths.
Riding the wave
Charles Dow, in an influential series of articles in the Wall Street Journal, proposed that prices move in waves. A bullish trend is established and everyone follows it. Some would say that the key is to identify whether the market is bullish or bearish, depending on one's timeframe, getting on the bandwagon, taking advantage of the trend and making a profit. Of course things are not that simple, but it is sometimes useful to think of trading in this simple way. Some traders draw an analogy between surfing and trading. A surfer tries to find a wave that is high enough and moves with enough force to ride. One tries to ride the wave as far as possible, reaching the shore, or getting off before getting thrown off.
If you are new to the markets or have not been very successful, it is useful to try this simple trading approach. Look at indicators of momentum and try to determine whether the market is bearish or bullish. If it is bullish, find a share that seems to follow the general trend. Buy a few shares, hold on to the position for a few points, and then close out the position. See if you can make a quick profit. This strategy may seem simple and a little naïve, but sometimes such strategies have merit. Again, think of the surfer. When one is trying to ride a wave, he or she is not concerned with why the wave occurs. He or she does not worry about when the next wave will come. Surfers simply try to find a wave, or an opportunity, get on it, and ride it. They do not mull over issues, such as laws of motion according to classic physics or how gravity and the rotation of the planet influence the occurrence, height, or force of a wave. Such thinking is distracting. One does not need to understand why the wave comes in order to ride it. Some successful traders take a similar approach. At any given moment, one does not need to know why the share price seems to be building momentum, but merely that it is building momentum.
Traders get in, buy a few shares, and see if they can ride the trend to make a profit.
But just as the surfer is not interested in being slammed into the sand, seasoned traders take precautions. They do not enter a trade without a well-defined plan. They have an idea of when they will buy, what technical indicators show that the price is in motion, and how they will exit once the trade is executed. They set a stop loss order or develop an exit point. They decide beforehand that they will get out of the trade if it goes against them. They do not wait until the last minute before taking action. And they do not risk it all on one trade. They manage their risk by limiting the amount of capital on any one trade to a small amount of their total trading capital. Similarly, a surfer would not want to surf only one wave, destroy his or her board, or hurt oneself and not be able to surf again. The fun comes from surfing wave after wave. Similarly, a successful trader enjoys executing trade after trade and "riding" each "wave" or trading opportunity that presents itself. It is useful to consider the surfing analogy when trading. Sometimes, there is a natural human tendency to make things more complicated than they need to be, and it is useful to simplify things once in a while.
Almost every trader has experienced the adrenaline pumping effects of a fast paced market. Many know it so well that they understand what it means to succumb to the rush, and they recognise how it can lead to making hurried and poor trading decisions in spite of all their trading knowledge. As a committed trader who is always watching the markets, reading the news, and setting goals for yourself, you are likely to experience what might be called "mental isolation". This occurs when you are so involved in the micro-view of things that you mistake unjustifiable and hasty conclusions about the market as confident decisions in tune with your mental edge. And it is usually after you are faced with the results of your decisions that you realise you gave in to the rush.
Successful traders realise that the risk of swaying from their trading plan due to mental isolation is always there. The risk is associated with being in an environment where there is a barrage of information (bids, offers, prints, headlines, analyst commentaries, etc.) that is coming at you in a short amount of time and that you have to process. Clearly, you cannot ignore any of this information, because it is what you will ultimately use to plan and time trades, determine signal generations, and execute orders. Instead, the key is to create a trading environment that assists you in avoiding mental isolation. That way, you still have the information you need at the same pace, but you do not run the risk of getting caught up in the rush.
There are a variety of ways you can create this type of "reality check" environment, according to what suits your trading personality. Some have found that taking short breaks away from the influx of information is helpful, although practically difficult to do. Most traders, especially those who are very experienced, prefer communicating with others while reading and watching the information. Although many have tried using online message or bulletin boards to this end, there is no replacement for real human interaction.
Why wait for the dust to settle?
Many traders like to sit out the first hour, cautiously waiting for the dust to settle. It is true that things can get a bit crazy early in the trading session and that it is often wise to avoid the stresses and pitfalls that often attend such craziness. But it is also worth considering that some of the best trades of the day tend to occur shortly after the opening, when relatively few traders are confident about where to enter or exit amidst the flux and confusion. It is their nervousness and uncertainty that creates opportunities for those of us who can make sense of it all.
Remember, the Chinese character for "risk" also denotes "opportunity." Indeed, that is the key premise on which most investment decisions pivot: The more risk we are willing to take, the greater should be the potential reward. This relationship is often at its most enticing in the opening hour, before shares have carved out a price range. That price range reveals a process of price discovery wherein traders try to feel the upper and lower limits of supply and demand. This creates an opening range on the intraday chart that defines a kind of "comfort zone" for going short or long. Once the range has been established, traders will tend to go short (or to take profits on longs) just beneath the opening-hour high; and to buy just above the opening-hour low. But you can see where this leads: As the highs and lows come to be anticipated by more and more traders, the cycle of anticipation, and hence the range itself, will begin to narrow. The result is a shortening intraday of up and down cycles that will necessarily limit the profit potential of each trade. As such, it motivates us to find a technical tool that will help us trade more confidently in the first hour. That is where some of the best opportunities lie, and where competition for the spoils of trading will be at its lightest.
How many news headlines did you read this morning? How many research reports did you read or market commentary did you listen to? Too many? Traders often struggle with information overload. This can be detrimental to their focused pattern of decision making or trade system application. There is a huge amount of information out there, and if you have been trading for a while, you would have probably experienced being able to draw two different conclusions about the same trade instrument on the same day, depending on which research report you have read. And that can be frustrating, especially if you plan on trading that particular share on that day. So how do you deal with it? You do what successful traders do: be selective about your resources and the information that you pay attention to.
Some of the most popular sources of information these days are finance message boards or Discussion Forum on the PSG Securities Ltd
website. Unless you are subscribed to a small, professional service, you can bet that you are far more likely to waste your time than to gain anything from such sources. Some traders claim that message boards are useful for gauging "mass psychology". Realistically, that is extremely difficult to do, especially when you can have such a variety of viewpoints, have no demographics on those who are participating, and besides, you would have to read, record, and measure an unreasonably high number of messages.
As for the different news services and providers, it is usually a good idea to survey a variety of sources for objectivity and accuracy, and then select the few that you think are best. Once you have done that, you will still find that there is a large amount of information to process. The simplest and most effective way to handle all that information is to be selective about what you review, read, and use in your analyses. Do not shy away from weighting different pieces of information according to importance, relevance to your trading methodology, and most importantly, to your trading experience. By being selective about your information sources, you are being selective about the factors that can influence your decisions. You already know how difficult it can be to stick to your trading plan and apply it properly. The small percentage of your trading plan that might account for news should not be the primary driving force behind your decisions. Be selective and do not shy away from denying certain influences. You can then focus on making the decisions that work for you.
John has been looking at a profitable trade setup all day. He has tediously studied technical indicator after technical indicator, even though many are redundant and converge. He continues his search, nevertheless. He irrationally believes he has missed something, but he is not sure what it is. He is reluctant to put his money on the line until he is absolutely sure that his trading plan is fool proof. He thinks, "I have got to account for every possible factor that may go against my trade, or else, I will lose money, and that would be fatal blow." John is afflicted with analysis-paralysis. He cannot make a decision that needs to be made immediately, and he hesitates out of fear and uncertainty. People differ regarding the extent to which they are afflicted with analysis-paralysis. For some people it is relatively benign and may even work as a very adaptive approach to decision-making, but for others, "analysis paralysis" is a deep-seated psychological problem.
Normal versions of analysis-paralysis - Careful analysis of all possible alternatives and all possible consequences of one's decisions is the hallmark of good decision-making. It is important to avoid impulsive decisions where one takes unnecessary risks. For example, you would not want to purchase an expensive house or car that does not fit into your budget. If you have saved enough money to have a trading account, you probably know that, and have a strong desire to apply what you have learned from your personal financial life to your professional trading life. When it comes to trading, it is vital to have a clearly defined trading plan. Make sure that a single trade does not have the potential to completely wipe out your trading account. In addition, clearly define the signs and signals that indicate your trading plan has gone awry, suggesting that you should close out the trade to protect your capital. It is useful to conduct a thorough analysis before making a decision, but it is not useful to become completely paralysed by it.
Pathological variants - A pathological variant of analysis-paralysis is quite different from sound decision-making. Traders with this pathological affliction have an insatiable need to seek out certainty and security. For these individuals, uncertainty represents insecurity. It is not merely that they have a pessimistic outlook, although they have one. They equate money with psychological security; losing money represents not only a loss of financial security, but also a loss of basic emotional security and wellbeing. How does such an affliction develop? For many it is rooted in early childhood. Parents often impose rules for their children to follow and punish them when the rules are broken. Young children are on the lookout for what rules to follow so as to avoid punishment and the unpleasant feelings associated with it. As adults, we make our own rules and decide to follow them or not; we no longer act as children searching for the "right" rules to follow in order to avoid punishment. People with analysis paralysis, in contrast, tend to search for the "right rules." They continuously search for rules to follow, and when no clear rules exist, they simply make them up. It is as if their parents have followed them into adulthood. They are always there next to them nagging and threatening punishment when the "right" rules are not identified and followed unconditionally.
For traders with analysis-paralysis, this past childhood conflict manifests itself as searching for the "right" technical indicator or the "right" trade setup. And even when they see it, they have a strong need to want everything to be perfect. Because if they do not, they are certain that some form of unspecified punishment will follow.
Do you have an extreme form of analysis-paralysis? If you do, it is vital that you identify this affliction and develop a strategy to fight it.
Market moods - how do they affect your wealth?
It is true. Short-term trading must rank near the top of the list of the most unpredictable and exciting occupations on our planet. As the aggregate of market players ride the market to soaring heights and terrifying lows, the collective consciousness of the crowd soars to euphoria and falls in despair in concert with the movement. If the crowd experiences a cumulative emotion ranging from mild optimism, greed and euphoria, to minor anxiety, then fear and outright panic. It stands to reason that all but the most robotic of traders go through personal feelings that mirror the experience of the crowd.
It is common to find traders who stay in high spirits when the market trends up and feel dejected and depressed when the market falls. In past years, this may have had more significance because many traders refused to sell short and they missed out on market action when it tumbled. Another reason for the "up is good, down is bad" emotional seesaw lies in the unfortunate fact that when markets fall, many novice traders ignore their stop-loss strategy. A falling market equals a falling trading account value. The downside to this syndrome, however, is more than detrimental to your wealth. Attaching your emotions to market gyrations can adversely influence your relationship with your loved ones and friends.
How do you stay disconnected and detached from market moods? First, we state the obvious: acquire the knowledge and discipline needed to make wise trading choices. Second, refine money management skills; it is an absolute "must." Establish an overall, big-picture plan for your trading business, so daily market gyrations do not look so daunting. Always plan your trade and trade your plan. When in doubt, get out. If you do not enjoy selling short, when the market "rolls over," take profits and stay on the side lines until conditions improve. After all, when you are in cash, you will have no emotional connection tied to market activity. Once you learn to disconnect from market mood, you will shake off emotional limitations that may have hampered your trading decisions. And that should have a positive impact on your trading success.
Traders are made, not born
Why do some traders make money with seemingly effortless confidence while others sweat bullets every time they act? We sometimes delude ourselves into thinking that the most successful traders somehow differed from everyone else at birth and that they were born to win no matter what they did. But for many, this is just an excuse used to avoid confronting a more difficult truth; those who succeed tend to do so not because of their genes, social background, or luck, but because they pursued success with more diligence, patience, objectivity and hard work than most of us care to bring to a task.
This is a hard lesson to swallow, especially for traders who think that they have worked hard, only to have consistent profits elude them time and again. They are likely to envy the success of traders who have had million-Rand years rather than to emulate it. Why? Because it takes unusual maturity and emotional detachment for someone who has been losing money in the market to see that winning traders are simply working harder at it, quite literally, doing whatever it takes to achieve profitability.
Are you willing to do the same? This is by no means an easy question, since it implies that to win, you must be capable of confronting each and every loss as evidence of a defect or a weakness in your trading approach. Repeat this process often enough, though, and you are certain to eventually understand the reasons for your failure. But one does not attain this level of self-awareness easily or without pain. The first step is to acknowledge that traders are made, not born. Once you truly understand this and take it to heart, then and only then will you be able to accept the inevitable setbacks as part of a learning process, rather than as a path to defeat.
What colour is your stock market?
Our past experience often colours the way we see things. We touch a hot stovetop and we experience pain, and we decide never to do that again. Or, when we hug a loved one and receive a hug back, we learn that hugging that person produces pleasure . . . so we try to do it again, and soon! Our experience with the markets similarly colours our perceptions, and it may sway the way we approach the markets.
How do you envision the financial markets? More importantly, how do you conceive of your role in the market? Do you see the market as a hazardous place full of malicious "experts" out to take your money? Or do you view it as an arena of dynamic profit opportunity? Each time you sit down at your trading workspace, do you sigh and wish you were doing something else? Or are you generally eager to jump into research and charts? Does wading through new material feel like drudgery, or do you take true pleasure in learning new information that will add to your trading foundation and bottom line?
No matter what colour you paint your picture of the market, positive or negative, either way, it will have a powerful influence on your actions! So it is vital that you are acutely aware of just what your perception is and what past experiences coloured your perception. This may be a good time to honestly assess your vision of-and feelings toward the market and your role in it. It will surely be time well spent.
Plan to reach your goals
Since trading is largely a self-directed business venture, embarking on a trading career requires that one be able to set clearly defined goals and develop a specific plan to achieve them. Clearly defined goals and well-developed plans are the hallmark of success in any profession. Imagine an airliner taking off without a flight plan, a surgeon operating without full knowledge of a patient's disorder and a proven surgical technique to address it, or the Shark's rugby team running onto the field without a game plan. In each case, the lack of a clearly defined plan in which specific goals are set and specific steps are outlined could produce disastrous results. Clearly defined plans are vital. The pilot files a flight plan, with the safe and on-time arrival to a destination city. The surgeon examines the patient's X-rays and uses the correct surgical procedure to cure the patient's ailment. The coach tells the Sharks rugby team to run a specific play to beat the opponent.
Prosperous trading careers start with plans that specify goals, which in turn lead to success; the process neatly filters down to all aspects of it. There are psychological benefits to establishing goals, and developing plans to reach those goals. First, you may find your stress levels are reduced. Making a specific plan can allow one to break down an amorphous and seemingly unattainable goal into clearly defined steps, which in turn make the larger goal seem more attainable. When you have a specific plan, you can more easily identify which steps to do first, and then figure out how you will achieve each one. In addition, you will find that following a plan ensures that you stay proactive, and so you control each aspect of your trading day (instead of it controlling you). This leads to increased confidence and consistency…which leads to increased effectiveness . . . which leads to advancement toward your ultimate goal.
What will this goal look like? Perhaps you will state it as something like this: "My goal is to become a fulltime trader by this date next year. I will work toward capital growth of at least 20% a year. In doing so, I will not take more than a R6 000 aggregate drawdown during any five-day period, nor will I risk more than 1% -2% of my trading account on any trade. (If your trading account equity is R300 000, then 2% is R6000. Accordingly, you adjust the share size and protective stop loss so that you never lose more than R6 000 on any trade.) 10% of my monthly gains will be moved to an alternative, low-risk investment strategy that will apply toward my retirement."
Now, map out your plan. What is your budget for equipment, software, and education? How much time can you devote? How much money will you use (assuming it is money that you can afford to lose!)? What trading time frame, or style, matches your personality? (For example, if you cannot make split-second decisions, then intra-day trading, for example, is not for you. Perhaps swing trading, with a 2-5 day hold, better suits your personality.) Maybe you want to target certain shares in certain indices and become a "specialist" in those shares.
Or maybe you prefer to trade ETFs (Exchange Traded Fund) such as the Satrix 40.
What technical trading set-ups do you prefer? Become an expert at trading a particular trading set-up and have it deliver the core of your gains. Flesh out money-management strategies. Finally, establish a list of trading guidelines that you keep at your elbow. Once you establish compelling and realistic goals, and then plan a map that leads to those goals, you will find your trading journey to be easier, more exciting and surely more successful!
Commit to trading success
"Until one is committed, there is hesitancy, the chance to draw back, always ineffectiveness. Concerning all acts of initiative (and creation), there is one elementary truth, the ignorance of which kills countless ideas and splendid plans: that the moment one definitely commits oneself, the Providence moves too. All sorts of things occur to help one that would never otherwise have occurred. A whole stream of events issues from the decision, raising in one's favour all manner of unforeseen incidents and meetings and material assistance, which no man could have dreamed would come his way." - Goethe
The most important step one needs to take to become a successful trader is to make a firm commitment to trading. Further, commitment needs to travel the 18-inches from the head to the heart to make it real and enduring. Webster's dictionary defines the verb "commit," as pledging oneself to a certain action. Those who pledge to commit a chunk of time and resources to their trading career, then commit to developing a plan and the discipline to follow it, have a much better chance of succeeding in this business than those who take a "potshot" and hope for the best.
Why can you not just "dabble" in this arena? Why can you not just saunter into the trading day at will, scan a few charts, and throw a trade in if you feel like it? Because, when you trade half-heartedly, you are telling yourself, your trading account, and the world, that whatever the outcome, it does not matter. (If you have money to burn, and lackadaisical trading provides your entertainment, by all means ignore this article and enjoy yourself.) Further, in many occupations or undertakings, a slapdash attitude will mean simply that you do not excel. In most situations, you can shrug that off. In your trading career, though, this mind-set almost assuredly will devastate your trading account and take your self-esteem with it. If you decide that trading is your part- or fulltime occupation, commit.
Rumination - do not make losses even worse
Steve has just made a losing trade. Although he is only down 2%, he cannot stop thinking about it: "What did I do wrong? How could I have prevented this loss? What am I missing here? What does this loss mean for me as a trader? What is going to happen next? Can I handle it?" Steve is a ruminator. He cannot just let it go. He persistently mulls over the loss, playing it over and over again in his head. Ruminating about a past loss not only intensifies a bad mood, but a recent study by Dr. Andrew Ward and colleagues demonstrates that ruminators are less satisfied, less confident and less committed to planned courses of action, compared to non-ruminators.
People differ on the extent to which they ruminate. Some people do not ruminate at all; they may deny or avoid thinking about their bad feelings, vent their feelings to friends and confidants, or take clear and specific action to change the circumstances that bring about the bad feelings. Whatever strategy they use, unnecessarily dwelling on the problem is not one of them. Ruminators, in contrast, repeatedly focus on the meaning, causes, and consequences of their bad moods. Engaging in these strategies usually intensifies the bad mood, adversely influencing problem-solving ability, attention and concentration. Such an approach is not conducive to skilful trading, where a calm, relaxed, and focused problem-solving approach is crucial.
In their study, Dr. Ward and colleagues diagnosed and classified university students as either ruminators or non-ruminators. Each participant was then asked individually to develop a specific plan to solve a pressing university-wide problem, such as how to solve a housing shortage. Participants were asked to present their plans to a member of a university planning committee. In contrast to non-ruminators, during their presentations, ruminators were less satisfied, less confident, and less committed to their plans. In addition, they said in their presentation that they needed additional time in order to seek out new information and to revise their plans. In summary, those with a ruminative personality style were so debilitated by their rumination that they could not make a commitment to a specific course of action. Rather than moving forward, they were stuck and paralysed.
As a trader, it is imperative that one quickly commits to a reasonable trading plan and take decisive action. But some traders second guess their trading plan and hesitate, missing an important move in the market. The ruminative personality style may explain why some traders experience this malady. Are you a ruminator? It is essential that you determine if you have this personality trait, and if you do, gain awareness of it, and make every effort to work around this problem. Self-awareness is key. Once you know you have a problem with rumination, you can develop a plan to manage it. It is not easy to change a ruminative personality style. If you have one, you have probably developed the habit of ruminating about your emotions over many years. But this tendency can be controlled. Carefully monitor your thought processes, and when you find yourself ruminating, remind yourself that by doing so, you will intensify your bad mood, and that in turn, will interfere with your concentration, and reduce your ability to think of creative solutions to trading problems. Some psychologists suggest that a ruminative person immediately yell, "stop" when they find themselves ruminating. This usually halts the repetitive and incessant need to over-analyse one's mood. In contrast to a non-ruminator, questioning one's decisions and over-analysing them is not productive, and it is necessary to remind oneself that he or she is making no progress by doing so. Over time, and through practice, it is possible for a ruminator to take quick and decisive action, instead of being paralysed by a hard decision or a recent trading loss. So if you are a ruminator, do not make a trading loss worse by dwelling on it too much. Identify the problem, develop a method to control it, and do not let a ruminative style interfere with making confident, committed trading decisions.
Striving for independence
The entrepreneur, the corporate CEO, and the top-notch trader are all viewed as exemplars of independent thinkers. They go their own way, go against the status quo, and are unyielding individualists. Well…that is the perception. This issue of conformity versus independence is addressed several times, in weekly assessments, daily columns, and trade doctor questions. This issue always seems to spark controversy. Folks do not like it when it is implied that they are not completely independent, and even slightly conforming. Ironically, some have even argued that they are indeed independent, which seems contradictory, since truly independent people could care less what people think of them. There is nothing wrong with being a little bit of a conformist, rather than a firm individualist. Psychologists have conducted comprehensive research studies of business leaders, and guess what? They are conformists. They have to be. A skilled conformist has an astute sensitivity to social cues, can read social situations accurately, and can easily modify his or her behaviour to react to the situation in a manner that puts him or her at an advantage. So there is nothing wrong with being a little bit of a conformist, so if you have been a successful businessperson or other professional, you are probably a conformist relative to the entire continuum of conformity versus independence.
It is the conformist in you that has made you successful and gotten you ahead, so extol yourself for being an effective and adaptive conformist. Perhaps some people strongly dislike being called conformists because they think that "conformity" means "thoughtless adherence to social norms." That is ultra-extreme conformity, overly dependent and probably not very adaptive. Healthy conformity entails social sensitivity, and adaptive rule following. Extreme individualists, in contrast, tend to be loners who do not care about social rules. The unkempt eccentric artist comes to mind as one exemplar of the extreme individualist. They truly go their own way, and do not care if they have no status, money, power, or friends for that matter. Although this exemplifies the kind of individualism that is conducive to trading, you can see that most successful business people do not fit into this category, and are more towards the conforming end of the continuum.
True independence is something one must strive to achieve. As a successful person, you have tendencies to look for subtle situational cues to guide you, and universal rules or unfailing signals that may not exist in the markets. Looking inward toward your own personal rules and values is something that novice traders must learn to do, and seasoned traders do already. True independence is not the same thing as non-conformity. Just like the ultra-conformist, non-conforming rebels also allow societal norms to overly control their behaviour; they merely automatically break the rules rather than automatically follow them. True individualists, instead, are willing to go against the crowd in effective ways. They do not break a norm just to do it, but they break a rule because their own personal motives and values tell them that there is a valid, more compelling reason to go their own way. Complete independence means both the abandonment of conforming and non-conforming behaviour. The individualist is free to conform or not conform; they just do what they want. They strive for the optimal balance between complete self-reliance and identification with the broader group and societal norms.
In the end, you have got to develop an awareness of how independent and non-conforming you are. Again, your past success probably means that you are used to being a little bit of a conformist. So be on the lookout for when you are conforming and strive for true independence. Look inward to what you really want to do. When it comes to trading, do not pay any attention to societal norms or rules. By searching for what you truly want to do in any decision, you will be striving for independence.
Commitment to trading - why it is so difficult
You have been told time and again that a strong commitment is vital to long term trading success. We have all seen the adverse consequences of people who are not committed to their goals, in other fields as well as trading. When one is not committed, he or she waxes and wanes, procrastinates, gives up easily, and never seems to achieve one's goals. Accomplishing significant life goals requires strong commitment, whether it is graduating from university, starting a business, or getting a significant promotion. But trading seems a little different; many people have a difficult time making a strong commitment. There are several good reasons why. It is useful to gain awareness and come to terms with them.
Trading is different from many professions in that the effort one puts in is not directly related to a clear and immediate payoff. With most professions, it is a certainty that the number of hours you spend learning a craft, and applying it, has a direct payoff. For example, if one were a stone mason building a wall, he or she knows with certainty that placing brick upon brick, hour after hour, will lead to completion of the wall (The wall may look unattractive if the mason is poorly skilled, but the wall will get finished, nevertheless). There is a direct one-to-one correspondence between effort and final outcome. When it comes to trading, in contrast, traders can put in hours of effort, but success can elude them. With trading, a threshold of skill must be achieved before rewards, or profits, are consistent. (This may be true of other professions, but whether one has the talent to learn the skills is immediately apparent to teachers and gatekeepers, and one is prevented from even trying to master the profession.) Unless one achieves a high level of trading proficiency, one may never cent trading. The possibility that one's time and effort may not pay off immediately, or at all, makes a strong commitment to trading difficult to nurture. It is reasonable to question whether one will become a successful trader. A Pollyanna "can do" attitude is not going to alleviate these doubts, if deep down you know that the doubts have some truth to them.
How can one cope with this issue? There are several ways: Accept the possibility that it may take you some time to build the skills you need to become a profitable trader. Do not think that you MUST be profitable immediately.
Follow the old adage, "Practice makes perfect." Give yourself time to build the trading skills that you need. Just as with any activity that requires skill building, such as playing music or sports, it is vital that you practice, enjoy the process of learning, and patiently wait to build up the necessary skills.
Put your goals in perspective. You may need to initially set modest goals, such as learning how to "paper" trade, or successfully trade small positions, before deciding to trade full time to make your entire income. Perhaps you will make it as a professional trader, perhaps you will have to settle for being a proficient amateur, but if trading is your passion, and you enjoy it, the idea that you need to spend time developing these skills should not deter you. Becoming a trader who is consistently profitable is rare, and this fact hinders one from making a firm commitment. Many professional traders warn novices that trying to gain success overnight is daunting, unrealistic, and quite discouraging. It is best to take it one step at a time. Gain knowledge, develop skills, and then gradually increase your trading position size. Even seasoned traders point out that trading is so difficult in the long term that they just take it "one day at a time or one trade at a time". It is easier to develop commitment by first committing to smaller goals before striving for larger goals. Following this wisdom will help you strengthen your long-term commitment to trading.
Skill building produces consistent profits
Seasoned traders often describe peak experiences in which they trade "in the zone." Everything seems to "click." They trade in synchrony with the markets, and act almost instinctively with the ebb and flow of market prices. Although seasoned traders frequently report trading in a peak performance state, novice traders rarely achieve it. That is because trading in the zone comes with experience, and in that sense, trading is much like professional athletics; one must build up a high level of skill so as to perform effortlessly and intuitively, and for traders, which in turn leads to consistent profitability. Once you discover a winning trading strategy, using it to make consistent profits is a matter of reading the markets accurately, executing the strategy, and exiting the trade flawlessly. The strategy may not work every time, but from historical data, you know it works with "casino odds;" just like a casino, the odds are in your favour. When the overall odds are in your favour, it is just a matter of making trade after trade so that "the numbers work for you." The more trades you make by trading your plan, the more likely you will make an overall profit across the large sample of trades.
However, if you "choke" on some trades because you have not yet developed a high level of trading skill, it does not matter that you have a strategy that puts the odds in your favour. It is similar to professional sports. There are strategic plays that are executed during the game, but an athlete must have honed a set of advanced skills to execute the play flawlessly. Otherwise, it does not matter how ingenious the play, it will fail without capable players. When the professional athlete sees the ball coming, he or she must take action in an instant. The first or second centre on the rugby team needs to get into the right position, catch the pass, and make it to the try line. He does not have time to let his poor catching ability prevent him from spoiling the game plan. The wicketkeeper is better off during a cricket game if he can automatically and almost instinctively catch the ball without having to over-think it. When one does not have a high level of skill, an inspired plan is doomed. And it is the same with trading. It does not matter how favourable the trading strategy is if one does not have the skill to execute it flawlessly.
Both traders and athletes must act on a moment's notice. They must work intuitively to observe and interpret signals quickly, yet accurately. They need to work intuitively to see signals so quickly that it is almost unconscious. Building such skills takes practice. One needs to make trade after trade, so as to perceive subtle changes in market conditions that are hard to read. Across time, one also learns how to set protective stop loss strategies to manage risk, without getting "stopped out" due to extreme and sporadic volatility. And, eventually, one learns to gauge when it is time to close out the position for a profit, or cut one's losses to protect capital. The markets are continually changing, and only with practice can one learn to execute trades freely, and intuitively react to subtle market conditions. So do not underestimate the importance of practice. Sure, a winning trading strategy is necessary, but you must also have a high level of skill to take advantage of those winning odds. Skill building can help you take advantage of those odds and generate consistent profits.
Support and resistance - more solid than ever
The financial markets are in constant flux, and in the past few years, we have seen many changes. The reasons are numerous; the availability of online investing, new government regulations, and technological advances are merely a few. Despite these changes, the markets are still free, guided by the good old invisible hand that drives supply and demand. But perhaps one of the most significant influences is the increased number of participants who have entered the markets. With more people trading and investing, the markets are more orderly, especially when it comes to identifying support and resistance levels. Support and resistance are key levels that estimate the probable duration of a trend. They are useful tools for trading effectively.
The bull market of the 1990s drove average daily volume to record levels as professionals and amateurs alike took part in a market that went virtually straight up. Years later, after the bubble burst and prices began to recover, trading volume, though lighter than year 2000 levels, is still much stronger than it was. This increased participation is reflected in huge average daily volume, which in turn has made support and resistance more solid and easy to spot. Pullbacks in the recent uptrend, for example, turn higher at the bases of support, as expected, but the quality of these bases is second to none. The bases of support and resistance are solid and clear, all because of the increased number of participants. And now that prices have turned higher, we have plenty of levels of resistance both above and below current prices in the equity and futures markets. This will continue until the markets make new record highs. Traders often wonder why prices rose so high and so fast during the raging bull market. The answer is simple. There was relatively little resistance. There were no areas of sellers above, as there are today. This is yet another factor that makes the current markets more orderly, with more clearly defined areas of both support and resistance.
Consider looking at support and resistance more closely. Learn more about it. A solid understanding of supply and demand, and its underlying dynamics, is key. Develop the skills to properly identify quality support and resistance levels. And once you have mastered those areas, get the necessary tools and methods to take proper action when prices move into these levels. With study, practice, and determination, you can use support and resistance levels to trade consistently and profitably.
Complex and always in flux
Alan Greenspan (the former Federal Reserve Bank governor), in his opening remarks at the August 29, 2003 symposium sponsored by the Federal Reserve of Kansas City, said, "Uncertainty is not just an important feature of the monetary policy landscape; it is the defining characteristic." He went on to say that macroeconomic models are vastly over simplified. Indeed, the economy is complex. There are so many forces and variables, known and unknown, that influences the economy, it is impossible to account for all of them. The economy is not the only complex system. Complex systems proliferate in nature. Ancient philosophers, such as Heraclites of Ephesus, made this observation long ago. All the elements of the world, such as time, fire, water, earth, and air are constantly in flux and figuratively, it is impossible to "step into the same river twice." Nature is constantly dividing and reuniting itself. And the market is no different. You will never enter a trade in the exact same river (market) you previously traded. It may look the same, but it will be different. The current will be faster or slower (volatility); it will be deeper or shallower (volume); the water will be clearer or muddier (visibility). There are thousands of variables, and almost none of them are comprehensible.
And what would you guess is the biggest variable of all, which you probably assume, is constant? As Pogo so aptly put it, "We have met the enemy and he is us!" Your personal psychology is also constantly in flux. You are happy one day and melancholy the next; you are continuously learning new things about the market and forgetting others; your confidence level twists and turns like the river's path. When you left the house for your trading desk, did anything go wrong or especially right? What about the trip? How did your first trade go off? Did you have clarity the minute you began trading or did you struggle for it? Everything is moving, whether we see it or can measure it. This insight is particularly important to system's developers or traders using black box software. It helps explain why certain trading software programs work well for only a short time before they crash and burn. There are many other reasons for this phenomena but the ever-changing interplay among market forces is certainly a big part of it.
How can you deal with constant change? First, always be aware of it. Expect it. Accept it as normal. Second, protect your profits from the ravages of the unexpected. Risk management, such as protective stop losses, is vital. Constant vigilance can make a big difference; healthy scepticism can be a lifesaver. Third, become a full-time student of the particular market you trade. Develop a passion for trading and your primary trading entity. Work at becoming a Zen-trader, where you become one with the market and feel its moves as you would if you were swimming in the river. None of these approaches are easy, but neither is becoming a successful trader.
The mind-set of a professional gambler
Many members of the "established" investment community are quick to point out that investing is not gambling. To the general public, gambling has many negative connotations. When professional gambling is mentioned, most people immediately think of compulsive gamblers who seek out high levels of unpredictable risk and impulsively lose their pay cheques, and money that is crucial to their basic survival. But gambling is not necessarily "bad" or "evil." Indeed, professional traders are essentially professional gamblers. It is all a matter of cultivating the right mind-set, the cold and focused mind-set of a professional gambler. Although trading is a form of gambling, it is vital to make a clear distinction among compulsive, amateur, and professional gamblers. Compulsive gamblers are addicted to gambling. They gamble to get a rush and a feeling of euphoria. They have absolutely no discipline. Obviously, trading is no place for the compulsive gambler, or compulsive trader. But many confuse compulsive gambling with professional gambling, yet these two types of gamblers are polar opposites. Professional gamblers, as well as professional traders, may take risks, but they manage them carefully. They look for high probability trade set-ups and only then do they place a bet. Amateur gamblers, or social gamblers, are interested solely in enjoyment and entertainment. They budget a fixed amount of money for gambling entertainment, and then, spend it as they would for a movie, concert, sporting event or some other fun activity. Fun is fun, so it does not make sense for a social gambler to develop a detailed strategy for beating the casino, or carefully limiting risk at the blackjack tables, for example. Part of the fun of social gambling is getting a thrill, and the hope of finding Lady Luck on one's side and winning a big jackpot.
Many novice traders, however, make the mistake of applying the amateur, social gambling mind-set to trading. They view trading as entertainment. If you have got money to burn, there is no harm in taking this attitude toward trading, but most of us want to make profits. And a social gambling mind-set can quickly wipe out your trading account. If you are serious about trading professionally, changing this mind-set is vital. You may find trading enjoyable, but the main objective of professional trading is making profits. Not only does that mean building winning trading skills, but careful risk management, discipline, emotion control, and executing trading strategies in a peak performance mental state. Do not put on trades just to get a rush of excitement. Seek out high probability trade set-ups, and stand aside until you find a setup where you can win. In gambler's parlance, "you have got to know when to fold 'em." You must also act like a professional gambler when it comes to risk management. Just like a professional gambler, trading is a matter of patiently waiting for the odds to move in your favour. On each roll of the dice, a professional gambler risks very little, so as to anticipate and recover from a losing streak. Professional traders also face losing streaks, and it is vital to minimise risk to survive those times when your game is a little off, and you need to wait for the odds to return to your favour. It is useful to view trading as professional gambling. It puts it in proper perspective. However, rather than an amateur player, you are the casino who carefully discerns the odds, makes sure they are in your favour, and takes advantage of the "law of averages" to ensure that over a large number of trades, you make a big profit. By abandoning an amateur mind-set and cultivating a professional mind-set, you will trade profitably and consistently.
Overconfidence, risk and rewards
Throughout our lives, we are told to foster a competitive spirit. We compare ourselves to others, inspire ourselves to do better, and try to beat out our peers. As children playing sports, we are advised to hone our skills and become a star player. In school, we are warned that higher grades are the key to long-term success. And when we enter the working world, we learn that survival depends on beating out our competition. But when it comes to trading, you are not actually competing with anyone but yourself. When it comes to trading, cultivating a competitive spirit can actually do more harm than good.
Comparing our performance with others does seem to have some advantages. Knowing that a goal is attainable is often a powerful motivator, for example. Several scientific discoveries were slow to materialise because they were thought impossible at first. But once the goals were deemed feasible through comparisons to others in the scientific community, progress was accelerated. But comparisons can also have adverse influences. Ironically, people who achieve great things usually work independently and could care less how others are doing. They follow their own timeline, follow their own passion, and look inward for where to go next. Trading is a similar creative process. You are the one who needs to hone your trading skills. You are the one who must find a method that matches your aptitudes and personality. Comparisons to other traders can often prove problematic. How you perform has nothing to do with how others perform. It is likely to cause negative emotions, such as jealously or envy. Upon seeing that you are doing relatively poorly compared to a fellow trader, you are likely to think distracting thoughts such as, "Why can I not do as well?" or "I must not be as good of a trader as I had thought," Such thinking does nothing to keep you focused on honing your trading skills.
Do not look at anyone else's record but your own. You will often be tempted to compare your current performance to that of others. That is how it has been throughout your life, and it is not easy to change a lifelong pattern overnight. But with trading, you must restrain this urge. Everyone has a different learning curve. To keep your spirits up, you will do best as a trader to focus on improving your past performance record, rather than looking at those of other traders. You do not know what factors created their performance records, so comparisons can only mislead and hinder you. Other people's records do not have a direct bearing on your own record. By searching for factors that are going wrong with your method, however, you can identify the personal factors that have been specifically holding you back, those that are unique to you.
What factors distinguish your winning trades from your losing trades? Where can you improve? Once you identify these factors, the next step is making a plan for the future to maximise your strengths. For example, if you find your strength lies in trading at the open of an upward trending market, focus on honing skills to trade consistently under such conditions. Who cares if you make 50% less than other traders? Your energy should be focused on making yourself consistently profitable, not on beating others. Such comparisons will only disappoint and distract you. (And in the end, in all likelihood, you will eventually end up making huge profits anyway, if you just focus on you.). Although you may have achieved success in the past through comparison with others, it can be detrimental for trading. You will be more successful by scrupulously examining your own past record, identifying factors that predict your own personal low performance, and modifying your approach. So curb your competitive spirit. Focus on you, the markets, and nothing else.
How accurately do you track your performance?
John and Sean, two part-time online investors, are discussing the performance of their share portfolios at lunch. John inquires, "How well did you do last year?" Sean with assurance declares, "I made a return of 20%." John replies sceptically, "That is a little hard to believe. Are you sure?" Sam says, "I can prove it. I have got the records on my laptop." To Sean's dismay, a close examination reveals that he has overestimated his performance. He actually made only 15%. His estimate was off by about 5%, which is typical when investors are asked to recall their performance record from memory. It is hard to defeat strong ego defences. We all want to believe that we are top performers, and unless our record is right in front of us, it is easy to let our ego bias and distort our recollections, all in an effort to bolster our self-worth. When asked to estimate how well we will do on a task, we tend to optimistically think that we will do better than we actually do. And when asked to recall how well we have done in the past, we tend to remember only the good trades, while forgetting the bad.
Overall, our performance is seen through rose-coloured glasses, which may be a little inaccurate. This pervasive bias is nicely illustrated in a study by behavioural finance researchers Drs. William Goetzmann and Navav Peles of Yale University. They asked a sample of investors to recall their return on investment for the previous year. On average, investors recalled an investment performance that was about 6% higher than their actual returns. This study shows how with no information but one's memory, people tend to distort their estimates upward. These overly optimistic estimates are easily explained by psychological dynamics. All people, including investors and traders, want to believe that they made the right decisions. It is hard to admit that one has made a mistake. Rather than change the self-view of themselves as "good investors," they unconsciously elevate their performance levels to be logically consistent with their positive view of themselves. This type of memory bias is something that all investors and traders should work to prevent. The solution is quite simple, and common among seasoned traders: Keep a scrupulously accurate record of all your trades, the amount you lost, the amount you won, and your overall balance. By regularly calculating objective measures of performance, you will be less likely to rely on your memory, which tends to be biased.
Seasoned traders are not afraid to look at their objective performance records. They know that the key to survival is to quickly identify what is going wrong with one's trading plans and to fix it as soon as possible. Do not rely on your biased memory for an objective account. It is wise to keep careful trading records, and have your actual record right in front of you, so that you know where you stand at the end of each trading day. Do not let psychological defences get the better of you. Keep an objective record of your trades at the forefront.
Be flexible and relaxed
Here is an example of how preconceptions and a blind adherence to conventional wisdom may allow one to miss what is happening in the current moment. It is conventional wisdom that the strength of the U.S. Dollar influences share prices on Wall Street. But this correlation is hardly a trading universal. It is crucial to consider that although a strong correlation is possible, it is not always strong. It depends. There are times when the US Dollar has been relatively weak, but the weak Dollar has not influenced share prices for the most part. Even on more pronounced days of intraday Dollar weakness, share prices have had little intraday swings in response to Dollar swings. In these situations, the so-called conventional wisdom did not hold. A flexible trader, while aware of the conventional wisdom, maintains an open mind and is ready to see that in the current climate, the supposition does not hold.
Flexible traders are adaptive. They simultaneously consider what "should happen" according to conventional wisdom, along with what is currently happening. Rigid traders, in contrast, are confined by their unfailing adherence to their preconceptions. They are not open-minded, but are on the lookout for when a rule is confirmed. Rather than proficiently acting on current market conditions, they wait for the rule to gain confirmation. In this case, they wait for when there is actually a strong correlation between the strength of the Dollar and share prices. When that time finally comes, they are likely to say, "I told you so." Well…conventional wisdom is somewhat true, otherwise it would not be conventional wisdom. So if one waits long enough, one's preconceptions are bound to receive confirmation. But what are the costs? By waiting, one has likely missed many good trading opportunities. Rather than let preconceptions guide you, it is better to just look at the current market conditions and take decisive action.
Being adaptive is critical. Every day it is useful to ask, "What is working TODAY in the markets?" It may be initiating trades from the long side only. It may be buying strength in mid cap shares with big short interests when they are up good, even though the major indices are lower. By being adaptive one can simply look at what seems to be working each day on its own and stand a much better chance of being successful. So enter each day with an open mind. And if you do form an opinion, know how to tuck it away temporarily, and do not let it interfere with your ability to be objective, and adaptive to whatever the markets tells you today.
What do you do when the markets change?
"Be a rugged individualist. Think independently. Take a contrary position occasionally. Anticipate changes in market conditions, and be ready with alternative plans." These are common, yet somewhat abstract, themes in investment psychology; each can be illustrated with countless examples in the history of the markets. But let us try to simplify things for now, and consider a few simple, basic examples, even if they may seem a little oversimplified to some. In our first example, let us consider the impact of a basic difference in market conditions between late 1990s and post-2000.
The difference between the way traders approached the markets before and after the year 2000 illustrates many concepts in investment psychology, but it is a classic example of how market conditions can change, and how with this change, it was even more necessary to think independently and act like a rugged individualist. For our first example, let us look at traders and investors who made seemingly impressive profits before the markets changed in 2000. Back then in the late 1990s, a "profitable" trader did not necessarily need to be much of an individualist or take a contrary position. It seemed as if everyone was trading. You could walk into almost any office in those days and find nearly everyone talking about the huge profits they made in the markets. Optimism was high and the expectation was that the share prices were going to go "up, up, up." These were ideal market conditions, the kind of conditions that draw many into trading (who later find out that it is harder than they initially thought).
In some ways, all one had to do was to pick a share that the masses thought would go up (such as any information technology or Internet company back then) and wait for the share price to move upward. And it did, back then, because there were so many new amateur participants entering the markets every day. They were ready to buy, put their money into the markets, and the prices went higher and higher. Simple adages applied in these ideal conditions: "Buy low, sell high", "The trend is your friend." You could actually "follow the crowd" in these conditions. In all likelihood, the price of a popular share would go up because there were plenty of buyers behind you, ready to buy your share as the share price increased. It was a matter of getting in at a low price and just waiting for the price to go up. You found people, who knew relatively nothing about trading, making substantial profits. Ironically, the "herd instinct" was somewhat useful when so many amateur buyers were willing to invest in the markets. If you were unsure of yourself, you could just wait to see if masses agreed with your hunch, and join them as the price edged up. Now it was not exactly that easy, but you see the main point: compared to today, all you had to do was find a good technical indicator that momentum was building, get in early and wait for additional buyers to.
If only conditions were as ideal today. Today, the "waves" are much shorter, and there are fewer naïve amateurs ready to continue the buying spree once it starts. These days, you need to think more creatively and independently. In several interviews, the interview candidates tell a familiar story, "I learned to trade in a bull market, and I wrongly thought I knew how to trade." What they usually say next is that market conditions changed and they quickly found that they could not make a cent. When you look at those traders who reported big wins before 2000, you tend to find that many have not consistently made very much since. So that is one common idea addressed: A trading approach may work impressively until the markets change. When they change, one cannot simply follow the crowd or let the "trend be your friend." It is not that easy. You have got to evaluate the markets from multiple perspectives, rely on your own instincts, and think independently.
The appeal of trading systems
The main appeal of mechanical trading systems is the promise that they will somehow free us from the stresses of decision-making. But can they really do this? And if so, why do so many traders seem to spend years dabbling with various trading systems without ever getting rich? Of course, it is natural to want to reduce the stress of a particular job, and few occupations produce greater levels of stress than trading. So it should not surprise us when we hear of trading systems that are sold for R20 000 or more in some of the specialised technical analysis magazines such as Stocks and Commodities that geared toward active traders. Often in these ads, an impressive claim is made concerning the profitability of a particular trading system, usually a software application that crunches real-time share market data to produce buy and sell signals.
But anecdotally, how many traders do we know of who have become rich using such trading systems? More often, we hear of traders who have tried numerous automated systems, only to achieve mediocre results. Still, there are indeed a few who do quite well with a mechanised approach, and it behoves us to ask why. Could it be that they are the type of traders who would have succeeded anyway, with or without a mechanical system? The answer, probably, is yes. And one quality that all of them would likely share is that they take a systematic approach toward trading. Which is to say, their methods and decisions are rooted in disciplined behaviour that can be applied consistently in a wide variety of circumstances. This is learned behaviour, though, and many would-be traders make the mistake of thinking that the requisite skills can be acquired easily. In fact, achieving rock-solid discipline is a process that one can never complete, since the share market will always challenge and assail our confidence in new and unexpected ways.
Armed with discipline and a sound trading system, however, we can categorise and map these inevitable challenges so that they will seem more familiar to us each time we experience them anew. For it is only when we are firmly anchored that we can attempt to make sense of the seemingly chaotic eddies and currents around us. A mechanical trading system can help us not only to observe share market activity objectively, but also to measure and fine-tune our reactions to it. For that reason, it matters little which trading system one uses, so long as it has a reasonable track record, and provides a consistent and immovable vantage point on the market. The important thing is to stick with the system for long enough so that you can apprehend and understand the fundamental rhythms of the market. For example, by meticulously observing the interaction of, say, two different trend lines over a long period of time, to come to know them like the proverbial back of your hand, is to gain sufficient knowledge about them to be able to exploit them profitably. But trading systems offer no easy path to riches; only patience and diligence can make them winners.
Classic chart patterns - know how to use them
Technical analysis and short-term trading go hand in hand. The revelation that one can make huge profits by looking for reliable chart patterns that repeat with unfailing regularity has raised many traders' outlook from bleak desperation to euphoric optimism. To many novice traders, chart patterns are the elusive Holy Grail. But the excitement soon fades as one discovers that identifying chart patterns is subjective and quite difficult, and that history rarely repeats itself with infallible accuracy.
Besides a desperate search for winning strategies, it is easy to see why so many are drawn to the study of classic chart patterns. The numerous hardbound weighty texts lend credence to the entire enterprise. "If everybody is writing about them and talking about them, they must work" is a reasonable supposition held by many traders. Perhaps they do work to some extent, but it is vital to avoid trading chart patterns in a shallow and mechanical manner. It is important to fully understand how they work and how to trade them. For example, some novice traders place too much faith in the chart pattern: They believe that if A occurs, and B occurs, then C must occur. Consider the classic head-and-shoulders pattern, for example.
The typical head-and-shoulders pattern (which occurs in an advancing trend in this example) consists of a final rally of a share price (the head) separated by two smaller rallies (the right and left shoulders) that occur before and after the final rally. The line joining the lows of the two rallies is called the neckline. Most trading books suggest entering a short trade at the break of the neckline, since it is at this point where the trend should start declining. If this trading pattern recurred with unfailing regularity, trading would be easy. If A occurs (left shoulder), and B occurs (head), then C should occur (right shoulder). Right? If only it were that simple. Some traders make the mistake of entering prematurely. They enter after B on the assumption that C will indeed occur. That is, they forecast a bearish trend based on an incomplete head-and-shoulders pattern. They impose their expectations on the market before seeing what actually happens. The right shoulder, or C, may not happen, however. A better trading strategy is to wait for C to actually occur, and possibly signal a declining trend. But it is still not that easy.
Martin Pring in his book "Technical Analysis Explained" warns, "the prevailing trend is assumed to be in force until the weight of the evidence proves otherwise. An incomplete head-and-shoulders charting pattern is not evidence, just a possible scenario." It is important to remember that a chart pattern may not always work in the way that you expect. You must fully understand all forces that contribute to its formation. For example, it is useful to also consider trading volume. Volume is critical for the verification of this chart pattern. Activity is usually heaviest during the formation of the left shoulder and also tends to be heavy as prices form the head. But the strongest confirmation comes if the formation of the left shoulder is accompanied by lower volume. So always remember to fully understand the dynamics of the market forces that underlie the pattern.
Developing trading strategies based on chart patterns is useful, but it is crucial to think critically and not oversimplify. Technical analysis still requires a mastery of one's personal psychology. John Murphy, in his book "Technical Analysis of Financial Markets," reminds us that chart patterns merely describe past market behaviour. They summarise in a descriptive statistical sense only. There is no scientific or statistical reason to believe they forecast the markets with precision. It is important to remember that it is more art than science (not science at all actually), and that, in turn, means that you must develop an intuitive feel for the markets and learn to trust it. The development of intuition only comes with experience. You have got to build up your trading skills, experience a variety of market conditions, and learn the "conventional wisdom." But at the same time, cultivate healthy scepticism. Remember to question "conventional wisdom." The astute trader asks, "How is the chart pattern supposed to work," yet also asks, "Is it working under the market conditions I am seeing right now?" In the end, it is still about developing the proper mental edge, even when studying a seemingly objective method of trading, such as classic chart patterns.
Piloting through support and resistance
Trading is difficult to master, especially for scientists and engineers who are trained extensively to understand complex systems in an effort to account for all possible adverse events and gain control over them. It is possible to look at the markets in a similarly comprehensive manner, trying to search for consistency, all possible predictors of price trends, and interactions among predictors. But such an approach complicates trading more than necessary. Many trading coaches and seasoned master traders advise against taking such an overly complex approach. "Keep it simple" is their mantra, and it is useful to remind yourself that professional traders tend to take a simple, straightforward approach to the markets rather than a complex one. If you need convincing, look at the traders at the Chicago Mercantile Exchange. There is something simple and basic about what they do. Ask traders who have been there. They all say that CME traders just look at a few key pieces of information as a guide, such as price and volume, and go out on the floor and trade. They stick with these key variables and do not make trading more complex than necessary. So if you are looking for a profession that is similar to the way traders actually trade, a scientist, mathematician, or engineer is not it. One of the more apt professions is that of a pilot. Indeed, some trading instructors have noted that former pilots seem to make some of the best traders. Let us look at some of the similarities to understand why.
In many ways trading shares and flying airplanes are very similar. As with flying, you have choices when it comes to managing your money. You can fly commercially and let a professional take you to your destination or you can fly yourself and take personal control. But just as with piloting your own plane, you would be wise to avoid taking matters too lightly. It is crucial for your survival that you build up the requisite skills and take proper precautions to protect yourself from a graveyard spiral, in flying as well as trading.Pilots and traders work with basic forces (such as support and resistance), and they trust their instincts and intuition, while simultaneously looking toward objective indicators to gauge significant parameters. When flying an airplane you monitor the instrument panel to glean several pieces of key information from the airspeed indicator, altimeter, and directional gyro. This information is vital for keeping you on the right direction. When managing your own money (electronically), the trading platform (such as that on PSG Securities Ltd
website) similarly provides key information: price, volume, and momentum. These key factors help you navigate and plot a course of action. On the other hand, neither the pilot nor the trader should make things too complex. It is vital to focus on the on-going process of trading, anticipating potential changes in the trading climate and taking decisive and immediate action. One does not need to be an aerospace engineer to fly a plane, and it is probably better that one is not. It is crucial to focus all attention on flying the plane, rather than mulling over esoteric issues, such as laws of motion, aeronautics, or other theoretical factors that keep the plane up in the air. It is crucial to focus all attention on just flying the plane. Traders should also just focus on trading, rather than pondering similar impractical issues, such as the validity of the random walk theory.
It is also necessary to remain logical and unemotional. Professionals do not let their feelings and biased perceptions get the best of them. Pilots rely on their instruments rather than their feelings and beliefs. It is possible, for example, to believe one is flying "up" when one is actually flying upside-down. Pilots are warned to "trust your instruments." As with flying, it is vital to keep your perceptions and feelings in check while trading. You cannot let feelings of panic, fear, or greed interferes with your cold and objective view of the markets. You must carefully and objectively develop a trading plan, trust it, and execute it skilfully. You cannot let emotions get you excited and cause you to trade irrationally. In flying and trading, managing emotions, remaining objective, and taking decisive action are key components for survival.
Peak performance trading
Seasoned traders frequently describe moments when they trade in a peak performance state. There are various names for it: "trading in the zone" or "flowing with the markets." But the defining characteristics are focused and concerted attention on the markets and a carefree, unemotional approach. Traders in this ideal mental state almost completely lose themselves in what they are doing. They are focused only on the on-going process of the moment. They are not self-conscious, concerned with how well they are doing, or worried about doing poorly. Everything just seems to "click" as they move effortlessly with the ebb and flow of the market. Most traders agree that a peak performance mental state is a necessary condition for trading profitably. It is worth reviewing some of the ways that you can enter and maintain this optimal level of consciousness.
- Resolve personal conflicts - Not everyone who trades has personal conflicts that need resolution. But if you are prone to carry "unfinished business" with you, it will always be there in the back of your mind, haunting you, interfering, and inhibiting you from entering a peak performance mental state. Examples of some common psychological conflicts include the need for self-worth, the need to prove one's value, the need to be right, or the desire to feel superior to others. Many traders discount these issues, thinking they are just a lot of psychobabble. They think, "That does not apply to me." Well, it may not apply, but it is people with these kinds of issues who tend to be drawn to trading. Ironically, these conflicts are what drive them to pursue a challenging trading career that requires them to beat overwhelming odds to become one of the select few who make a high salary relative to the vast majority. Before you disregard these issues, make sure that you really do not have psychological conflicts that interfere with your ability to enter a peak performance state.
- Think in terms of probabilities - In his book "Trading In the Zone," Mark Douglas discusses a "thinking strategy" called "thinking in terms of probabilities." In a nutshell, a trader should not focus on the outcome of a single trade. Instead, he or she should focus only on the big picture, the overall outcome across a series of traders. When it comes to trading, you should go in expecting to lose more trades than you win, but mathematically, with the use of proper risk management, it is possible to achieve a profit across a series of trades, even when many are losers. It is wise not to make such a big issue of losses. Put them in proper perspective. It is useful to view trading in the same way that a profitable professional gambler approaches gambling, according to Douglas. Professional gamblers look at gambling objectively; they place bet after bet with the assumption that the law of large numbers will work in their favour if they make enough trades. Traders should use a similar "thinking strategy." An essential prerequisite is a trading strategy that has a proven track record. But once you have it, you must execute it many times to take advantage of this winning track record. The trading strategy may fail a few times, but your goal is to replicate the past odds of success by giving it an opportunity to work across a series of trades. Once you understand and accept the idea that your overall success is all that matters, it will ease your mind, and allow you to approach trading with a more carefree attitude.
- Use proper risk management - Careful risk management is a key component of trading in a peak performance state. If there is a real danger that you will lose large amounts of capital, or money that you just can't afford to lose, you will feel the stress, whether you are conscious of it or not. But if you limit your risk on any single trade, you will know deep down that you have little to lose. And when you know that even a worst-case scenario is of little threat, you will feel less emotional, and be able to enter a peak performance mental state more easily. So follow the advice of seasoned traders who risk only a small percentage of their trading capital on a single trade, and use protective stop losses to further limit your risk.
- Trade an extremely detailed trading plan - Perhaps the most essential key to entering a peak performance state is to have a scrupulously detailed trading plan. Outline the plan completely from the necessary market conditions for its use to the specific entry and exit points. Unless you have every aspect of the plan outlined, there will always be an opportunity for indecision, and that will take you out of the peak performance mental state. Do your preparation before you enter the markets, not during. It is too hard to remain objective when you are trying to make unnecessary last-minute decisions. Plan out your strategy as much as possible and it will allow you to stay focused and trading in a peak performance state.
Many traders believe trading in a peak performance mental state is a key factor for trading profitably. Not everyone has a natural affinity for entering this ideal mental state, but it is possible to do with the right preparation and practice. It is worth the effort to learn how to do it.
The number of psychological theories to explain human behaviour seems endless. It is as if every psychologist wants to propose his or her own theory, and convince the rest of the psychological community that it offers a new perspective. A few psychologists have extended psychological theory to the study of the markets, and have presented their theories in investment psychology books. But in a rare example, Dr. Karl E. Scheibe, a psychology professor at Wesleyan University, has done the opposite; he uses investor behaviour in the stock market to support a general theory that he has proposed about human motives. In his book "The Drama of Everyday Life," Dr. Scheibe argues that everyday life is replete with numerous dramas that are played out over and over. As humans, we seek out drama. "Drama relieves human beings from the boredom and sameness of repetition," according to Dr. Scheibe. Throughout his book, Dr. Scheibe describes several examples where people in their everyday lives seek out drama as an antidote to boredom. In a chapter entitled, "Fear and Greed," he discusses how people find drama in the stock market.
The drama of the markets
As you have probably heard countless times by now, market behaviour is motivated by fear and greed. Dr. Schiebe tries to expand this position. He notes an asymmetry between fear and greed: a loss is more fearsome than a gain is pleasing. Tversky and Kahneman's studies on risk aversion provide the best scientific illustration of this principle. For example, when asked to make a choice, people accept a sure profit of $100 over a 50% chance of winning $200. People do not like risk and will always take the sure profit. The consequence of risk aversion for investor behaviour is that, in general, people's losses exceed their gains. That is, most people will be primarily motivated to avoid the unpleasant feelings of a possible loss, and thus, liquidate their trading positions prematurely. And because of their insatiable greed, they will keep reinvesting in the markets. This cycle of selling prematurely and re-entering the markets means that most investors will lose overall rather than profit. So why do most investors continue to invest in the markets when they will continue to lose? It is not merely greed, since the greed motive is less powerful than the motive to avoid risk. If it is not greed, then what is it? They need the drama. To fight off tedium and boredom, they invest. They create a dramatic interplay. They become excited about winning but get scared about losing, and sell to protect what they have left. But then boredom sets in again. The desire to make big profits excites them, and they enter the markets again. And so the drama repeats over and over.\
Dr. Schiebe notes that the search for drama is not restricted to amateur investors, but extends to professional money managers as well. All professional money managers are aware that the vast majority does not outperform the indices. They would be better off purchasing a representative set of shares and just leaving it alone for a year. They could go fishing, relax on the beach, or climb a mountain, do anything but touch the investments. By doing so, their funds would at least match the annual growth of the index, which is better than what most fund managers achieve. So why do they not do so? It is the need for the drama. It is not very exciting to leave the investments alone. They sought out exciting professions as fund managers, and so they continue to go to work every day, try to beat the index, and add more drama to their lives, even though the majority would do better to just leave the funds alone.
Dr. Schiebe's psychological analysis of share trading may not provide very many new insights, but it is interesting, nevertheless. Behavioural economists and seasoned traders have long noted that market trends are a function of the fear and greed of the masses. But why people are drawn to the markets in the first place is a matter of debate. Dr. Schiebe's explanation that people invest so as to satisfy a motive to seek out drama and ease boredom is a reasonable explanation.
What does this psychological account offer to the professional trader? It is useful to understand the motives of the masses and see how irrational they are behaving. By seeking out thrills and excitement, they will buy shares, but sell them prematurely for a loss, out of panic. As a trader, you can be right there, ready to take their money. While they buy and sell shares to add drama to their lives, the professional trader can anticipate how they act on their fear and greed and make money from their predictable moves. But on the other hand, it is vital to acknowledge one's own powerful need for drama and excitement. A professional trader is just as human as an amateur trader, and thus, has a need for drama and excitement in everyday life. Everyone needs drama and excitement, but it is vital to keep these needs out of your trading life. Trading can often be tedious, repetitious, and boring. One must systematically execute a trading strategy consistently, over and over. It is a mistake to fall prey to the need to seek out drama. The solution? Make sure that you get your drama and excitement in a different arena, outside of trading. If you satisfy this need somewhere else, you can deal with the relatively boring and repetitious nature of methodically trading your plan. The markets are exciting and offer drama, but make sure that you stay professional, and do not let the drama of the market undermine your trading plan.
Do not follow the crowd! You have been warned over and over. It seems easy, but it is harder than it looks. We are all familiar with the rebel, the person who breaks all the rules and is sceptical of the status quo. At the other extreme, the ultra-conformist seems to follow the rules too blindly. Neither extreme is optimal for trading. It is necessary to find the right balance between these two extremes. It takes a great deal of trading experience, self-searching, and a firm, concerted effort to act independently, but it is essential to develop this skill.
The standard error - why the opinion of the masses can never be measured precisely
On classic episodes of "Star Trek," Captain Kirk often asked Mr. Spock, "How far away is the target?" In his typical reply, Spock gave the exact distance down to at least the fifth decimal place (such as 10.10321 meters). Although it sounds scientific, nothing is measured that precisely. Measurement instruments are rarely that accurate and such accuracy has no practical purpose, since most measurement is merely a rough estimate at best. This is especially true when studying the markets, since it is human behaviour that we are studying, and human behaviour is difficult to measure. You could speculate whether Mr. Spock would make a good trader. He is cold, logical, and objective about things, so he would not be swayed by fear, hope, or greed, but would his need for precision and accuracy get the better of him? Nevertheless, when it comes to forecasting market conditions, it makes absolutely no sense to strive for extreme accuracy. Market prices are based essentially on people's opinion (and although a company's profits and assets play a role in the price of a share, share prices these days are far above their "true" value, and thus, to a large extent, prices are based primarily on psychological beliefs). Pollsters and other social scientists are the most qualified experts on measuring public opinion, so it may be useful to consider what they know about measuring people's beliefs and apply this practical knowledge to intuitively assessing the current opinions of market participants and anticipating what they will do next.
When measuring human behaviour, the error is substantial. Have you ever noticed that when a poll is taken, the results consist of two parts: the parameter estimate (for example, 80%) and the standard error (for example, plus or minus 5%)? An estimate of public opinion is merely an "estimate" because (a) not everyone has the exact same opinion and (b) it is hard to accurately measure an opinion. The variability from these two factors is reflected in the standard error. At best, a social scientist makes a probabilistic statement based on a few key assumptions. One is that the "sample" represents an actual population. Another is that the measurement of the opinion is reliable. The first assumption is often met because very well developed sampling procedures are used. The second assumption is more suspect. It is hard to measure an opinion. And even if someone holds a particular opinion, he or she may not act on it. These issues have a direct bearing on trading. As traders, we are basically trying to assess current opinion, and anticipate what the masses will do based on that opinion. The masses react to what they see and think others are doing, and traders base their decisions on the potential reaction of the masses. So at the core of trading is the notion that the opinion of the masses is measured accurately by the current prices, and that upon seeing the current prices or current market conditions, the masses react in predictable ways; that is, when prices fall, they become fearful and sell off their positions to protect their remaining capital, and buy again when they see prices rise so as to satisfy their greed. Indeed, a central tenet of Dow theory is that the masses react to specific situations in a consistent and predictable fashion. But there is good reason to doubt whether observed prices do accurately reflect the true opinion of the masses, or whether people do; in fact, react to situations in a consistent manner.
Social scientists claim that there are regularities, or general laws, when it comes to understanding human behaviour. Even though a goal of science is to delineate general laws, it is rarely achieved in the social sciences. People are much too complex. Human behaviour is too hard to measure and people do not always act on their attitudes and beliefs in consistent ways. Although many social scientists work under the assumption that human behaviour is consistent and predictable, there is little evidence to support this claim. In an influential analysis, for example, Professors David Funder and Daniel Ozer examined the extent to which people responded consistently to structured situations. They analysed findings from seminal studies in social psychology, such as studies on conformity, obedience to authority, and the "bystander effect." In general, structured situations accounted for only 16% of the variance (out of 100%) in people's behaviour, which suggests that situations do not account for 84% of the variance in human behaviour (this other 84% is mostly due to individual differences and unreliable measurement). In other words, it is hard to measure human behaviour, and people do not respond consistently to situations, even standardised well-controlled laboratory situations. So if social scientists can't measure people's behaviour with relatively accurate measures in well-controlled standardised situations, and people do not seem to respond consistently to these situations, how can we expect to measure the behaviour of market participants precisely? Why should we assume that people would react consistently to particular market conditions (and thus, form the price patterns outlined in classic technical analysis texts)? We probably cannot make the assumption. Sure, there is some consistently. But it is nothing like the consistency we are used to measuring in the physical world. Our estimates are merely best guesses, and potentially inaccurate ones. So when you are trying to anticipate what the masses of market participants will do, remember that humans are not like rising and falling tides. They are not nearly as predictable as that. When studying human behaviour and that is what you are doing as a trader, there is no such thing as certainty. It is all just a matter of probabilities. And that means no one will ever know what will happen in the markets next.
Getting in sync with the market
Professional athletes practice extensively in preparation for a game. It is critical to be well prepared, ready to perform at your best, and ready to take care of anything that may come your way. But at game time, even top athletes do not jump into action on impulse. They may be well prepared, but that does not mean that they are warmed up and ready to play at their best. They must also develop an initial impression of how well things are going. The best athletes "feel" out their opponent, their team-mates, and their current ability level. Basketball players, for example, stick to 10- and 15-foot jumpers initially, and allow themselves to find their rhythm before stepping back behind the three-point line. Players try to get a sense of whether their team-mates are supporting them by setting good picks and allowing them clean shots. After they sense that everything seems to "click" and that they have entered "the zone," they build on their momentum and take their performance to a higher level. Starting out slowly and finding your rhythm before kicking it up a notch is also a key to profitable trading.
Early in the trading day, it is useful to "warm up" and "feel out" the situation. Make a few small trades, for example, 10% of your normal lot size. (And by all means, limit your risk by trading a detailed trading plan.) Putting on a small position usually helps you focus and see the subtle impact of the market factors that may be helping or hurting you. After you have entered the market, see if the trades are working out. See how well your indicators and other trading tools are working, your "fellow team mates." Did they identify a good trade setup? See if you can "feel" the rhythm of the market. Are you in synchrony with it? Are you moving with each ebb and flow? Make sure you have entered the zone.Some days may not be as good as others. Even the star player of the team gets bumped if he or she is having a bad day on the court or playing field. There are times when even the best athletes get stuck in a slump. It does not make sense to keep trying, when in all likelihood, your mind-set will keep you from performing at your best. That is why it is useful to see how well you are doing at the start of the trading day. Are you in sync with the markets or is your "game" off. Many seasoned traders suggest standing completely aside when one is not having a good day. Perhaps you have a good "feel" for a specific share, but not the rest of the market. You may feel that things are going against you. Perhaps, you keep scratching trades. Scratching trades is all right to a point, but if you scratch too many trades, you will feel the losses eventually.
Ultimately, it may be a good idea to take a long break, try again later, and see if you can find a time during the trading day when everything is going your way. And if you still cannot get in sync, you may want to take the rest of the day off. When it comes to developing the proper mind-set for trading, it is sometimes useful to approach trading in the same way an athlete approaches playing a sport: Warm up first, and see if you can get in sync and play in the zone. Novice traders may need to gain extensive experience before they know if they are really playing in this peak performance state. But with time, they will learn to get a feel for when they can apply their skills and tools effortlessly to score big profits. Experienced traders know when they reach this optimal performance state. If you have not developed this ability yet, do not worry, with time and experience, you will learn how to "warm up, assess your team-mates and opponents," and get in sync with the market.
Next time you get a hot tip - beware!
Few things appeal more to our sense of greed than a hot share-tip. Sometimes it comes in the form of a phone call: "I have got a buddy who works for Ajax Widgets," the tipster will tell you, "and he says that the company is going to announce a huge deal with China next week." Or you might be playing golf and someone in the foursome mentions that she has just bought 10 000 shares of XYZ Corp. because her broker says some "big news" is due out on the company "any day." Or a friend of your friend's lawyer confides that the "ink is dry" on a deal that will seal the acquisition of one company biggie by another.
The temptation to act on such tips can be hard to resist, notwithstanding the fact that you could be breaking the insider trading law by doing so. Indeed, any tip that proves "hot" enough to act upon is probably illegal, coming from company insiders and revealing privileged information that public investors know nothing about. As we know, acting on such information is insider trading, a felony for which some violators have received large fines or even jail time. That is one reason why it is a good idea to tell the would-be tipster "thanks, but no thanks" when he or she calls. But if the temptation seems too great to resist, there are two other reasons to consider before you take the plunge. First, relatively few hot tips pan out; and second, even when they do, it is often impossible to accurately predict how the share will react.
Of course, no one keeps statistics on the percentage of hot tips that worked or did not. But if you are the sort of investor who talks about shares at cocktail parties, chances are you have heard a few hot tips yourself. But ask yourself, how many of them panned out? And how often did the supposed insider news become public within the predicted time span? If your answer to either question was "most of the time," then you are probably getting your information from sources that even the Scorpion police force would envy. But for each person who has gotten rich acting on a hot tip, there are probably fifty who have been burned when it failed to materialise. And there are twenty-five more losers who acted on the tip, only to see the share react in an unexpected way. We have all seen shares fall on ostensibly good earnings news, and rise when the news seemed outright bearish. Take note of these occasions, for they are not as uncommon as you might think. And to be sure, tally up the tips that turned out to be winners, for that is the best way to build up resistance to the gambling fever that sometimes possesses us when some alleged insider has a secret to share.
Must trade - sometimes it is better to stand aside
A dream. Pure hope. A winning lottery ticket. These images capture what the masses think of trading. They do not take it seriously, and in the past couple years, they think that anyone who trades the markets is wasting their time and money. Unfortunately, many would-be traders do not seem to take trading seriously either. For example, many traders fail to properly set realistic goals. It is quite common to hear a trader proclaim, "My plan is to make R1 000 a day, so I can make R250 000 a year." Where is the flaw in this kind of thinking? Setting a performance goal based on a specific objective per day compels one to think that he or she must trade every single day, to meet the R1 000 a day, R250 000 a year objective. But what if the markets do not move at all on a given day? Is it time to become the range trade specialist? What if the markets are quiet ahead of an important economic or earnings announcement? Is it still a good idea to trade? Sometimes it is better to stay out of the market completely, rather than fail at trading the low probability set-ups available on a given trading day.
Even if one has the skills to make R1 000 a day, when opportunities are available, it may not be a good idea to conceptualise your goals in this way. Consider the consequences of such a strategy. Suppose Monday's trading session comes to a close and one's Profit/Loss statement remains unchanged. On Tuesday there will be a strong need to make R2 000 so as to stay on track with the R 1000 per day, R250 000 a year goal. But if there are no trading opportunities, the objective again will not be achieved. Not only will you fail to make profitable trades, you will spend a tremendous amount of your capital on brokerage commissions. And your stress level will be elevated as well, potentially starting a never-ending cycle of frustration and disappointment. So after spending hundreds on commissions on Monday, and possibly losing a little capital on poor trading opportunities, what happens if Tuesday is also a poor trading day? At this point, it is quite likely that the majority of the move will take place overnight and a trader will be "forced" to evaluate the market at levels far beyond the previous day's settlement. Inevitably, the market will then move erratically for the first 30-minutes and then "fall asleep" for a number of hours, creating even more frustration, which is further intensified when one continues losing money and falling behind the goal of meeting the R1 000 a day objective.
Setting more appropriate goals will relieve frustration. It is useful to have a rough idea of how much money you want to make on a given day, but setting a specific amount that you must achieve on any given day is often a hindrance for a novice trader. Research psychologists have found that pushing yourself to achieve a specific goal only works when one has the skills to back it up. In other words, if you have a strong track record in which you have proven that you can make R250 000 a year, then by all means, go for it. However, if you are a novice trader and the most you have made is R15 000 a year, then setting a goal of R250 000 may be unrealistic. You may be setting yourself up for failure. When you fail to reach your goal, you will feel frustration and disappointment, and may start trading based on your emotions. Setting a daily goal is even worse. Seasoned professionals suggest taking it one day at a time. Overall, they may aspire to make R250 000 a year, but they know that on any given day, opportunities may be limited. They know how to patiently wait for the opportunities to come to them. They do not impose their will on the market. And that is what traders are doing when they set a performance goal in terms of a specific Rand value per day. They are implicitly thinking, "I must get R1 000 out of the market today and every single day." But it does not matter what you wish for. There may not be enough opportunities to get R1 000 out of the market on any given day.
How can this potential pitfall be avoided? Remember that you do not have to trade every single day. Winning traders patiently wait for market conditions where they know they can excel. If the market is quiet, they wait for optimal market conditions. They understand that the same quiet market will handsomely reward traders who are patient. They understand that forcing the markets to move to their levels is not a blueprint for success. It is also useful to remember that all that really matters is performance across a series of trades. Many traders can lose 60% of the time, four days a week, but on that fifth day, a winner of many thousands quickly offsets nominal losses accrued across a series of trades. When you are setting goals, it is vital that you keep them in perspective. Goals are useful when set correctly. Set goals that match your skill level. Shooting for goals that are beyond your skills will frustrate you more than motivate you. Also remember that you cannot impose your will on the market. You do not know what market conditions will be until you see what they are. And if optimal conditions are not there, you cannot do much about it. You must accept what the market is willing to give you, which may mean patiently waiting for conditions to change. By doing so, you may not profit every single day, but over the long run, you will be a consistently profitable trader.
Drawn to complexity - when keeping it simple is better
In the mid 1980s, Steve Wozniak, the creator of the Apple II computer, was asked about the future of computing. Interestingly, in hindsight, he said he thought people were making too much of the home, or personal, computer. He said that many simple tasks, such as organising one's recipes, are better left to an old-fashioned card file, rather than using a complex computer program. He made his point by recalling an incident that happened when he returned to college to earn his BSEE degree. He took along an Apple II, but he spent more time using it to do tasks that he could have done more easily with a less complex method. Now, Steve did not anticipate the widespread popularity of the Internet, and computers these days can do tasks more easily than those of even a decade ago. But there is a solid lesson in this anecdote: Sometimes complexity is a distraction and it is much better to keep things simple.
In these modern times, we seem to be drawn to technology and to the complexity it may bring. But is technology and complexity always better? For example, do we really need to store our appointments and address book on a PDA? Is it really more efficient? When it comes to trading, technology has indeed helped. Real time charts are useful for analysis, and it is vital to have summary data of current market conditions immediately available. But seasoned traders warn not to get too wrapped up in all the complexity. Many seasoned traders note that one can just look at price and volume and make huge profits in the markets, which is quite the opposite of what one might think after having read popular trading magazines touting overly complex indicators.
For anyone who aced introductory statistics in university, some of the "statistical" indicators presented in trading books and magazines seem unnecessarily complicated. It is as if someone went out and made up complicated formulae to impress people who equate complexity with innovation. There are numerous examples of common indicators that summarise basic market information, yet seem unnecessarily complex, but let us look at how even a seemingly simple indicator should be examined in even more basic terms. Take the simple moving average, for example. What is an average, or mean? What does it do? It does nothing more than describe the "centre" of a distribution. The first lesson a statistics professor teaches is that the mean is only a good measure of central tendency when there are no outliers or extreme scores. An extreme score biases the mean. In other words, if there is a big price spike anywhere in the series of prices that go into the average, it will bias the estimate. The lesson: Remember what a mean is, and thus a moving average, and keep in mind that it is doing nothing more that summarising a series of prices. Also keep in mind that under certain conditions, the mean is a fallible measure of central tendency. Thus, when you look at a moving average, always look at the basic information that went into its calculation. Remember to move to the chart at a higher timeframe to see the actual time points that were used to calculate that average. Do not get overly wrapped up in all the complexity. The point is that when looking at any statistic, such as a simple moving average, it is important to remember that it is doing nothing more than summarising basic price information. Do not think that a statistical indicator does something magical.
With all the complex indicators out there, it is easy to believe, however, that some indicators are magic. But all any indicator does is describe a series of numbers. It is useful to remember a basic data analytic principle: Look at the original values that went into calculating the summary statistic. Do not focus only on the summary statistic itself. And also remember that complex is not always better. Many times it is useful to keep things simple.
Justified versus unjustified wins
John is a novice trader celebrating his latest win. "I have just made a big profit on a trade by pure chance," John says in an excited tone. "I went long on a share, expecting it to go up about .90 points. I was wrong. It went down .50 points, but I figured I might as well just wait it out to see what happened next. At the end of the day it was up .60 points past my entry and I sold for a profit." His friend asks, "Did you have any idea that the share would rebound?" "No," John replied, "I was just lucky."
Does this scenario sound familiar? John anticipated that the share would go up, but when it went down, he did not follow a trading plan. He was ready to accept whatever fate offered. But "all is well that ends well," right? Well, maybe not. John did make a big profit, but at what psychological cost? He did not have a clearly defined trading plan. He put on a trade, and as a result of pure luck, he made a profit. Such situations may provide short-term pleasure, but they can adversely influence discipline in the long term. Rather than developing a well-defined trading plan, following it, and getting rewarded by trading it, a trader puts on a trade haphazardly and is coincidentally rewarded. In this case, a lack of discipline is rewarded, and this unjustified reward may increase a trader's tendency to abandon trading plans in the future because he or she has been rewarded for doing so in the past. However, the positive outcomes are usually short-lived, and a lack of discipline ultimately produces trading losses. It is useful to distinguish justified wins from unjustified wins. A justified win is when a trader makes a very detailed trading plan and follows the plan. A win that results from following a trading plan is justified and reinforces discipline. An unjustified win occurs when a trader does not make a plan or drifts from the plan. He or she may be rewarded, but the outcome occurred by chance. The win is unjustified and can reinforce undisciplined trading.
Cultivating discipline is vital for consistent and profitable trading. Trading is basically capitalising on chance. One implements proven trading strategies, over and over, so that across a series of trades, the strategies work enough to produce an overall profit. It is like making shot after shot on the basketball court so as to accumulate a winning number of points. The more shots you take, the more likely you will amass points. But the winning player is the person who first develops the skill to make the shot consistently, so that at every possible opportunity, the ball is likely to go through the basket. To a great extent, consistency is key. If the player uses one approach one time, and a different approach at another time, performance is haphazard. It is the same for trading. One must trade consistently, following a specific trading plan on each and every single trade. This allows the law of averages to work in your favour, so that across the series of trades, you will make an overall profit. If you follow the plan sometimes and abandon it at other times, you throw off the probabilities. Suppose you used a strategy that had a track record of 80%. Under the best-case scenario, you could only expect to win 80% of the time. But since history does not always repeat itself, it is likely that you will win less than 80% of the time. If you do not execute the trading strategy the same way each time, you will decrease your winning odds. And fewer winning trades may mean an overall loss. That is why discipline is so important.
With discipline comes profitability. Do not let unjustified wins interfere with your ability to maintain discipline. Follow your trading plan, and reinforce the idea that if you follow your plan, you will end up with profits in the long run. If you abandon your trading plan, and get an unjustified win, you may feel good in the short term, but you will pay a long term price when it comes to your ability to maintain discipline. So clearly define your trades, and stick with your trading plan. The justified wins you receive from following your plan with help you develop an unwavering pattern of disciplined trading.
Striving for consistency (part I)
When it comes to trading, profitability is frequently equated with consistency. The novice trader is often inconsistent in terms of profits. This inconsistency is reflected in a jagged equity curve that may soar to the heights of profitability but frequently plunges deeply into the red. The consistently profitable trader, in contrast, has a smooth curve that grows exponentially upward. Trading consistently means approaching each trade in a logical, well-prepared, and decisive manner. Striving for consistency should be a main objective, especially for novice traders. There is an old saying that applies to trading, "First learn the rules and then learn how to break them." Experienced traders may not follow rules consistently, but they know what the so-called "rules" are and when to break them. Nevertheless, it is useful for the novice trader to try to follow conventional wisdom at first. It is wise to learn how to follow a method consistently and trade profitably before testing the limits.
The rationale for learning to trade consistently is based on the idea that trading profitably is a matter of probabilities. If you trade a sound trading method with a strong track record, success is merely a matter of odds: If you make enough trades, the odds should work in your favour, and you will take home profits. It is like rolling dice or flipping a coin. For example, if a coin is flipped over and over again under identical conditions, it will tend to come up heads 50% of the time. But the key to getting heads 50% of the time is to repeat the flip of the coin "under identical conditions." When one views trading as analogous to flipping a coin, the theoretical probability of getting heads is the best-case scenario. One achieves the maximum wins by flipping the coin under identical conditions. However, finding "identical conditions" when trading the markets is difficult. Market conditions are hardly ever consistent, and the adept trader is always on the lookout for subtle changes. You cannot control the markets. One must take what the markets have to offer, and thus, one must look elsewhere when searching for consistency.
A source of inconsistency that you can control lies within yourself. You can strive for consistency and try to eliminate inconsistently by looking at the way you trade. The first step in cultivating a consistent trading style is identifying sources of inconsistency. Remember the analogy of flipping a coin. You must flip the coin under identical conditions, time after time to maximise profits. So how can you trade consistently time after time? One way is to limit your risk in a consistent manner. For example, only risk about 2% of your trading capital on each trade. Novice traders have a tendency to get a little excited when they have hit upon a winning streak, and increase the amount they risk on a trade to take advantage of the streak. This approach produces the jagged equity curve, however, and a rollercoaster ride of extreme ups and downs in terms of profits. By keeping your risk constant, you can introduce consistency into your trading (Again, a seasoned trader may adjust risk depending on the quality of the trade setup. That is taking a big risk, but a seasoned trader usually has the skills to make up the losses should the trade be a loser. Novices, on the other hand, are better off in the long run taking precautions).
What other sources of inconsistency can traders eliminate? Another source of inconsistency is the market conditions under which a trade is executed. Although it is necessary for a top-notch trader to master a variety of market conditions, it is wise for novice traders to stick with what they know. Some traders, for example, know that they are most profitable when trading in a bull market two hours after the open. This may not be a very challenging set of conditions in which to hone one's skills, but it is worthwhile when starting out to trade under these ideal conditions, or trade in whatever conditions where one consistently finds success. Your initial goal as a novice should be establishing consistency. Once this criterion is met, the novice can build skills in a variety of market conditions. But initially, it is useful to trade under conditions where success is assured. There are other sources of inconsistency requiring standardisation. For example, it is necessary to prepare for trades and develop a scrupulously detailed trading plan in which you know where to enter and when to exit. (And it is also important to stick with a trading plan, instead of following the plan only when you feel like it.) Many novices fail to achieve consistent profits because they impulsively put on trades rather than following a detailed plan. Careful planning reduces impulsive over-trading and produces consistent trading. All traders want to be profitable, but that is especially difficult when learning how to trade. One of the keys to success as a novice is to strive for consistency. Consistency not only gives you financial profits, but psychological profits as well. Once you've achieved consistency, you will develop a stronger sense of self-confidence, and then you will be ready to trade consistently with a variety of trading strategies across varying market conditions.
Striving for consistency (part II)
Ask almost any trader if he or she regularly listens to financial reports on Summit TV (or other television networks), and the unanimous answer is a resounding "no." Listening to Summit TV or Bloomberg's or CNBC, and then trading based on the latest news delivered by a so-called "informed analyst," is seen as amateurish. But is basing a trading plan on the news media always misguided? Sometimes, and if done correctly, it is possible to make a few extra Rands trading off of the media news. Why can you not follow the news? There are a number of good reasons. First, the news may be old, and the market participants who trade a particular share may not be influenced by it. Second, it is hard to capitalise on the news if you are not in the trade already. Suppose an analyst announced that share XYZ is a good buy. That piece of news might encourage online investors, for example, to buy a few shares and take advantage of the "bargain." But this group is a relatively small number of buyers. The price may jump a little, but there is not enough momentum in the trade to push the share price up far enough (and long enough) to buy, and then sell at a higher price. The momentum will run out before the price moves high enough. Perhaps a better strategy is to go short: wait for the momentum of the short-term bullish trend to dissipate, watch the share price move back to its previous low, and take profits.
Just as with all conventional trading wisdom, there are always exceptions. And trading the news is one of them. It is often a little naïve to think that the television analysts or the reporters in the financial sections have new, insightful analyses. Usually, reporters' main objectives are to entertain, achieve high ratings, or sell newspapers. So it is usually sensible to take everything you hear with a pinch of salt. But that does not mean that one cannot take advantage of their poor forecasts. Here are a few actual examples where traders capitalised on the media news and made big profits. Most strategies, however, only work if one has a position already open. For example, one way to capitalise on news involves closely following a share price pattern over time, so that one knows almost exactly how the price moves in cycles throughout the day or week. When a research analyst or financial journalist makes a prediction, the share price should move a little, and should the move be in one's favour, the position could then be liquidated to capitalise on the news.
A related method some traders have reported involves sheer luck. Suppose one has an open position in a particular share and a news report rightly or wrongly claims the share has potential growth. Some traders are able to sell off their existing position for a huge profit, as investors following the advice of the research analyst purchase shares. In our final example, some traders have based trades solely on the news. One can trade an index, and assume that the index will move across a week based on what the media reports; it is a little like using the news as a general indicator of market sentiment. Although trading the news has made profits for some traders, it is not a fool proof strategy. There are some drawbacks. You must hope that everyone else sees the news as you do and tries to act on it. But nothing is a sure thing. One should take proper precautions to control risk in the event that it does not work. It takes a special kind of trader to develop trading strategies based on media news. One cannot be a follower of the pack, but an innovative contrarian who must anticipate how the masses will react to the news. The approach may not always work, and so a trader must be able to accept that he or she may be wrong and live with the consequences. But occasionally, trading the news can make you an unexpected profit.
Stay in the moment
Existential psychotherapists point out that people experience fear and anxiety when they think about, and regret, their past mistakes, or when they worry about an uncertain future. The antidote: Experience or live in the moment. Focus on the process of living in the here-and-now. Seasoned traders describe a similar experience when they enter "the zone." There is a point where a trader is not worried about past mistakes or future profits. All one's attention and energy are focused on the current trade. When they are in this optimal mental state, they achieve a higher level of existence. They are more in touch with their instincts. They see the markets and their trades more clearly, and are intensely aware of their feelings, sensibilities, and judgements. They can review a multitude of details, and can effortlessly identify the key factors that are likely to drive market action. Moving into this higher level of awareness during a trade can greatly increase one's chances of success. It is useful to learn how to move into this peak performance state.
How does one live in the moment? Perhaps the first step is just intellectually considering the existentialists' proposition that anxiety is sometimes a matter of focusing on, and mulling over, the past, or worrying about the future. When you consider it, it seems reasonable to think that if one could just forget about the past and avoid thinking about the future, one will live in the present. It seems unrealistic and perhaps a little reckless, however, since it is often prudent to both learn from past mistakes and to make sure you avoid potential adverse events. But again, when you do so, it takes you out of the moment. You start to analyse and remove yourself from the on-going experience rather than enjoying it. In contrast, trying to stay in the moment will keep you focused on the trade. And by focusing all your energy on the trade of the moment, you will reach that higher level of awareness where you will see the market more clearly and be able to run through all possibilities at lightning speed.
These concepts sound good in theory, but how does one put these ideas into practice? Well, first it may all depend on how many past conflicts you have in the back of your mind and your self-esteem. If you are unsure of your abilities, it is hard not to worry about the future, especially when you are facing extreme pressure in the midst of a trade. If you are easily shaken by uncertainty and stress, your mind will tend to wander toward your past mistakes and regrets and you will tend to question your ability to control your destiny. But, if on the other hand, you are especially confident, you are not likely to be troubled by your past, and can more easily live in the moment. That said, it may be extremely difficult for some people to live in the moment for very long, or to stay there and completely cast aside all past regrets or worries about the future. One can strive to reach this state of existence for a short time, however, at least long enough to evaluate a trade and take decisive action. The first step is to monitor one's thoughts and identify instances where one is mulling over the past. The second step is to actively try to push such thoughts out of one's awareness. For example, one may think, "I wish I did not lose so much money on my last trade," or "I am frustrated that I have had so many losing trades." One may think these thoughts throughout the day and it is difficult to just shut them out. But it is definitely possible to put them aside for about an hour, while you monitor a trade and decide what action to take next. One may similarly worry about the future: "I wonder if I will keep losing or will I finally make huge gains?" After one is aware of the kinds of thoughts that indicate one is mulling over the past or worrying about the future, such thoughts can be pushed aside temporarily. It may be necessary to yell "stop" or think, "Do not think about that right now; I can consider these issues later, after I am done evaluating my trade." Now, using these strategies would not put you in that ideal mental state where you are completely in the moment, but it will help you get to a mental state that is close to the ideal. It may take some practice, but you can eventually reach this mental state (and if you have some difficulty, always consider the possibility of seeking out some professional help from a trading coach). The best traders are not self-conscious about their mistakes. They don't regret past mistakes or worry about the future. They live in the moment. You can also live in the moment, if you practice cultivating the proper mind-set. When you reach this peak level of experience, you will not only be more profitable, you will enjoy trading, and find it to be fulfilling in its own right.
Take responsibility and take control
The prominent psychologist Dr. Julian Rotter noted that there are basically two ways to understand and interpret events in one's life: One can attribute the cause of events to internal forces, such as hard work, talent, or ability, or one can attribute the cause to external forces, such as luck or fate. When one looks for internal forces, one tends to take full and complete responsibility for an outcome. For example, one may say, "I made a profit on the trade because I prepared properly, waited for the right signals, and traded my plan." That is an explanation based on internal forces. For a winning trade, it is easy to explain the outcome with internal forces. We have a natural tendency to build ourselves up and enhance our ego when we win, so it makes us feel good when we do well and believe it is due to our talents and skills. But what about a losing trade? When we lose, it is also due to our talents and skills, but in this case, it may be a lack of talent and skills. Such a possibility is harder to accept. When faced with a defeat, most people suddenly switch from looking for internal forces to looking for external forces: "The market conditions changed too quickly. The market makers are manipulating the price again. I should not have taken the advice offered by that uninformed research analyst. I was unlucky." It is easier to find an excuse than take full responsibility when faced with a loss. It is at these times when most of us tend to look at the world in a self-serving way, attributing our success to internal personal characteristics, but our failures to external situational causes. However, there are advantages to bucking our natural instincts and always taking full responsibility for both our triumphs and defeats: One gains a sense of power and complete control.
In a study of self-help instruction, it was found that participants who tended to attribute life outcomes to internal forces were more satisfied and able to use the self-help information to change their lives than people who tended to look for external explanations. They were able to more easily apply the self-help advice to their lives, and felt a sense of power and mastery. Taking responsibility for one's action allows one to gain full control of one's life, and make significant changes. Rather than always looking for excuses and trying to place blame on situational factors, all energy is focused on increasing performance and developing new skills. Traders who do not take full responsibility, in contrast, tend to devote the bulk of their psychological energy to defending themselves against their mistakes. Rather than cultivating an accurate, objective view of the markets, they are easily biased because of an incessant need to protect their egos. An emphasis on external causes for setbacks makes one feel good in the short term, but it hinders performance in the long term. Over time, skills are not developed, and limited psychological energy is wasted on protecting one's ego. It takes time and energy to find an external reason for a failure. This time is better spent identifying one's flaws and developing new skills to compensate for these deficits. Taking full responsibility is difficult, especially after a losing trade. It is hard to look at one's faults and limitations. But in the long run, the payoff is greater than the temporary uneasiness one experiences while reviewing one's limitations. In the end, if you look at your faults, acknowledge them, and take full responsibility, you will be gaining power and control. So take full responsibility and take control.
Time flies - but it is only fun when you get work done
Cultivating a positive mind-set requires stress management. The less stress you feel, the more energy you can devote to trading in a peak performance mental state. Time pressure is a significant source of stress. When you feel that you have too much to do and not enough time to do it, it will eat up precious psychological energy that you need to devote to trading. It is vital that you ease time pressure and free up wasted psychological energy. One of the most effective ways to cope with time pressure is to change your time perception. Time perception is the degree to which people perceive their use of time as structured and as contributing to a specific goal or set of goals. The more people perceive their time as structured and their actions as aimed toward a specific purpose, the less stress they experience and the more satisfied they feel. As a trader, it is useful to gain awareness of how you perceive time, and make sure that you see your actions as meeting specific trading goals.
Trading has advantages compared to most jobs. Traders are free to work on their own terms. They do not have to satisfy the expectations of supervisors or punch a time clock. As bothersome as these constraints may seem, however, they do have some advantages. In many traditional work environments, time is well structured, and the purpose of work tasks is relatively straightforward. A clear routine is set and it is easy to follow. Trading can also be structured and meaningful, but there is a danger of these important psychological elements being lost when one embarks on a trading career. Novice traders, especially, may not organize their trading activities in the same way as they would for a traditional job. They may not follow a strict routine, set clearly defined goals, or try to meet specific deadlines. For some traders, time may seem to slip away. When this happens, one may feel as if he or she has accomplished very little during the day, and eventually this can produce uneasiness and stress.
Do you feel that your time is basically without structure? Do you feel as if you put in a lot of effort, yet are not making adequate progress toward your goals? When you look back at your daily activities, do you question what you are working toward? If you answered "yes" to any of these questions, you probably feel time pressure, and may have a problem with time management. You may feel confused and unorganized, and this may produce unnecessary stress. If you have a problem with time management, you may want to try a few simple time management strategies to structure your time, and relieve some of the time pressure. An important step is setting clear priorities. Your priorities as a trader, however, should be based on whether you are a novice or advanced trader. A novice trader, for example, should devote a fixed amount of time to learning about new trading strategies, while a more seasoned trader may know which specific methods he or she will use and can devote less time to this activity. It is also important to set a specific amount of time aside for each goal; otherwise you may spend all your time on one goal at the expense of others. For example, one cannot merely study trading strategies without testing them out in the markets, so it is important to set aside time for both learning about new strategies and actually trading them. However you spend your time, it is essential that you set time limits for each goal, and that you monitor the amount of time you spend on each one. As you systematically complete each task, you will naturally reward yourself, and at the end of the day, you will feel that you have achieved a meaningful goal. And in turn, you will find that you will enjoy the process of trading. Rather than merely looking at the equity in your account as the all-important gauge of your performance, you will gain a feeling of mastery just by completing various tasks you deem as valuable for developing your skills as a trader. Everything will start to feel as if it is coming together into a whole.
It is important to view time as structured and as having purpose. This perception can be maintained if one uses time management techniques, such as listing specific goals, ranking each goal in terms of your priorities, setting deadlines for each goal, and rewarding oneself when the goal is completed. When you perceive your time as structured, you will feel less stress and feel more satisfied with your overall trading experience. And this in turn will help you cultivate the positive mind-set you need to trade profitably and consistently.
Free up psychological energy by relieving stress
There are limits to the psychological energy you have available to devote to trading. And this limited energy is diminished when you let too many issues remain unresolved, lingering in the back of your mind. The more issues you leave unresolved, the more they build up and the less psychological energy you will have to address them, and also devote to trading. When built up and left unresolved, there's a high probability that these conflicts will creep out when you least expect it. Some conflicts are conscious and may enter your mind during some point during the day. Other conflicts are unconscious; you may rarely think of them. But whether they are conscious or unconscious, psychological issues are always there lurking to some extent. It is in your best interest to bring them into awareness, resolve them, and prevent them from taking up psychological space and energy.
To free up psychological energy and resources, it is important to identify stressors and conflicts and work tirelessly to resolve them. You can free up psychological energy by practicing stress prevention. Stressful emotions can build up, and if not released occasionally, one can be overloaded by stress. You cannot completely remove stress from the trading environment, but you can prevent the stressful aspects of trading from making you feel overly anxious and fearful by developing a stress management plan and following it. Some useful ways to manage stress include:
- Avoiding caffeine,
- Exercising regularly,
- Minimizing daily hassles and
- Seeking out social support.
Caffeine helps many people wake up in the morning, but it may often elevate your nervous system to the point of making you hyper-alert to the slightest form of stress. Trading is stressful enough; it is not useful to pre-elevate your nervous system and feel a heightened sense of anxiety. Tension can also be reduced through regular exercise. Tension builds up during the trading day, and a regular exercise program ensures that pent-up frustration and tension are released, and do not build up to influence subsequent trading decisions unexpectedly. It is also important to reduce stressors in your environment. Daily hassles, such as time pressure, traffic congestion, or feeling over-extended can build up psychological tension and loiter in the back of your mind. Try to minimise these hassles and relieve the pent-up tension. But however you cope with daily hassles, do not ignore them; do not try to pretend they are not important enough to deal with immediately. They can accrue and cause you great strain in the long run.
Seeking social support from friends and loved ones is an effective way to cope with stress. When extremely stressed people have a person, or persons, with which to vent their frustration, they are able to better cope with the stressors. Oftentimes, merely expressing stressful emotions of anger, fear, and frustration can make one feel optimistic, empowered, and ready to tackle new stressors with renewed vigour. That said, it is important to remember that relationships can be a double-edged sword. They can help relieve stress under the right conditions, but they can also be a substantial source of stress. Not just anyone can serve as a vital member of one's social support network. Ideally, people in one's social support network should be good listeners; they should actually want to hear about your unique problems, support your feelings, and help you alleviate stress. Some relationships are uplifting, but other relationships provoke frustration and anxiety. This may be especially true for traders, since not everyone in a trader's social support network understands trading or is supportive of it. For example, suppose a loved one is not supportive of trading, and frequently provokes anxiety by saying things like, "How much did you lose today?" or "When are you going to give up trading and go back to your regular job." Similarly, a conservative, risk-averse friend may not want to hear about relatively risky trading activities. In these cases, such relationships are unsupportive at best or extreme stressors at worst. Thus, it is vital for your psychological health to seek out the right kind of social support.
It is essential to trade with the proper mind-set. If your mind is frantically consumed with conflict and stress, you will find that a large supply of your psychological energy is depleted, and when you shift your attention to trading, you will be unable to focus and concentrate. But when you relieve stress, you free up psychological resources and can purge the conflicts and stressors lurking in the back of your mind. Your trading will benefit from the peak performance mind-set.
Organize your workspace and relieve stress
Trading the markets is a stressful occupation. The markets are unpredictable and chaotic. No outcome is a certainty, and many times, when it seems as if you know where the market is going, you discover you're wrong. It can be extremely confusing and disorienting. And this confusion and disorientation can produce stress. Winning traders must do whatever they can to remove some of the confusion and reduce stress. One of the best ways to relieve some of the stress, and put order into a face-paced unpredictable environment, is to organize your workspace. Throw out the old and make room for the new. Clutter and stacks of old paperwork can be distracting. Piles of newspapers you will never read can make you feel as if the clutter is closing in on you, and cramping your style. Removing some of the clutter and opening up some space often symbolically gives you increased psychological space and renewed creative vigour. You feel you have more room to breath. Some traders may prefer a messy workspace and feel that it is more stressful to organize it than to succumb to the disarray. But most people associate untidiness with confusion, chaos, and ultimately, stress. An organized workspace, in contrast, is less distracting. When one is trading, it is essential to focus on your screens. Too much clutter in the same room, or on one's desk, can grab one's attention and shift it away from monitoring the trade of the moment. A clean, sparse and organized workspace makes many people feel that they have greater control. They may not be able to control the markets, but at least they've mastered their environment, and minimized any possible psychological influence that it may have on their awareness and ability to objectively assess market conditions.
Organizing one's workspace does indeed take some effort, but it is well worth the price when one considers the peace of mind you will gain. The first step in organization is to throw out old, worthless information. This is the hardest part. We collect books and papers because we think we will need them. Yet many times we accumulate so much stuff that its actual contribution is minimal. We will never find the time to read all of it, and it will just take up valuable workspace. But it is hard to throw it away. It took time and energy to assemble these items, and throwing it out subtly suggests that you wasted your time collecting the stuff. But most of it can be tossed out. Make tough decisions and commit yourself to throwing out at least 25% of it. If you still cannot throw it away, box it up, put it away, and sift through it when you find the time. But get it out of your workspace so that it no longer impinges on your consciousness. Developing an informal filing system can be helpful. It does not have to be formal with folders for each topic and precise categories typed on labels for each folder. Sometimes you can merely place documents for a particular task or project in a large attractive looking box. You can then pile the boxes in a corner of your office, or if it is still a distraction, you can stack the boxes in the garage. But it is important to get it off your desk and prevent it from encroaching on your workspace, and more importantly, on your mind. Relieving clutter and working in a sparse workspace can greatly relieve stress. The markets are impossible to control, but your workspace is something you can master by keeping it organized. So, throw out all the old stuff taking up precious space. You will feel energized and ready to tackle the challenges that the trading day has to offer.
The New Year - a time for psychological renewal
For many, New Year's Day is a time of psychological rebirth. It is a time to forget our past defeats and get ready to focus on new challenges. But for some people, it is hard to put aside the past and devote full attention to capitalizing on the opportunities of the coming year. Casting aside the past can be difficult. There are many sound reasons for clinging to the past. First, we believe that we can learn important lessons by studying our past mistakes. Second, some people believe it is impossible to shrug off the past. A common belief is that our personality, habits, and current performance are a function of our past experiences. Third, there is an emotional attachment to the past; if we cast our past history aside entirely; we fear we are also casting aside a vital part of ourselves, or a cherished memory. Despite these very good reasons, it is useful to put the past behind us, especially memories or beliefs that interfere with our current functioning or future performance. Upon close examination of the reasons for clinging to the past, we find there are also good reasons for putting the past behind us, and moving forward.
It is often productive to learn from our past mistakes. That is especially true of trading. If you keep a trade diary, it is useful to see if your trading decisions were impulsive or emotion driven. It is also useful to determine which trading strategies are producing profits and which ones are not, and make changes accordingly. However, there is a tendency to think that there are more lessons to learn from our past mistakes than there really are. Many people tend to mull over the past in excruciating detail, needlessly trying to find a lesson in every past mistake when there is none. It may be useful to study past mistakes, but agonizing over the past is not useful. A sensible rule of thumb can help you overcome this quandary: If a past mistake does not have a lesson that is immediately apparent, you probably are not going to find it, or your psyche may not be ready to learn it.
Many times it seems impossible to just shrug off the past. After all, are we not the products of our past histories? Although this belief may be true to some extent, it can be limiting. If we believe we are a product of our past, it is tempting to further believe that our past dictates our future performance. But this is not necessarily true. Past performance need not dictate, or even influence, future performance. Psychologists who study optimal performance have discovered that individuals who achieve success tend to focus on the here-and-now, the immediate experience. Focusing on the past often causes anxiety. It precludes you from paying enough attention to your immediate experience, and the opportunities for success that are immediately ahead. A strong focus on your immediate experience, the here and now, is vitally important for your trading success.
There is a deep emotional connection to the past, and this is why we are hesitant to just abandon it. But reliving the past is much like daydreaming; it's fun to daydream, but doing too much of it is a means of escape. One tends to focus too much on getting away from living life in the moment. And that's what mulling over the past also seems to do. It takes us out of the immediate experience. In bad times, it helps us to remember the good. But it may be useful to just move forward, rather than find solace in the past. However grim one's current circumstances, it is always better to find a solution in the here-and-now and move forward. With every New Year, it is wise to put the past behind us and move forward. Think optimistically. Look at each New Year as full of opportunities. Through hard work and persistence you can overcome all adversities to trade consistently and profitably.
New Year's resolutions - how to keep them
To lose weight or to quit smoking. These are just some of the common resolutions people make on New Year's Day. Do you make any New Year's resolutions? If you do, you are not alone. Most adults make New Year's resolutions. Unfortunately, few people keep them. New Year's resolutions are particularly interesting to psychologists. They illustrate the psychological processes that many people go through to change important patterns of behaviour. The same processes that people go through to make New Year's resolutions are the same processes that traders go through to improve their trading skills, so a review of why people fail, and how to prevent failure, may help you reach the peak level of trading performance you are seeking. Psychologists Drs. Janet Polivyand C. Peter Herman suggest that there are four reasons people fail. Gaining awareness of these four reasons, and developing a plan to work around them can help you stick with your resolution to change.
First, people think they can make dramatic changes when modest change is more realistic. People reject more modest, achievable goals for ones they cannot possibly achieve. Since their expectations often exceed what is feasible, they fail quickly, feel disappointed, and just give up. An obvious example in the trading arena is expecting to make huge profits with inadequate capital. It is essential to work with a trading coach or adviser to develop realistic goals. A second reason people fail is that they underestimate the time it takes to make a substantial change. For example, novice traders assume they can trade profitably in a matter of months, whereas seasoned traders emphasize that such changes may take years. A third and related reason people fail is that they think change is easier than it actually is. It is hard to change. It requires a heroic effort, yet most people think only minimal effort is required (It is like thinking you can trade profitably by treating trading as a hobby rather than as a business). And similarly, it is hard to master trading. There is a powerful human tendency to over-estimate one's ability level, to overconfidently think that one has skills and abilities that one does not yet have. Do not ever underestimate the tendency to be overconfident. Conquer the tendency to trade beyond your skills by cultivating a sense of healthy scepticism regarding your trading skills and your trading strategies. And remember, behaviour change is harder than you think.
Finally, people fail in terms of changing behaviour because they overestimate the potential rewards they will receive through behaviour change. For example, they believe that if they can change their behaviour, their life will be ideal. For example, they may believe they will get a big promotion at work or an exciting, new romantic partner. But these expectations rarely materialize and one usually encounters disappointment, and a reluctance to continue on a given course of action. This is especially true of trading. Novice traders envision extreme wealth and the attention it brings. Media images do not help matters. Expensive cars and luxurious homes are associated with happiness and bliss, and it is reasonable for people to think that making huge wins will produce ultimate contentment. But these potential rewards are often unrealistic. It is wise to make sure that your expectations of reward are realistic. When it comes to trading, long-term enduring financial rewards may take a little while. In the meantime, it is useful to enjoy the process of trading. Trading is a fun and rewarding endeavour in and of itself. Whether you are trying to keep your New Year's resolution or trying to make significant changes to your trading approach, it is useful to accurately estimate the amount of change you can make, the speed at which you can make the change, the difficulty of behaviour change, and the actual rewards you will get once you make the change.
Have you ever had one of those days when everything went wrong? You may have had a string of losing trades or had a bad dream the night before, but you woke up on edge. When you are on edge and a little anxious, everything can seem to start to go wrong. You may not get a proper order fill, or you may misread information, and then your equipment may malfunction. Suddenly, you are unable to regain your composure and trade in a focused, logical state of mind. At times like these, the only way to recover quickly is to take precautions to prevent a worst case scenario getting the better of you. In his book, "Mastering the Trade: Proven Techniques for Profiting from Intraday and Swing Trading Setups," John F. Carter shares his office arrangement, and tells readers how he takes precautions. Mr. Carter's office consists of multiple computers. He has one computer dedicated to emails, instant messaging, and searching the Internet. He notes that this computer is likely to be attacked by viruses and spyware, but since it is not used to execute trades, when it becomes disabled it has no bearing on trade execution. He also has a backup laptop that is attached to a dialup modem connection. Should the electricity go out or the broadband Internet connection fail, he still has access to his trading accounts and price quotes. Mr. Carter represents the trader who is prepared for any circumstance. Should one of his computer systems fail, he has a backup system.
When it comes to trading, the motto, "be prepared" is tantamount to success. There are many things that can go wrong, so why worry about your computer equipment failing? When you must concentrate intensely on how earnings reports, media coverage, or world events may ruin your trading plans, why spend precious time worrying about the things that you could have controlled interfering with your trades? The winning trader takes precautions to control the things that can be controlled, so that he or she has enough mental energy to focus on market events that cannot be controlled.
What can you control?
- You can control your energy level by eating right and getting enough sleep.
- You can control your feelings of anxiety by avoiding caffeine and exercising regularly.
- And you can avoid serious losses by managing risk and trading high probability setups.
It may seem obvious, but many traders fail to take precautions. They trade by the seat of their pants and when something goes wrong, they blame it on anything or anyone but themselves. We cannot control everything, but it is vital to our survival to control what we can and accept what we cannot. Taking precautions is a significant way that you can increase your chances of achieving financial success.
Fearless and profitable trading
Everyone is a little afraid of losing. It is natural. You have worked hard to earn enough capital to trade, and it is reasonable to worry about losing it. But winning traders are objective when it comes to trading capital. Losing does not faze them. Some of the biggest winners are fearless. In her book, "On Becoming Fearless...in Love, Work, and Life," Arianna Huffington offers advice on how to become "fearless about money." Ms. Huffington astutely observes, "It is impossible to be fearless about money if we do not value other parts of our lives and ourselves more than we value our bank accounts."
Market observers have long observed that when traders need to make profits to maintain a highflying lifestyle, they usually choke under the pressure. Winning traders learn how to look at trading capital coldly and objectively. But as Ms. Huffington notes, "it is hard to be fearless about something that is so elemental, so wrapped up with survival." Not only are some people unable to view money objectively, they have deep seated psychological conflicts about money. For example, "poverty consciousness" is a problem for many. Poverty consciousness is the fear that no matter how much money you have, it is never enough. The idea of possibly losing it all can "fill us with gut wrenching terror," according to Ms. Huffington. Poverty consciousness can at times act as a motivator to drive us to accumulate so much wealth that we will never face poverty again, but many times, it is a constant source of anxiety.
For people with poverty consciousness, money takes on symbolic meaning. Money may act as a social barometer of how well we are doing, or it may become associated with security, freedom, and choices. As true as this may be, it is the root of fear. It is hard to stay objective when significant psychological meaning is placed on money. For some people, the pursuit of money reflects a way of coping with fear. The quest for money may represent emptiness in one's life. When money has such symbolic meaning, a person can never have enough money.
How do you overcome your fear about losing money? "True fearlessness about money can come only when we are not driven by an insatiable desire for security," according to Ms. Huffington. Instead, a person must live a life driven by passion and purpose, regardless of financial circumstances. When you are passionate about something, it will override your fear of poverty. If you have abundant passion, abundant optimism, and abundant nerve, you will overcome your fear of losing.
In the end, our happiness depends on whether or not we find our lives meaningful, or at the very least, inherently rewarding. We must do something significant with our lives. It does not necessarily have to be significant like becoming the leader of a country or an inspirational guru, but in our own way, we must make some sort of contribution. We must believe that we have our own place in the world and that it is important. Money is not everything. It is the process of how we live that matters, not the prize. It is much more satisfying to pursue objectives for the pure joy of pursuing them, regardless of how much money you can make.
Winning traders are motivated by the inherent rewards of trading rather than profits. It is common to hear winning traders say, "I love trading so much that I would do it for free if I had to." They find trading personally meaningful. The markets fascinate them. Market action is intrinsically interesting. It is a rewarding intellectual challenge to devise innovative new trading strategies, and seeing how well your ideas pan out is exciting and enjoyable, regardless of whether you win or lose. Viewing trading from this perspective can act as powerful motivators. Individuals who pursue trading in this way are more likely to feel satisfied and can more easily manage the extreme stress the market is infamous for producing. When you are not focused on the profits, it is easier to stay calm and focused. The money, and possible losses, is either secondary or not an issue at all. Successful traders love the challenges the markets offer and view their work as meaningful. And because they are doing what they love, they are fearless.
The well planned trade
It is not whether you win or lose but how you play the game. This old adage is especially relevant to trading. Many novice traders assume that winning is the only thing that matters, but what they soon find out is that profiting over the long-term requires discipline and trading well developed trading plans. Sure, you can capitalise on chance and make a few winning trades here and there, but you can only win in the long run by developing a trading plan and following it.It is important to distinguish justified wins from unjustified wins.
- A justified win is when a trader makes a very detailed trading plan and follows the plan. A win that results from following a trading plan is justified and reinforces discipline.
- An unjustified win occurs when a trader does not make a plan or drifts from the plan. He or she may be rewarded, but the outcome occurred by chance. The win is unjustified and can reinforce undisciplined trading.
For example, suppose you go long on a stock, expecting it to go up, but it went down. If you followed your plan, you might close the trade. Suppose out of frustration, though, you hold out and hope against hope that the trade will turn around. Now suppose that it does, and you end up profiting. You have ended up with a profit, but you may have reinforced an impulsive trading style.
You might think that profits are all that matter. "All is well that ends well," right? Well, maybe not. You may make a big profit, but at what psychological cost? Unexpected wins may provide short-term pleasure, but they can adversely influence discipline in the long term. Rather than developing a well-defined trading plan, following it, and getting rewarded by trading it, a trader puts on a trade haphazardly and is coincidently rewarded. In this case, a lack of discipline is rewarded, and this unjustified reward may increase a trader's tendency to abandon trading plans in the future because he or she has been rewarded for doing so in the past. However, the positive outcomes are usually short-lived, and a lack of discipline ultimately produces trading losses.
Cultivating discipline is vital for consistent and profitable trading. One implements proven trading strategies, over and over, so that across a series of trades, the strategies work enough to produce an overall profit. It's like making shot after shot on the basketball court so as to accumulate a winning number of points. The more shots you take, the more likely you will amass points. But the winning player is the person who first develops the skill to make the shot consistently, so that at every possible opportunity, the ball is likely to go through the basket. To a great extent, consistency is key. If the player uses one approach one time, and a different approach at another time, performance is haphazard.
It is the same for trading. One must trade consistently, following a specific trading plan on each and every single trade. This allows the law of averages to work in your favour, so that across the series of trades, you will make an overall profit. If you follow the plan sometimes and abandon it at other times, you throw off the probabilities. Suppose you used a strategy that had a track record of 80%. Under the best-case scenario, you could only expect to win 80% of the time. But since history does not always repeat itself, it is likely that you will win less than 80% of the time. If you do not execute the trading strategy the same way each time, you will decrease your winning odds. And fewer winning trades may mean an overall loss. That is why discipline is so important.
With discipline comes profitability. Do not let unjustified wins interfere with your ability to maintain discipline. Follow your trading plan, and reinforce the idea that if you follow your plan, you will end up with profits in the long run. If you abandon your trading plan, and get an unjustified win, you may feel good in the short term, but you will pay a long term price when it comes to your ability to maintain discipline. So clearly define your trades, and stick with your trading plan. The justified wins you receive from following your plan with help you develop an unwavering pattern of disciplined trading.
Motivated, persistent, and profitable
The markets have been bullish recently, but that is still no guarantee of profitability. The only sure path to profitability is through hard work and persistence. First you have to find a high probability trading setup. Next, you have to patiently wait for ideal market conditions and get in and out at the right times. And if everything goes well, you take home profits. Most of the time, though, you have to face setbacks and losses, and unless you are persistent, you can feel like giving up.
For the past week, shares have been on the rise, reaching new heights, but how long will it last? If you get in now, you may end up selling as a turning point happens, and may end up as merely one of the many sellers looking for buyers who just are not there. The only way to ensure profitably is to work hard, search for trading setups and execute trades with discipline.
It can be hard to find the proper motivation at times, especially during a sideways market. But the way the markets have been behaving lately should motivate you to believe that if you execute enough trades, you will take home profits. It is at times like these that you can trade in earnest until you hit upon a winning streak, and when you get in the zone, push yourself to the limits. But at the same time, do not get overly confident. Sure, the markets have been on the rise, but that does not necessarily mean you can buy a share at the wrong time and profit. The overconfident trader, however, falsely believes that trading is that easy, especially after a big windfall. Do not let the exuberance of the past week give you a false sense of security. It is vital to approach trading with a sense of optimism, but temper your optimism with caution.
It may also be useful to set modest goals. In times of exuberance, many traders are afraid they are missing out on opportunities. Instead of identifying just a few specific trades, they become over-ambitious and push themselves to identify more trading setups than they can handle. They spend too much time trying to find as many trading setups as possible, and in the end, they do not end up paying enough attention to a few specific trades that are likely to produce a profit. Rather than set yourself up for failure by trying to do too much, set realistic objectives and accept what you can accomplish with the time and resources you have available.
Most importantly, profitable trading comes with persistence. As overwhelming as trading can be at times, it is essential to believe that if you work hard enough, you can make profits. Even when times are good, setbacks and losses are commonplace. If you are not careful, a series of setbacks can get you down. But if you work hard, persist, and work diligently to overcome obstacles, you can take home huge profits, especially during a bull market.
Paying your dues
The great trader Jesse Livermore blew out his trading account more than once in his illustrious career. It is scary to think about, but if you want to become one of the few who reach the top in this business, it is necessary to face the possibility that you may blow out your trading account. Many seasoned traders have had to start over more than once. You may not be immune to this ailment. Just like all top-notch traders, you may need to pay your dues and learn what it is like to lose and come back.
Tom, a long time market observer once noted, "I have yet to meet a successful trader who has not paid his dues." Tom observed that every successful trader has blown out his trading account and learned how to recover from it. "Take the best traders in the world...they have blown out. If trading was easy, everyone would be trading and everyone would be making money. You have to pay your dues. Some people are lucky and only pay those dues for a very short period of time, and others are going to pay their dues for a very long time."Another seasoned trader, Dan, described how he lost big before making a comeback: "One time I lost virtually everything in one or two days, and a good friend of mine came over to make sure that I was not going to do something stupid. ... I told him, 'It is only cash. It is not my life that I lost. I can get it back. It is not the end of the world. I am not losing my house, my car, my credit cards, or my friends. I made a mistake. I am angry that I made a mistake, but the cash has nothing to do with it."
The trading lore is replete with similar stories. One young, promising trader, for example, lost so much money that his brokerage decided to fund him to make back what he had lost. Even the best traders blow out. Why? For some it is merely mathematics. They are under-capitalised and end up spending what little earnings they make on a few wrong trades and on trading commissions. They never had a chance. Other traders are overly impulsive. In a sense, the old adage, "you have to risk money to make money," is true. To make big profits and turn a small account into a large one, it is necessary to take big risks when a once-in-a-lifetime trade comes along. That said, you may also be taking a big risk that has dire financial consequences. There is no one right way to trade. If you want to make it big in the trading business, you may need to take risks. But you should be ready to deal with the consequences. Other traders may want to play it safe by trading small and building up their trading skills and trading capital before scaling up to make those bigger, riskier trades. Whatever you decide, it's necessary to keep up your spirits on the one hand but be ready to pay your dues on the other. You can make it if you stick with it, but everyone has to put in the required time and effort, and learn to pick yourself up after a setback.
Cold, hard facts: look honestly and make adjustments
When it comes to evaluating your performance, there are times when there is no substitute for studying the cold, hard facts. In the end, the bottom line is unavoidable: If you are not profitable across a series of trades, you are out of business. It is vital to realistically gauge your performance. If you are like many traders, however, your unbridled need to win takes over. You see only what you want to see, but an outsider would see that you are about to fall into the abyss yet do not know it. It is a more common ailment among traders than most people realise. Looking at the cold, hard facts can ding your ego, and that is why it is so hard to look at our performance honestly. It is often easier to put on blinders to avoid seeing how poorly you are actually doing. The winning trader, however, is not afraid to coldly and objectively look at performance statistics.
From a purely psychological view, it is not always useful to focus only on performance outcomes. If you are a novice trader, for example, it takes time to build up your trading skills. Expecting too much, too quickly in terms of performance outcomes will frustrate you. That said, if you lose a great deal of money trading, you might end up in so much debt that it would be virtually impossible to break even. Looking at the cold, hard facts realistically is a necessity, not an option. Let us consider a few popular statistics that indicate how well you are doing.
First, what is your hit rate? How often do you make money? Is it 20%, 10% or less? It is necessary to look at your past record and calculate a rough estimate with regard to the percentage of trades you make that are winners. This is not the only statistic you should look at, but it does suggest how well you are doing. The downside of relying on just this one indicator is that subconsciously, or in the back of your mind, you may want to increase your hit rate by making a few small profitable trades. For example, if out of 10 trades, you make eight losing trades, you might be tempted to make two winning trades, even if it is just R20 per trade, to make yourself feel good about having a 20% hit rate. Obviously, the 20% estimate is off. It means essentially nothing if you lost R10 000 on the eight losing trades!
That is why you must also compare the amount of money you lose on your losing trades to the amount of money you gain on your winning trades, what some traders call the Rand-based win-loss ratio. Psychologically, this is a much harder statistic to calculate than your hit rate. It is hard to look at just how much you are losing compared to how much you are winning. Many traders prefer to deceive themselves. They focus on their winning trades, but ignore their losing trades. You can feel like a super-trader if you focus solely on the winning trades where you made huge profits, while ignoring losses. All you are doing, though, is fooling yourself. For example, who cares if you made R30 000 on your winning trades if you lost R35 000 on your losing trades and had to feed your trading account R5 000 last year to make up the difference? It may be hard to put your pride and ego aside, but unless you take an honest look at your Rand-based win-loss ratio, you will not have an accurate gauge of your performance.
Finally, it is also important to look at commission costs and the size of your trading account. If your trading account is small, brokerage commissions will put a dent in your overall profits. Trading account size does matter, but many newbie traders like to hold on to the dream of striking it rich even though they have a relatively small trading account, and thus, they avoid taking an honest look at trading account size and brokerage commission costs. Do not set yourself up for failure. You need money to make money. It is wise to look at how much it costs you to trade and adjust your goals accordingly. You may have to get a second job to build up investment capital, for example, if your trading account size is too small for your objectives. Again, it may be hard to admit that you have limited financial resources, but it is better to look at it now, and make plans for the future, than unrealistically and fruitlessly waste your time working toward a pipedream.
Humans are prone to eternal optimism. Optimism is good, but it must be tempered by realism. Do not be afraid to take a good hard look at your trading performance. By looking at your performance honestly and frequently, you will be able to make midcourse corrections so that over the long run, you will end up profitable.
The thrill seekers
Have you ever been on a diet and eyed a piece of chocolate cake? Or perhaps you had decided to cut back on expenses, but could not resist buying a new pair of shoes. We all have our addictions, whether it is gourmet food or fast cars. It is human to want to seek out fun and excitement. You work hard. Why should you not play hard? The problem, though, is when a trader starts trading like an addict. Addictive traders seek out thrills, even if it means losing money they cannot afford to lose. Your long-term survival depends on your ability to avoid seeking out thrills and remaining disciplined.
Psychologists have studied the dynamics of thrill seeking. Some people have a natural born affinity to seek out risk. They have difficulty controlling their impulses and are quick to act without thinking. That said, many people, especially traders, have trouble maintaining discipline. Research studies have shown that despite the claims of pop psychologists, people have trouble controlling their drinking, eating, and smoking. Sure, there are some people who have no problem with discipline in these areas. It is a matter of biology, but many people have trouble maintaining discipline. Is it hopeless? No. Psychologists suggest looking at your limitations regarding discipline, and taking active, preventative steps to maintain discipline.
When trying to maintain discipline, many people make the mistake of trying to do too much at too fast a pace. People think that they have super-human strength when it comes to discipline. But, in reality, the ability to maintain discipline is a fixed resource. Just like physical strength, you can only maintain discipline for so long before your ability to stay controlled fails you. For example, if you work all day long, and keep under control, you are bound to want to go wild at the end of the day. That is all right. It is natural to want to celebrate. The mistake, though, is thinking that there are no ramifications for maintaining strict discipline for long amounts of time. You cannot keep strict discipline forever. At some point, you need a break. Obviously, just like building up muscles, practicing discipline allows you to get better at it. But it is vital to know your limits. You can only be disciplined for so long before you naturally want to break out and act on impulse.
What are a few ways to stay disciplined when you need to? First, always get plenty of rest. When you are tired, you are prone to impulsive decisions. Do not skip sleep. It is the key to maintaining discipline. Second, remove stress from your everyday life. This is easier said than done, but if you feel stressed out, you would not have enough psychological energy to maintain discipline. You will be on the verge of seeking out a thrill to make yourself feel better. Third, do not try to be disciplined for too long. When you try to live a monastic life as a trader, you will eventually feel a need to alleviate the monotony and boredom. When you feel bored, you are likely to make an impulsive trade and lose money. The best preventive step is to restrict the amount of time you trade. If you find it hard to maintain discipline for an entire week, for example, then do not try to trade with extreme discipline for two weeks. It will take all the psychological energy you can muster to make it for the week. Do not make matters worse by pushing yourself to go for two weeks. You will increase the odds of making impulsive trading decisions. Instead, trade for a week, take some time off, and then return after you've had some time to recover. It is just like building up muscles. Work out, rest, and go back and work out a little more. If you "work out" your discipline muscles in moderation, you will make more progress. So avoid seeking out thrills. Trade with discipline and you will trade to win.
Decisive and responsible trading
To those who want to take home big profits, trading is not a hobby. It is serious business. If you want to make profits consistently, you must have respect for your trade. You must treat each trade like a business transaction. It should be well planned and deliberate. You should follow a business plan, which outlines a strong rationale for making the trade. You should have a realistic profit objective, and execute the trade with a strong resolution to make a profit.
Many novice traders do not approach trading seriously enough, however. They do not carefully delineate a trading plan, and when they do, they do not follow it. In the "The Disciplined Trader," author Mark Douglas observes, "The typical trader will do most anything to avoid creating definition and rules because he does not want to take responsibility for the results of his trading." According to Mark Douglas, traders have a strong motive to avoid responsibility. And one of the most effective ways to avoid responsibility is to pretend that trading is nothing more than a leisure activity.
By taking trading lightly, you can always say, "It was not important anyway; there is no reason to worry about it," whenever things do not go your way. On the one hand, approaching trading as if it were just a hobby will allow you to minimise the psychological importance of a setback or a loss, but on the other hand, unless you take trading seriously, you will never give trading your best shot, and you will never make the huge profits you have been dreaming of. You will always have a way out, and it will be too easy to make excuses for things going wrong. Making excuses may make you feel good in the short term, but eventually, you will start to realise that you are taking the easy way out. And the more excuses you make, the less decisive you will feel.
If you want to make profits, you must feel you are in control of your actions. Taking a decisive approach to trading requires that you take responsibility for all your actions. That does not mean beating yourself up for making a mistake, but it does mean trying to gain as much control of your trading as possible. You cannot control the markets, and you cannot control what other market participants will do, but there is a great deal that you can control. You can manage your risk. You can carefully measure your trading performance, and discover what works and what does not. You can decide which trading setups to take and which trading setups to avoid, and you can decide to trade only under market conditions that are conducive to your methods and style. The astute trader distinguishes what he or she can control and what he or she cannot control.
Winning traders take responsibility for their actions. When you identify what you can control, and take responsibility for it, you feel empowered. You feel in control, and you are ready to act decisively. And when you feel in control, you will enter a winning state of mind. You will feel relaxed and alert, and ready to see opportunities and profit from them.
Scheduling your worry time
Winning traders execute and monitor their trades in a peak performance state. They are not worried about past mistakes or future profits. All their attention is focused resolutely on the on-going trade. But it is hard to focus on your on-going experience when you are worrying about losses, or some other trading problem. It may sound easy to take losses in stride, and avoid letting them interfere with your on-going experience, but when you are in a severe drawdown, and worried about how you will get out of it, it is hard to avoid letting it get to you. You may become consumed with guilt and anxiety. It is natural. Your future may actually be at stake. But you cannot trade at your best when you are worried. Somehow you must train your mind to put the losses out of your awareness. One way to train your mind to temporarily forget about losses is to schedule worry time.
The natural human tendency to worry about problems protects us. If we did not worry, we might take dangerous risks, and pay a steep price. But worrying can be a problem for successful trading. If you are the kind of person who worries uncontrollably, it may interfere with your ability to pay attention to executing your trading plan. Not only can it distract you when you try to execute a trade, excessive worrying can prevent you from getting a restful sleep at night, or keep you so uptight that you cannot relax. Without proper rest and relaxation, you will find it difficult to mobilise your psychological resources for optimal trading performance.
Worrying becomes a problem when you do it too often and for no good reason. For example, if you have mounted losses and worry about it, you tend to think the same thoughts over and over again. It does not help much. You are likely to just let it interfere with your ability to make back the money you have lost. You need to put such thoughts out of your mind while you trade. When you worry too much, you feel out of control. One way to regain control is to schedule worry time. The basic idea is to set aside a certain part of the day, seven o'clock, for example, and only worry for 30 minutes during that time. The goal is to worry only at a specific time for a fixed length of time. When you catch yourself worrying during the day, you can tell yourself to stop with the knowledge that you can worry about whatever is bothering you later. Knowing that you can worry during the "worry session" will help you control your worrying.
It may sound a little simplified, but it works for many people who have trouble controlling their worrying. Try it. See if it works. If you are like most people, you will find that you worry less, and can control it. So do not let worrying interfere with your ability to trade successfully. Worrying seems like a natural response to a setback, but it usually gets you nowhere. Rather than hopelessly worry, it is vital that you take an active problem solving approach. If you can control your worrying by scheduling regular worry sessions, you will be able to recover from a setback fast and return to profitability.
Appreciating the moment
Have you ever lost yourself in a trade? You focus intensely on your screen and wait for the ideal time to enter. You are fully attentive as you continue to watch your screen as the price creeps up to your profit objective. All your attention is channelled on your on-going experience. Without even thinking, you exit according to your trading plan. It is as if you are in a meditative trance. There are times when everything just seems to click. Many trading experts, such as Mark Douglas and Dr. Ari Kiev, call it "trading in the zone."Trading in the zone is a peak performance mental state. It happens when you engage in a task that requires your full attention and skill. The task is not so hard that you feel anxious about it, but it also is not so easy that you are bored. There are times when every trader enters this peak performance mind-set. How do you get there? For one thing, you need to feel calm and relaxed.
Existential philosophers noted long ago that people experience fear and anxiety when they think about, and regret, past mistakes, or when they worry about an uncertain future. James Dines makes a similar observation about trading. In his book "Mass Psychology," Dines observes, "anxiety results from spending too much time in the future." "Spending too much time in the future is punished by anxiety, while getting stuck in the past is punished with regrets," according to Dines.
How do you stay in the moment? It is important to focus your attention on your current experience, rather than self-consciously mulling over the past or worrying about the future. Focus on the process of living in the here-and-now. Dines suggests, "taking it one day at a time." Scott Shellady, a seasoned trader on the Chicago Mercantile Exchange (CME), similarly suggests compartmentalising each trade. By taking each trade one trade at a time, you will feel more relaxed, and are more likely to enter the zone. In other words, do not worry about past losing trades or future profits. All your attention and energy should be focused on the current trade. When you are in this optimal state, you will trust your instincts. You will see the markets more clearly and objectively. You will be intensely aware of your feelings, sensibilities, and judgements. You will be in tune with the market action. You will be able to effortlessly review a multitude of details. Key factors that are driving the market action at the moment will come to mind with ease. When you enter the zone, you will significantly increase your chances of success.
It is not possible to always trade in the zone, but when you do, it is a peak experience. At that point, you will reach a state of bliss. So increase your odds of trading in the zone. Appreciate the process of trading. Do not focus on the prize. Do not worry about past mistakes, and avoid worrying about the future until it happens. By appreciating an on-going trade moment by moment, you will not only have more fun; you will end up more profitable in the long run.
Affirm to win
Trading can be exhilarating. When you see a trading plan come to fruition, you cannot help but feel a little special. There are those times, however, when you feel frustrated and disappointed. You regret making a few bad decisions, and may question your ability to return to profitability or achieve enduring financial success. Your confidence can become shaken, and you can lose yourself in feelings of doubt and despair. At times of uncertainty, making affirmations can help you recapture a winning state of mind.
Affirmations are positive statements that motivate you. They remind you of your goals, what is important to you. For example, suppose that you have just made a series of losing trades and are feeling disappointed and stuck in a psychological rut. You can recover quickly by repeating a series of positive affirmations:
"I am human. I can make mistakes. Losing trades are just part of the business of trading. My goal is to achieve enduring profitability. The big picture is all that matters. A few losses here and there are of little consequence for the big picture. Through hard work and experience, I will achieve my financial goals." Affirmations remind you of who you are and where you are going. If you repeat the affirmations over and over again, you will start to feel empowered. Even major setbacks suddenly seem unimportant.
You can make up a set of affirmations for any trading issue. For example, suppose you have trouble patiently waiting for a trading plan to pan out. Under these circumstances you might say,
"I have willpower. I am in control. Winning traders are disciplined. I have made my trading plan, and I can follow it and wait to see what happens. I can learn to trade with discipline. The more I practice discipline, the more disciplined I will become. With each trading plan I successfully follow, I will gain more self-control. Over time, I will become stronger, decisive, and able to control my emotions."
Affirmations can also address a more general issue, such as low self-esteem. Some traders manifest low self-esteem by defining their self-worth by their net worth. They may feel on top the world when they make a winning trade, but worthless and inadequate when they lose. Affirmations can help matters. A trader with low self-esteem may affirm,
"I am human, and as a human, I have self-worth no matter how much money I have or how many losing trades I make. My worth is not defined by whether I win or lose. Trading is not my entire life. Winning or losing does not define who I am."
Affirmations are personal. What you write down and recite is up to you. Affirmations should inspire you, guide you, and motivate you. But whatever you write down and repeat to yourself, it should address your desires, goals, and reasons for trading. At first glance, repeating an affirmation over and over seems like an inconsequential solution, but try it. You will find it does wonders for your motivation and your mind-set. Soon, you will find that you do not have to consciously repeat the affirmations; you will think of the positive statements automatically. Over time, you will train your mind to think positively. You will approach trading with a winning mind-set that will help you achieve enduring financial success.
Clear and specific goals
Trading can be tedious at times. Day in and day out you have to look for market opportunities, and once you find them, you have to put your money and a little bit of ego on the line, and suffer the consequences, good or bad. If your heart is not in it, you will eventually join the disillusioned minions who have left the trading profession. To make it as a trader in the long run, you must love the process of trading. You must think it is so exhilarating that you would do it for minimum wage if that were the only way you could trade. It is not about the prize. It is a calling, a noble mission.
Who would not want to be a winning trader? With complete financial freedom, you could do anything you wanted. It is necessary, however, to turn the abstract goal of becoming a winning trader into a specific, concrete plan. In their book, "The Inner Game of Trading," Robert Koppel and Howard Abell argue that your trading goals should be clear, precise, and well defined. You must also try to complete your goals within a reasonable time. You should state your goals in an empowering way, and your goals should be realistic. And it is also necessary to set a goal that is easy to quantify.
There are a variety of ways to define trading goals, according to Koppel and Abell. First, you can set performance goals in which you focus on how well you are doing in terms of your own personal standards. When trying to achieve a performance goal, you try to increase your physical and psychological skills related to trading. Second, you can set outcome goals. Outcome goals help determine what is important to you. They allow you to develop trading techniques and strategies that match your personality. Third, a motivation goal helps increase your effort, and allows you to focus your attention on honing your trading skills. Motivation goals allow you to maintain a high level of enthusiasm and confidence.
Koppel and Abell list some important goals that novice traders should set. It Is important, for example, to learn to control your emotions. Many traders act emotionally rather than rationally. They also have difficulty taking losses. It is necessary to take losses quickly and easily, rather than dwell on them. It is also important to develop a trading system that is consistent with your personality. All traders should also limit their risk. These are just some examples, but with each of them, it is essential to strive to achieve specific goals every day. On some days, you might just try to set a performance goal. You might practice a trading skill you are trying to hone based on a standard you personally define as adequate. On other days, you might try to achieve a specific outcome, and see how well you do. It is vital, however, to set clearly defined goals, and enthusiastically pursue them. Log your advancement, and reward yourself when you make significant progress.
Many traders make the mistake of trading aimlessly every day without trying to achieve specific goals. As Koppel and Abell put it, it is like trying to saw down a tree without making sure that your blade is sharp enough to cut wood. Goals direct and motivate. Without clear and specific goals, you are making a journey without a map.
Trading with discipline
Top-notch traders have unwavering discipline. Expert trader John Hayden notes, "Without discipline, you will be unable to master your ego, create empowering beliefs, have faith, and develop confidence in your abilities. The lack of discipline will prevent your skill as a trader from progressing." It may be tempting to trade by the seat of your pants, but if you do not develop clearly defined trading plans to follow, and follow them consistently, you will have difficulty achieving enduring financial success.
What is the harm in abandoning a trading plan if you make a profit anyway? Making an occasional winning trade, even when you threw your trading plan out the window, may provide short-term pleasure, but entering trades haphazardly can adversely influence your ability to maintain discipline in the long term. When you stop following your trading plans, you become rewarded for a lack of discipline and you may start believing that abandoning a trading plan is no big deal. An unjustified reward may increase your tendency to abandon trading plans in the future. You may be prone to think consciously or unconsciously, "I was rewarded once; maybe I will be rewarded again. I will take a chance." But the positive outcomes of undisciplined trading are usually short-lived, and a lack of discipline ultimately produces trading losses.
It is useful to distinguish justified wins from unjustified wins.
- A justified win is when a trader makes a very detailed trading plan and follows the plan. A win that results from following a trading plan is justified and reinforces discipline.
- An unjustified win occurs when a trader does not make a plan or drifts from the plan. He or she may be rewarded, but the outcome occurred by chance. The win is unjustified and can reinforce undisciplined trading.
Cultivating discipline is vital for consistent and profitable trading. Trading is a matter of getting the law of averages to work in your favour. One implements proven trading strategies, over and over, so that across a series of trades, the strategies work enough to produce an overall profit. It is like making shot after shot on the basketball court so as to accumulate a winning number of points. The more shots you take, the more likely you will amass points. But the winning player is the person who first develops the skill to make the shot consistently, so that at every possible opportunity, the ball is likely to go through the basket. To a great extent, consistency is key. If the player uses one approach one time and a different approach at another time, performance is haphazard. It is the same for trading. One must trade consistently, following a specific trading plan on each and every single trade. This allows the law of averages to work in your favour, so that across the series of trades, you will make an overall profit. If you follow the plan sometimes and abandon it at other times, you throw off the probabilities, and you are likely to end up losing overall.
With discipline comes profitability. Do not let unjustified wins interfere with your ability to maintain discipline. Follow your trading plan, and reinforce the idea that if you follow your plan, you will end up more profitable in the long run.
Staying calm through the ups and downs
Many novice traders ride an emotional rollercoaster, feeling euphoric bliss after a win, but overwhelming disappointment after a loss. Experienced professional traders, however, stay calm and relaxed even after a series of losses. They do not let the natural ups and downs of trading impact their emotions.
Ideally, the winning trader stays rational and unemotional, but even a seasoned trader can fall prey to emotional ups and downs occasionally. It is natural to question your method at times. "It is easy to start doubting my approach and wonder about the validity of what I am doing," said Manuel, a hedge fund manager. At the other extreme, it is also natural to become euphoric and feel omnipotent. "During winning periods, it is easy to become overconfident, and that can lead to trouble. While overconfident, I feel a false sense of security. I am tempted to take unnecessary risks, and I start to think that I do not have to do any more research to find and figure out new ways to extract money from markets. It is easy to fall into a sense of complacency."
Novice traders are especially prone to experiencing an emotional rollercoaster. They may not use proper risk management. They are prone to risking too much capital on a single trade. And when they take big risks, they are likely to feel overly ecstatic when they win big, but especially beaten when large amounts of trading capital are wiped out after a big loss. Through proper risk management, however, relatively little is lost on a losing trade, and that helps minimise the sense of disappointment after a loss. It is easier to stay even handed in terms of your emotions when your equity curve is smooth, rather than jagged due to extreme losses. Trading is a business. It is not recreational gambling. As a business professional, it is essential to maintain objectivity. The more objective you are, the easier it will be to creatively analyse market action and trade opportunities as they present themselves.
How does seasoned trader like Manuel control his emotions? He realises that his trading performance moves in cycles. Sometimes he is profitable and sometimes he is not. Gaining awareness of this fact helps him control his emotions. "I realise that if I have a big winning period that I should not get overly excited because, most likely, I will have a flat or losing period just around the corner. That is the way the market works. No style of trading makes money all the time. The odds are that after you have a big winning period, you will go through a period of losing money shortly thereafter. I try to make enough money to give myself a cushion to handle the losses when they come."
Trading can wreak havoc on your emotions unless you take precautions. Through proper risk management, though, you can control the extreme ups and downs that are inherent when you have your hard earned capital on the line. Winning traders, however, stay calm, objective, and rational. If you can trade in this optimal state of mind, you will increase your chances of achieving enduring financial success.
Risk tolerance: knowing your limitations and working around them
Winning traders know how to tolerate risk. Trading outcomes are far from definite, but they do not mind. They have no problem putting on trade after trade and doing so with grace and nonchalance. Not everyone can live up to this standard, however. Many novice traders have trouble taking a risk, even a small one. They either avoid executing a trade, or when they do, they find it excruciating to monitor the trade as they wait to see if their profit objective will be reached. Depending on your background and personality, you may have trouble tolerating risk. But do not let it dash your hopes of making profits. You can develop a way to work around a low tolerance for risk.
When you find risk taking particularly fearful, it is hard to concentrate. You are continually on edge and tempted to close out a trade just to end the uneasiness. Part of risk tolerance is biological and part of it is socially learned. Some people are easily agitated and once they become anxious, they find it difficult to calm down. They continue to remain anxious and on edge, even when a threatening event has passed. If you are easily agitated, it is useful to take precautions to reduce your propensity for over-stimulation. The mind and body go together and there are many ways to reduce your overall level of agitation. For example, if you exercise, avoid caffeine, meditate, eat nutritiously and get plenty of rest, you will stay more relaxed. That said, it is hard to fight biology. If you have always been the kind of person who gets anxious easily, you will have to find a way to work around this aspect of your personality.
If you find taking risks especially difficult and extremely anxiety provoking, you may need to adapt your trading style to fit your physiology. There is no one right way to do this. It depends on your preferences. But one issue to consider is the length of time you stay exposed to risk. The longer a trade, the more risk involved. Scalpers, for example, take minimum risk. They get in and get out of the market as fast as possible. Some anxiety-prone people may find this kind of fast-paced trading especially stressful, but others may find it appealing. You do not have to wait very long to see how a trade turns out.
At the other extreme, long-term investing can be another option. Some companies have relatively consistent long-term trends. By doing some simple homework, you can identify a few solid companies and use a buy-and-hold strategy. After you buy the share, make a conscious decision to restrict the number of times you look at the price. You might decide to look only a few times a year, for example. Looking at how the stocks are doing can be a lot like looking at a slot machine or roulette wheel. When you look at it, you will feel anxious as you anticipate what might happen. But if you avoid looking, you will see the grain of truth in the saying, "out of sight, out of mind." That is not all you need to do, however. You will also find it useful to put a stop loss in place to limit your risk. Defining the amount of risk you are taking up front will help you tolerate risk. (Remember, though, that you must account for volatility over the course of the trade. It is impossible to completely eliminate all risk. You must find a happy medium between getting stopped out too early or allowing your investment to fall in value to an uncomfortable level.)
There is one last thing you can do: Accept the fact that should the market go against you, you will definitely lose the portion of capital that is not protected by your stop-loss. In the end, you must accept that you may lose. One of the main reasons people have difficulty taking a risk is that they are afraid of the consequences of a potential loss. They wonder what they would tell their spouse or their parents should they lose. They wonder what they would need to do to make back the lost money. It is vital that you trade with money you do not mind losing. If you can truly believe that losing the money is no big deal, you will be able to tolerate the risk, even if you have extremely low risk tolerance. But if you cannot afford to lose the portion of your capital you are risking on the trade, do not risk it. You will never be able to convince yourself that it is a good idea, and if you have low risk tolerance, you will just be putting yourself in agonising pain.
Extremely low risk tolerance can severely hamper trading, but if you take the proper precautions, you can still trade profitably. By finding a trading style that suits your personality and only risking money you can afford to lose, you will feel calm enough to trade freely and profitably.
Making a strong commitment to succeed
Johan tells his trading coach, "Just show me how to make big profits. I am running out of time and money, and I just need to achieve financial success and get on with my life." Many would-be traders think this way. Trading coaches and instructors will tell you that of the masses that dabble in the trading profession, many do not want to put in the time and effort to master the markets. They are looking for a get-rich-quick scheme or they erroneously think trading is easy money. But making money in the markets cannot be approached like a hobby. You cannot take it lightly. Sure, you will make a few wins occasionally, but in the long run, you will end up losing more than you make. Some amateur traders do not care, and that is fine. They feed their trading account every month and see trading losses as the price they pay for entertainment, the same way visitors to Sun City gladly spend money on recreational gambling. But if you want to be a serious, active trader, you are in this business to make money, and that means making a solid commitment to achieving success.
Many would-be traders are afraid to take the profession seriously. They dream of making huge riches, but they are not willing to put in the time and effort to make their dreams come true. They fear that if they took an honest look, they would see what they needed to do, think it was too hard, and give up in defeat. For example, they do not do some simple mathematics and figure out if they have adequate trading capital. A trading account of only a few thousand Rand is not enough to make a living as a trader. Do you have enough trading capital to meet your financial objectives? You must save or raise adequate financial capital to trade seriously. You do not have it yet? That is all right. Get a second job and save up. Sufficient trading capital is vital. Make sure you have it. The issue of trading account size also applies to the professional trader. Professional traders must match their financial goals to their trading account size. You may need to raise more cash to make your trading business work. Instead of ignoring the issue, it is necessary to make the commitment to get the capital you need to make your chances of success realistic.
Trading capital is not all you need. You also need the right equipment: adequate computing power and solid, reliable methods. Money can buy you the equipment, but trading skills? That is where you have to make the largest commitment. You will have to study the markets, and appreciate the beauty in how they work. You must see them as exciting to the point that you would study market action even if they did not have a Rand on the line. Most traders fail because they just do not love the study of the markets enough. They are motivated by the goal of making huge profits rather than the process of trading. Trading is not a hobby or an easy way to pay the bills. It is a lifestyle, something you have a passion for. It may take years to master. Not everyone makes it within a few years, but that is all right. As long as you love what you are doing, you will achieve success in the end.
Success in the trading business means that you must make a commitment. Do not avoid making it. If you find yourself procrastinating, rather than learning how to trade, you may just be going through the motions. If you are committed to trading, you will find a way to make it. Perhaps, you may just start out paper trading or making small practice trades where you make a winning trade, but break even due to brokerage commissions. It is all right if your heart is in it. Spending money to learn to hone your trading skills is all right if you know that you are committed to mastering this field. But if you are just feeding your trading account to avoid facing the fact that you really do not want to trade, you are just wasting time and money. You are postponing your inevitable decision to give up. So get motivated. Get committed, and master the markets like a winning trader.
Visualising the trade
Before the market opens in the morning, John has clearly outlined his trading plan. He knows where he will enter the trade, and which signals will indicate that the trading plan has gone sour. But when he tries to execute the trade a few hours later, he cannot control his emotions. He enters the trade, the market moves against him, and he panics. Stuck and frozen, he does not exit the trade as he had planned. The market continues moving against him, and he loses more money than he had planned. Rather than unnecessarily mounting losses, Gary can improve his performance by visualising the trade before it happens.
Whether it is perfecting a golf stroke or improving a backswing, visualisation can be used effectively to fine-tune a variety of skills. Many winning traders use visualisation to prepare for a trade before it happens. In your mind, you can play and replay the trade. You can pretend to look at indicators on your screens and interpret the market action. You can experience the thoughts and emotions you will feel as you watch the market action. You can allow your mind to visualise the precise movements your body makes as you click the mouse. Visualisation is the next best thing to being there.
Visualisation is based on the principle that a great deal of learning occurs in your mind, even if the activity is largely physical rather than mental. When playing sports, for example, it is possible to actually improve your skills by mentally rehearsing each action. Your body and mind can learn just by going through the motions mentally. You can replay an action. For example, you can pretend a tennis opponent hit a ball toward you, and you can imagine graciously returning it. You can imagine what you are thinking and feeling. You can practice over and over, and as you do, you will hone your skills.
Visualisation allows an athlete or a trader to prepare for how he or she might react to different scenarios. In rugby, the fly half, for example, can imagine trying to catch the ball passed to him by the scrumhalf so that he can execute a drop kick. A trader can similarly imagine what it feels like to execute a trade when the market is going against him or her, for example. You can pretend it is happening and feel the initial disappointment you might have. But rather than act impulsively, you can visualise acting calmly, and closing out the position. In the heat of the moment, without practice, you may be stunned and paralysed.
With visualisation, in contrast, you can practice what you would do over and over again. You can practice monitoring your internal dialogue. You can practice thinking, "The loss is no big deal. I have used risk management to cover the loss. Losses are an everyday event when you are a trader. I will just stay calm and follow my trading plan." It helps to practice a stressful trading event in your mind before it happens. You will learn to control your muscles, your thinking, and your emotions. Why try to practice this complicated set of actions during the trading day when all you do is choke? Do it off hours to prepare for the trading day. By using visualisation, you can hone your trading skills during off hours until you trade calmly, decisively, and profitably.
Happy traders seek out balance
Trading is a challenging business. Only the most skilled traders can make a living as an active, full time trader. Trading experts suggest that novice traders approach trading the same way that students pursue their vocation in professional school, which requires a resolute dedication to hone their skills in order to move to the top of their field. The seasoned, professional trader has rare and valuable skills, like those of a lawyer or a doctor. You have to limit your social life and focus on developing your skills if you want to be at the top of your class. Think of the interns and residents on the TV series "E.R." or the law students on the "Paper Chase." They focused all their efforts on learning about their profession, even if it meant sacrificing their social life. It required a life with little balance between work and pleasure. Is it a good idea? It depends on how much happiness you want in your life.
In an interview in the "APS Observer," Professor Laura King, a psychologist at the University of Missouri, Columbia, was asked how graduate students could make the most of the current lives. She said, "Enjoy the process as much as you can and try to maximise your positives by readily dedicating yourself to the goals that are likely to be rewarded." This advice is true for trading as well as for students in graduate and professional school. It is vital that you enjoy the process of trading, but should it be your ison d'être? Maybe not. Professor King suggests, "I am not one who thinks that graduate school is not a time to have a real life. You may have to keep it a secret, but have a life."
Many novice traders work under the assumption that because they are putting their money on the line to pursue trading, they should give it their all. Is it necessary? A study was conducted and it suggested that it is not. A group of traders was asked to fill out a questionnaire regarding their emotional mood. The sample was divided into happy and unhappy traders and they were compared. Compared to unhappy traders, who reported a tendency to feel disappointed, frustrated, and discouraged, happy traders reported that they enjoyed the process of trading. They liked the intellectual challenge trading provided. They enjoyed learning about how companies made a profit. They enjoyed learning about new investment (https://www.psg.co.za/wealth/investments) strategies, and enjoyed learning about how people made money in the markets.
These responses are consistent with Professor King's suggestion to "enjoy the process." When asked if they allowed their personal relationships to suffer as a result of devoting too much time and energy to trading, the answer was "No." Happy traders were clearly dedicated to honing their trading skills, and enjoyed doing so, but they did not allow their relationships to suffer as a result of their dedication. There is a valuable lesson to learn: Pursue trading earnestly, but also seek out psychological balance. Do not think that trading must be your whole life. Spend time with family and friends. That is what happy traders do.
Appreciating the beauty of the markets
Have you ever had one of those days where you wished you had stayed in bed rather than executed your first trade of the day? Perhaps you excitedly put together a trading plan the night before only to get a poor fill when the markets opened the next morning. Maybe you were just in a bad mood and frustrated that nothing was going right. Some seasoned, trading experts warn against trading while upset or frustrated. You may be prone to making mistakes. Many times, it is better to just stand aside. But walking away can make you feel as if you have been defeated. And if you stand aside too often, you may feel as if you are not giving trading your best shot. It can feel as if you are prematurely walking away from a challenge rather than gaining new experiences or learning how to overcome new obstacles. It may not be a good idea to stubbornly try to trade in market conditions that are not conducive to your trading style, but there is a compromise: You can move from a "doing" mode to a "being" mode. Rather than force yourself to actively trade, you can just relax and appreciate the complexity and beauty of the markets.
During the trading day, and often during off-hours, we are consumed with doing whatever we can to make a profit. We plan, anticipate, and find solutions to trading problems. We search for a winning trading strategy, even if it means ineffectually coercing ourselves to find a way to profit from the market action. But trading is a creative endeavour. It is a combination of looking for historical chart patterns and using your intuition to decide whether history is actually going to repeat itself at this time and at this moment. When it comes to using your intuition and creative skills, you have to be free, open, and ready to accurately perceive what the markets are doing. It is an art. You cannot force yourself to be creative. You have to let a creative idea come to you. But when you are upset, frustrated, and forcing yourself to find a winning strategy, you often choke under the pressure. You are closed off. You cannot see what you need to see.
When you are having a bad trading day, you cannot see clearly. You can be stuck in a "doing" mode, trying to take action, and frustrated because you cannot figure out what do to next. You can get caught up trying to find solutions and taking decisive action, and get mentally overloaded with details. You are overly emotional. You are frustrated and overwhelmed. When things get that bad, you just cannot think clearly enough to actually take action. The solutions to problems do not come easily, and it is quite possible that you will make trading errors. Is it time to give up? Maybe. But an alternative is to move from a "doing" mode where you are trying to take action to a "being" mode. Rather than trying to execute a trade, which is the main concern of the "doing" mode, you can try to merely observe and study the markets. Rather than try to take charge, you can be a mere observer. Rather than pushing yourself to figure out what trade to execute in the next few moments, you can settle for merely observing the markets. You can take a rest, relax, and just study the markets. When you fully commit to avoid making a trade in the next few moments, and are content with merely being a student of the markets, you will free up psychological energy. As you start to calm down, your creative juices will flow freely again. Suddenly, solutions that eluded you in the "doing" mode become obvious while in the "being" mode. You will once again feel free and creative, and when your head is a little clearer, so are your perceptions and intuitions. Soon, you have moved from mental stagnation to trading in the zone.
So if you find yourself frustrated and stuck, and fruitlessly trying to push yourself to the limits, stop. Allow your mind to step aside. Breathe freely and relax. There are times when you have to just stop and appreciate the complexity and beauty of the markets. When you do, you will naturally see new ways to trade freely, calmly, and profitably.
Do not make the odds even lower
"How many novice traders succeed?" asks a would-be trader of a group of seasoned experts. "Of the 40% who last about a year, only one or two become consistently profitable," answers the head of a major brokerage. "About five out of 100 is what I have found," remarks a top trader at a leading hedge fund. We have found that less than 25% last about six months. There seems to be a wide consensus: If your plan is to become a full time trader, the odds are against you. So one thing that you do not want to do is make the odds even lower. Here are a few of the ways that newbie traders can avoid common mistakes and beat the odds.
- Control Overconfidence: You have got to be optimistic: A pessimist could never face the dismal odds of success. But you must use your optimism effectively. Do not arrogantly think you know how to trade before you have built up the necessary skills. Study, practice, and learn. Set learning goals, rather than performance goals. In other words, reward yourself for learning techniques at first, and when you are ready, you can set an overall profit goal.
- Admit that You are Gambling and Limit Risk: Stock brokers and other members of the investment community think that they derogate traders by calling them "gamblers," but seasoned traders just admit it: "We are gambling," they freely say. Hey, there is risk involved and you better admit it. Traders are going for the big profits, and they are ready to take the responsibility. However, the difference between the professionals and the amateurs, whether trading or gambling, is that risk is carefully managed. Since you are trying to capitalise on winning odds, it is vital for your survival to anticipate a string of losing trades. That means looking at the risk to reward ratio before entering a trade, making sure that you have got a large enough account to take the risk, and if you do not, stand aside and wait for a trade you can take. Risk management is a trader's secret weapon.
- Use Sound Trading Strategies and Know When to Move On: This is so much easier said than done. Obviously, you cannot expect to profit if your trading strategy is flawed. But the hard part is knowing when it is flawed or just not working because of less than optimal market conditions for that strategy. All the trading books and experts warn, "Do not abandon a trading strategy prematurely." It is not wise to jump from strategy to strategy, but what is "prematurely"? Based on probability theory, even a winning strategy can produce a string of losers and a severe drawdown, so sticking with a sound strategy too long when it is not working is going to wipe out your trading account. So we are all walking a fine line. Perhaps the best you can do is decide how much of your trading capital you will risk on the strategy up front, and if you lose that predetermined stake, just move on. Also acknowledge the complexity of the markets. Know the market conditions that are necessary for the strategy to work, and make sure that those conditions are present. But in the end, there is no substitute for trading experience in terms of knowing how long to stick with a trading strategy before abandoning it.