Lessons from the Pros

India Markets

The Mental Game

When people ask me what training has helped me become successful as a trader, they are usually surprised to hear that it is my background in psychology. Of course, the ability to read price and understand technical indications is important, but even those traders who have well thought out trading plans will fail if they cannot execute properly.

We are all human, we have emotions and thoughts that need to be properly recognized and understood before we can excel in trading.  Most students of Online Trading Academy and even many traders will be able to answer correctly when asked, “What are the two biggest motivators in trading?”  The answers of course are fear and greed.  But how many of those same traders are able to recognize when they are trading with those emotions rather than on logic?

Think of the trader who bought a stock at Rs. 800 and watched it rise to Rs. 900.  They would be happy wouldn’t they?  Now what if the same trader held onto their position expecting more gains but instead saw the stock price drop to Rs. 850?  What do you think goes through the mind of a typical trader at this point?  What would go through your mind?  Most would think, “Darn, I just lost Rs. 50 of profits.  I’d better hold on and wait for it to come back.”

That is exactly the flawed thinking that hold many back from success in the markets.  Remember, the trader bought the shares at Rs. 800 and could now sell for Rs. 850!  That is a Rs. 50 per share gain, not a loss.  Often, our greed takes over and we end up holding onto shares longer than we should or even need to.  This also works in the opposite scenario where a trader maintains a losing position for fear of actually realizing a loss or due to faulty thinking that the position is bound to turn around at some point.

Do you know the trader’s definition of an investment?  It’s a day-trade that went wrong.  I am often asked by students and traders alike for advice on what to do with certain longer term positions or investments.  10 times out of ten those positions are in the red, (apparently no one needs help when holding winners).  Many of these positions were profitable at one time but were held until they dropped.

I am not in the habit of giving financial or trading advice.  I offer education and do the same when presented with this question.  I ask the person, “If you didn’t have this position currently, would you enter the security in the same direction now?”  It seems like a simple enough question.  However as humans we have the endowment effect.  We do not like to be wrong and we inherently believe that possessions we own are superior to others.  We do this with houses, clothes, cars, and even stock positions.

It is not easy, but you must evaluate each existing position independently from the current price, not your cost basis.  If we try to evaluate it from where we entered, we will typically seek out only information that supports our position and rationalize or even ignore information that tells us we are wrong.  This is called confirmation.  The fact that it has a name, tells you how common it is and how dangerous this psychological phenomenon can be.

We need to trade as logically as possible.  This starts from having structure in our trading.  At Online Trading Academy, we build that structure by teaching rule based trading strategies.  We then supplement that education with trading plans.  It is furthered by the examples given in the Extended Learning Track (XLT).  To truly be successful, you need the plan and the discipline and trust to follow that plan.  Overcoming your psychological traps can help you greatly on your path to trading success!

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

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