Focus your energy on what’s important
Letting go of the outcome
You cannot control the outcome, but you can control your actions and emotions
Do not focus on the $ and P&L fluctuations
Sports analogy: Don’t focus on the score!
Big picture: individual trades do not matter
Read more: Is Trading really Risky like Gambling? (How to Trade Like a Casino)
If you would like to learn more about trading psychology, also check out: “The Complete Guide to Investing & Trading Psychology”
Do not take profits until there is a good reason to do so
The Chicken parable
Do not count your profits until they are realised
Accept that you will have to give some profits back to the market
Do not become complacent or greedy after a huge windfall or winning streak
If you would like to learn more about trading psychology, also check out: “The Complete Guide to Investing & Trading Psychology”
Trade what you see, not what you think
Being objective despite having open positions
Anticipate, but only act when market confirms your opinion
When you see danger, get out first!
Clear all positions to have a neutral frame of mind
If you would like to learn more about trading psychology, also check out: “The Complete Guide to Investing & Trading Psychology”
Many new to trading have the tendency to liquidate positions that show a small profit, yet they keep those positions that show a loss as are unwilling to take a loss, in hope that prices will rebound.
Such a counter-intuitive strategy will result in small wins and large losses, but why do people still do it?
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Given a choice, which would you pick? (Profits)
Given a choice, which would you pick? (Losses)
Mathematically, both choice in each scenario give the same expected value, E(x).
You can calculate this by taking (% chance of 1st event x value of 1st event) + (% chance of 2nd event x value of 2nd event).
For example in the first question, (50% x $2000) + (50% x $0) = $1000, which is equivalent to the sure profit of $1000.
In the second question, (50% x -$2000) + (50% x -$0) = -$1000, which is equivalent to the sure loss of $1000.
However, most people will pick option 1 for the first question (profits), and pick option 2 for the second question (losses).
Why is this so?
With its roots from prospect theory, this refers to investors’ tendency to strongly prefer avoiding losses to acquiring gains.
For loss aversion, investors prefer an uncertain gamble to a certain loss as long as the gamble has the possibility of no loss, even though the expected value of the uncertain loss is lower than the certain loss.
For the breakeven effect, investors prefer a gamble that offers the potential of recovering to finish at an aspiration level rather than a certain rate of return.
Some studies suggest that losses are twice as powerful, psychologically, as gains.
Hence, investors will cling to the hope (including rationalization) that prices will rebound to their entry price, which they have now established as a reference point.
However, this reference point is illogical, since their entry point does not affect the future direction of prices.
One question to ask is, “if you don’t have a position now, would you open a new position?”
If prices fall past their stoploss (showing that their analysis was wrong), it means that the odds are now against them.
If prices fall but do not hit their stop, and subsequently rises back to breakeven, it actually shows that their initial analysis is still correct (not proven wrong), which means that exiting at breakeven is in fact destroying their winning trades.
This will lower their hitrate by causing them to exit winners prematurely.
According to the disposition effect, investors are less willing to recognize losses (which they would be forced to do if they sold assets which had fallen in value), but are more willing to recognize gains.
This can be explained by the value function curve, where investors turn more risk-seeking as the stock depreciates.
As shown by studies on ex-post returns, it would be more profitable to cut losses fast and let profits run.
Hence, investors should treat unrealized losses as a sunk cost, and focus on reducing prospective costs (likelihood of more losses).
Unfortunately, irrational hope destroys any edge their analysis provides, thus resulting in an unfair gamble.
Before taking any trade, you should already have the exact risk of the trade defined in the trading plan.
This means that you know in advance exactly how much you are risking on each trade, and exactly how much you will lose if the trade goes against you (and hits your stoploss).
Theoretically, this should prevent anyone from having large losses. But why does it not work for everyone?
The problem lies not in the theory or the trading plan, but in the person.
There won’t be any problem if you just stick to the plan, and watch the trade play out, even if it hits your stoploss.
However, most people do not have the mental ability to accept loses. Most people are conditioned to embrace winning, so they cannot stand losses.
For example, if you have calculated that the risk on a trade is $200, and you go ahead and place the trade, you know that in the worst-case scenario, you will only lose $200 of the trade hits your stoploss.
But the question is, deep down in your heart, have you really accepted that risk (potential loss)?
You will find out the answer when price comes close to hitting your stoploss.
If you have truly accepted the risk, and trust your analysis and trading plan, you will be able to sit there calmly and wait to see if your stoploss gets hit.
On the other hand, if you have not fully accepted the risk, then once price comes close to your stoploss, you will start second-guessing your plan:
If these are the thoughts running through your head, and you feel extremely stressed and end up watching prices like a hawk, then it means you have not truly accepted the risk of trading.
You cannot expect to win 100% of the time.
So in order to win in the long run, you have to accept that you will lose some of the time.
There are actually 2 main goals of the stoploss:
As we mentioned earlier, once you have learnt that losses are part and parcel of trading, and that you cannot win without the risk of loss, you will come to truly accept the risk of each trade.
Once you have that acceptance, the stoploss will no longer be a source of stress, and instead give you a peace of mind.
Because you will no longer have to monitor your trade 24/7. Once you place your trade, you can just walk away from the screen because you know exactly how much you can lose, so there is no fear of “blowing your whole account” on a bad trade.
If you follow your trading plan, it will help you get out when the loss is small. It is better to take a small loss than a big loss.
One of the most dangerous thing you can do as a trader is to average down and hope to get out of the trade at breakeven.
Averaging down refers to adding new positions to a trade that has gone against you, so that you can get in at a “better” price. This increases your risk several fold, depending how how many times you continue to average down, and turns a small loss into a big loss.
This is just another way of trying to avoid losses. (Which shows you have not truly accepted the risk.)
Traders should keep mind that trading with an edge will increase their wealth over time, but it is not possible to be right on every trade. The number of times you win or lose doesn’t matter.
It is how much you lose when you are wrong and how much you win when you are right that matters.
One should also separate decision-making from execution, meaning to “plan the trade” and “trade the plan.”
This means creating the plan during a low-stress period (when the market is not open), and sticking to the plan during a high-stress period (when the market is open).
Make sure you really trust and commit to the plan, and accept the downside risks, before you even place the first trade.
A good way to manage risk is to use a stoploss to limit your downside, and pick trades with good reward-to-risk ratio so that the profits from your winning trades will be more than the losses from your losing trades.
This will allow you to cut your losses fast, and let your winners run.
If you would like to learn more about trading psychology, also check out: “The Complete Guide to Investing & Trading Psychology”
Timing is an essential element in trading and investing.
For any product or market, if you buy and sell at the right time, you can make a lot of money, but if you get the timing wrong, you can also lose a lot of money.
And to get this timing right, you need to have the discipline and patience to WAIT for the right timing.
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In trading, there is a time for action, and a time for inaction.
Unfortunately, for most people, they cannot stand inaction. Or perhaps they think that trading should be full of action.
Hence they keep trying to find opportunities to take action, even if they opportunities are not the best opportunities.
Let’s be honest, good opportunities are rare. And best opportunities are even more rare.
Trading is 99% waiting (and researching), and 1% action (executing the trade).
If you are doing the opposite, then you will end up with a lot of activity, but very little profitability.
As a trader, we should approach trading like a sniper. (As opposed to wielding a machine gun.)
Back when I was doing full-time proprietary day-trading, we had to watch the markets closely for hours to wait for the best trading opportunities.
Sometimes, we could be eyeing a big juicy trade, and we all knew it would likely be the trade of the day.
It could be an unscheduled news announcement, price taking out a key level (breaking support/resistance), or a pullback opportunity to enter a trend.
Whatever it was, the event usually happened quickly, hence the window of opportunity is usually very small. So we would all wait patiently for this trade, while monitoring the prices.
Now here’s the tragic part.
After waiting for hours, you suddenly have to go to the restroom.
So you rush for a 5-minute toilet break and dash back to your trading desk, only to find that the event you had been waiting for happened while you were in the toilet.
Maybe the breakout happened and the price has gone up a lot from your original planned entry price.
The big question is, will you still want to take the trade even though it is no longer optimal?
Would you want to chase this trade?
Many people would, but it is a bad idea.
Because it causes you to deviate from your trading plan.
And when you end up taking sub-optimal trades, you end up with sub-optimal results.
It is painful, but it would be wiser to pass on this trade, and wait for the next better opportunity.
After all, it is better to miss the boat, than to leave on one full of holes.
Now you might be wondering, what’s the link between entry timing and risk management?
If you execute a trade according to your trading plan, you should already have a planned stoploss for every trade.
So if you make an entry using the entry price on the trading plan, then risk management is easy because you can just use the planned stoploss.
However, if you deviate from the trading plan (eg. chasing a missed trade), then the plan becomes useless.
For example, if you planned to go long, with a reward-to-risk ratio of 2:1, but you entered late, and price has already gone way above your intended entry price, where are you going to place your stoploss?
If you use the old stoploss price, then you will have to adjust down your lot size, otherwise your risk will be higher than your intended risk.
And even if you do that, your reward-to-risk ratio is now less than 2:1, so is this still considered a good trade?
We all hate losing money, and hence we sometimes get trigged emotionally by losing trades, and end up in a downward spiral of bad decisions.
Here are 2 common self-destructive behaviours:
This usually happens due to greed and hope, where people are afraid of missing out (FOMO), so they start to see every trade as a great opportunity, and want to take as many trades as possible.
When this happens, they usually do not bother to follow their trading plan (assuming they have one in the first place) or do any research, and usually just go with “gut feel” to justify their trading decisions.
To be honest, this is more like gambling than trading.
If you are new to trading, and you start finding trading opportunities on every chart you see, then you might want to watch out for impulsive trading.
Make sure you stick strictly to your trading setups, and avoid using random chart analysis to justify your impulsive trades.
This usually happens after a particularly unlucky trade (price almost hitting your target then reversing to hit your stoploss), or a string of losses.
People start to feel cheated or angry, or their ego might hit take a hit after this string of “failures”.
As a result, they take more trades because they want to win, in order to “take revenge on the market”, or “teach the market a lesson”.
At this point in time, they obviously no longer follow the trading plan or any risk management, and trading in this bad psychological state will often result in even more losses.
This is why it is often a good idea to take a break from trading after a string of losses, so that you can mentally recalibrate yourself.
In the next chapter, will learn how to deal with losses in a constructive and beneficial way.
If you would like to learn more about trading psychology, also check out: “The Complete Guide to Investing & Trading Psychology”
