Going Mental!

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 the best plans and 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 $35 and watched it rise to $40. They would be happy right? Now, the same trader held their position expecting more gains, only now the stock price has dropped to $37. What goes through the mind of a typical trader at this point? What would go through your mind? Most would think, "Darn, I just lost $3 of profits. I'd better hold on and wait for it to come back."

That is exactly the flawed thinking that holds many back from success in the markets. Remember, the trader bought the shares at $35 and could now sell for $37! That is a $2 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 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. Ten times out of ten, those positions are in the red (apparently no one needs help when holding winners). Many of these positions are just barely reaching their pre-2008 levels, or are still greatly down.

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 the 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) program. To truly be successful, you need the plan and the discipline and trust to follow that plan. Do this to keep from going mental in your trading. Until next time, trade safe and trade well!

Have a great day.

By Brandon Wendell, Online Trading Academy Senior Instructor and Trader Mentor