But it’s not just the human need to be right that makes trader psychology such a complex battle, it’s that other great power of the human mind—the power of rationalization. This is a topic I’ve already touched upon, but it’s worth another quick look from a slightly different angle.
In the film The Big Chill, Jeff Goldblum’s character discusses this subject in a particularly salient manner.
Michael: Don’t knock rationalization. Where would we be without it? I don’t know anyone who’d get through the day without two or three juicy rationalizations. They’re more important than sex.
Sam: Ah, come on. Nothing’s more important than sex.
Michael: Oh yeah? Have you ever gone a week without a rationalization?
Rationalizing the events on your screen means rewriting the story of what’s really happening in a way that feels comfortable to you, that makes your position seem like the correct one. “This trade isn’t going to go against me for long,” thinks Joe Trader. “They aren’t going to shake me out!” And if it works out, Joe Trader compliments himself for being the genius that he is. He just knew it would work out, especially this particular trade. Call it a gut feeling. And, of course, since it did work out, it just proves that his analysis was spot on. “You know,” he muses, “I think it’s time for me to up my trading size on this next one.”
People can gloss over reality in nearly all areas of their lives, reshaping their interpretations of events to put themselves in a favorable light and keep their pristine image intact. After all, it’s okay to ignore your kids when you’re on the computer if you’ve got VITTD (very important things to do)—or so goes the rationalization. None us wants to admit when we’re being a shitty parent.
In trading, however, at the end of the day, the result is right there on your profit-and-loss (P&L) statement. No matter how “right” you persuaded yourself you were, a loss that was incurred when you were trying to prove yourself right is still a loss, and your story doesn’t mean a thing to a neutral-minded market. The P&L statement is the great equalizer. It reveals you for who you really are, and in many instances the picture isn’t pretty. Unfortunately, most people would rather do anything other than confront themselves or their ideal image of who they are. It’s not fun. Believe me, I thought I had much better qualities as a person before I got into analyzing my trading personality. And this is why trading has such a high failure rate. Flaws explode onto the P&L statement. They must be addressed—not just in theory, not just through a few notes in a trading journal, but in practice, on every trade. The game changed for me when I committed to becoming a better trader on every trade, as opposed to rationalizing why I was right on every trade or getting caught up in my own idea of the hero’s journey by hanging onto a loser for the sake of the drama and chasing the feeling of victory I craved.
The first psychological issue that traders find themselves butting up against is addiction. When people hear traders talking about addiction, they often think about gambling. Addiction in a trader refers to the rush of placing the trade, and the anticipatory thrill as a trader establishes a position and hopes that it goes his or her way and brings in tons of cash. Yet that all pales in comparison to the addiction to being right or, worse, not being wrong. It drives human behavior into the realm of absurdity. When we dive deeper, addiction, any type of addiction, whether it is to alcohol or work, is just a way to numb painful emotions we don’t want to face. I think it is important we realize this and own up to it for our own sake.
For example, placing a trade that will make money, as long as that market doesn’t crash overnight, is a reasonable setup and a reasonable assumption. Stops can be used. Risk can be assessed. In the early morning of January 17, 1995, an earthquake hit in Japan, causing its stock market to take a nosedive. One particular trader saw this unfolding, watched his losses mount, and started doubling and tripling up in order to recoup his position and make money on the trade by bringing down his average cost. When the bounce failed to materialize, the trader, Nick Leeson, bolted out the door, leaving a note that said, “I’m sorry.” This trade lost $1.3 billion and bankrupted Barings Bank. Although this is an extreme example, it happens every day around the world with much smaller accounts. Maybe $5,000 doesn’t seem like much in comparison, but if that is your entire trading stake, losing that amount can be just as devastating as losing $1.3 billion. Okay, maybe not quite as devastating, as you could get another $5,000 with a credit card advance, but you get the idea. (See Figure 2.2.)
I’ll mention this book a few times as it is one I’ve found very helpful in my own life. It’s called Letting Go: The Pathway of Surrender by David R. Hawkins. It’s one of those books where I feel lighter, and experience more freedom, every time I read the first few chapters or listen to it on Audible.
In many facets of life having to do with careers, an addiction to being right is a strength. It forces us to work harder to meet our goals and to prove to ourselves and to others that we can, in fact, accomplish what we’ve set out to do. It can cause us to view a potentially devastating setback as a mere learning experience, and onward we go, dusting ourselves off and getting back on the horse for another ride. It’s like the movie Rocky every trading day. No one thought an uneducated but kind-hearted debt collector for a loan shark could get a shot at the world heavyweight championship. But he did, and he proved that everyone was wrong and showed everyone that he was right, and it made a great movie. It’s a fantastic life lesson in persistence and in following your dreams.
But if you try that in trading—try holding on to a losing trade until it turns back into a winner, just so you can prove to everyone that you aren’t wrong—you’ll get your ass handed to you. Maybe it won’t happen on this current trade and maybe not on the next one, but it will happen, and it will lead to a blown-up account. True, not many of us will ever bring down a bank, but wiping out your life savings is a close second. Trading is the only profession that punishes tenacity by taking your money. Be tenacious in learning how to become a better trader, not in proving that you’re right on this current trade.
Trader psychology is one of those subjects that doesn’t seem to matter until it really matters. You think the issue will never arise, or it won’t apply to you, or you’ll figure it out before the moment of truth. However, that moment of truth tends to happen at the least convenient moment, typically when things are about to go from bad to much, much worse, like when you’re changing a flat tire or when your three-year-old daughter yells out in the middle of traffic, “No, Dad, I have to go poop now!” It’s one thing for your daughter to say she has to poop in the car, but it’s a whole new ballgame when she actually cuts one loose.
The term itself, trader psychology, inevitably gets thrown around with greater and greater frequency as a trader nears the goal of trading the markets successfully, because the closer a trader gets to being consistent, the more apparent it becomes that his or her greatest enemy is rarely the individual on the opposite side of the trade. Far more often—as is the case in so many aspects of life—our worst enemy is the person looking back at us in the mirror each morning. Unfortunately, most traders, myself included, never realize this until they blow out an account. “Wow,” they say, “I didn’t think that would ever happen to me.” Seasoned traders call this the price of tuition.
The stupid thing I did was sit back and say, “Gee, I managed to take $10,000 and turn it into a little over $100,000. Now I’m going to try to take this remaining $100,000 and turn it into $1,000,000. Let’s do this!”
The first time I tried this, the experiment ended quickly, much like taking a Band-Aid and ripping it off with a flick of the wrist. It took all of six weeks to grind my capital down from $100,000 back toward the neighborhood of $10,000. Sure, it surprised me, but I chalked it up to bad luck. I rolled up my sleeves and went back to work. About a year later, I had built up my account to just over six figures, and then I paused and did the same thing. First, I took money out to buy real estate. Next, I decided to try turning $100,000 into a million dollars yet again. This time I lasted four months, but the result was the same: back to $10,000 and change. Hmmm. Third time’s the charm?
A few years after graduating from college, I was engaged to be married. I was in a nice swing trading rhythm. I had built up my small stake back into a $150,000 trading account. This time I decided to “chill out” and just trade for income, as opposed to going for a million dollars, as that didn’t seem to be working out too well. I took modest profits out of the account at the end of the month as income, proving to myself that I could be consistent, and I was getting closer to my goal of quitting my job as a financial analyst to become a full-time trader. At the time, my fiancée and I were living in Austin, Texas, but we were contemplating a move to Korea to teach English and just to try something different. We thought it’d be a bonding experience.
Then the company I was working for offered me a promotion and a transfer to Minneapolis, Minnesota. We thought about it, and in our youthful “wisdom” decided that Minnesota was probably a lot like Korea— cold. We moved to Minneapolis in the mid-1990s, during two of the coldest winters in the history of the city. Outside our apartment, the wind chill hit 40 degrees below zero, and our cars wouldn’t start. Inside our apartment, my fiancée, who had never seen snow before, sat. She was miserable.
I took taxis to and from work and came home to find her in the living room with a mask over her nose, sanding the apartment walls for the second time. Even I could see that she was going stir crazy. Then she issued an ultimatum: “Get us a house with a garage so that our cars will start; we’re getting the hell out of here.
It took a few months, but by May, just as the snow had melted, we found a house with a heated garage. I’d never heard of such a thing, but it sounded like the right thing to have. I planned to put down $30,000 at closing. About a week before closing, I sat and stared at my $150,000 trading account and wondered how it was going to affect me—psychologically—to take my account down to $120,000. I was in a comfortable rhythm. The money I was pulling out of my account I mostly put into rare coins that I planned to hold for years, so I didn’t have a lot of liquid assets other than my trading account. I liked my account size. I didn’t want to change it. I had only a week before the closing to decide what to do.
As I thought about it more, I chose to make just one big trade, enough to earn $30,000 so that I could take out the down payment and still maintain my $150,000 trading account. It was so logical that I truly thought it was a genius idea. I would do one of my normal setups—just with a much bigger size. And I would watch it like a hawk. I started flipping through the charts, and there it was. The OEX S&P 100 Index Options was knocking up against a serious downtrend line on the daily charts.
The next day at the office, I set up my laptop, poured myself a cup of coffee, and watched the charts. (By this time I’d been promoted into my own office, so it wasn’t difficult to do some swing trading while I worked.) The market started to rally, and it hit right into that mega-downtrend line. My heart rate quickened. I phoned my broker and bought 100 OEX puts at $8.00. Immediately, the market came down, and in 20 minutes I was up $10,000.
I thought, wow, this is going to work out faster than I’d hoped! The next thing I saw was a small kickback rally that brought new highs, and the options dropped to $7.00. I believed this was the deal of the century. I mean, I loved them at $8.00! I called my broker and bought 100 more puts at $7.00, which put my entire $150,000 into the trade. I skipped meetings and didn’t go to lunch. I did not take my eyes off the screen. By the end of the day, the market had edged down off its highs and I went home with an open position that was up around $12,000. I wasn’t going to take home a loser, so this fit into my plan of taking a “green” position home overnight. In fact, my thought was that I could close out this trade at the open, hit my goal, and live happily ever after.
But when I woke the next morning and turned on CNBC, I saw a green arrow indicating that the Dow futures were up +130 points. I turned off the TV, shook the remote, and turned it back on. The green arrow was still there. Ouch. I was hosed. I’d been trading long enough at this point to realize a couple of things:
I wasn’t going to make $30,000 on this trade.
My main goal now was to contain my losses.
I knew that this opening gap had a high probability of retracing half its opening range (to where the Dow was only up +65). I calculated that if I sold my puts at that level, I’d be out with about a $20,000 loss on the trade.
I got to my office. I turned on the charts. I watched and watched, and I waited and waited, but the retracement never came. Dazed, I stared at my account. The next day the markets gapped up again and rallied. For good measure, they did that for the following two days as well. I don’t remember this time at all. I do remember at some point that it was the day before we were supposed to close on the house, and I needed to sell out my position so that I could have money to buy the house. I had no idea what the options were even trading for. (I couldn’t look.) I just told my broker to sell. By the time the dust settled, I was able to check my account balance. I noticed that my $150,000 trading account had evaporated into the tidy sum of $8,000 and change. At this point I did what any man in his right mind would do—which means that I sure as hell did not tell my fiancée. For good measure, I stared at the charts a little longer. Maybe I was only dreaming this and I would wake up at any moment.
Finally I got up, went to the bank, and maxed out my credit cards in order to get the down payment. I went to the closing and handed over the $30,000 check, at which point the mortgage officer said, “Wait. I thought this was coming from an investment account. We need to see where this money came from.”
I acted ignorant. “Uh, what are you talking about? There’s the money right there. Right in front of you.” My real estate broker started to get angry at the closing agent (he didn’t know what was going on). An hour later, the agent finally allowed us to close on the house. I kissed my fiancée good-bye (she had no clue what was going on), drove to the par 3 golf course down the road, and attempted to play a round of nine holes. I drove. I chipped. I putted. And I threw up. I did that for five holes. My nerves were shot, and I felt horrible. After I’d calmed down, I asked myself, “What do I want?” I knew I could raise another trading stake. All I had to do was sell one of my real estate holdings. But did I want to continue to go down this road of uncertainty? How could I quit my job and rely on a trading income if I did stupid crap like this?
I loved—and still love—analyzing the markets. I love placing and managing the trade. It’s an intellectual challenge. And it’s an emotional challenge—not letting your emotions actually zip down your arm and into your fingertips and onto the keyboard. But most of all, it’s where my passion lies, and where it has lain since I placed my first trade.
Still, I decided that I wouldn’t trade again until I figured out what I’d been doing right and wrong up to this point. I knew I could make money trading—why couldn’t I keep it? For the next year, I thought, studied, talked to other successful traders, and read.
During this time I came across a book by Mark Douglas called The Disciplined Trader. This book was a real eye-opener in that Mark showed how to turn everyday stressful trading situations into “normal” trading behavior. His follow-up book, Trading in the Zone, is also excellent. His books have had a huge impact on me, and they are required reading for anyone I’m working with. Mark’s insights, as well as my long discovery period, finally gave me the answer: whenever I focused on the setups and not the results, I did fine. But whenever I focused on the results and not the setups, I got killed. Why is this? Once I got my hands on a decentsized trading account, I would start to think: “I want to turn this account into a million dollars.” Or even better, “I just need to make a quick 30 grand for the down payment on the house.”
Instead of focusing on the setups, I was focusing on making a million dollars or, in the case of the house, a $30,000 down payment. This caused me to jump into the trading habits that ruin all traders: betting it all on one trade, not using a stop because the trade “had to work out,” and focusing on making a million dollars instead of waiting patiently for a high-probability trade setup. All of these habits guarantee trading failure in the long run. Yes, it would have been easier to just blame it on my mother for hitting me with a wooden spoon once when I was a kid, but at some point we have to step up and take responsibility for our own actions. By focusing on “making money,” a trader will see a lot of opportunity where there is none.
Once this revelation sank in, I started to do two things differently:
First, I started wiring any profits out of my trading account at the end of each week. This kept me focused on producing a smaller, steady income, as opposed to making a grand killing. I later refined this and today call it “cash flow trading,” and I’ll talk more about this specific trading methodology shortly. (In trading, there is trading for cash flow and trading to create wealth; they are very different.)
I also discovered that wiring money out was a great way to protect profits. The market can’t have them if they’re safely tucked away out of reach. I use these profits mostly for longer-term investments like land and gold. But I also set aside some of the money for fun and interesting experiences—after all, we’re only here once, as far as I know, and at the end of the day, it’s the memories that stick with us, not the things we buy. And one important thing I realized from another successful trader is that there is no need to trade every day. I started to notice that there were days when I didn’t take a trade—not because I didn’t want to, but simply because the setup I was waiting for didn’t occur. This turned me into a more relaxed trader as I no longer experienced FOMO: Fear of Missing Out.
Second, I started a competition among the various setups I used. This way, I could measure the performance of every one of my setups at the end of each month. The setups that made money I kept using. The setups that lost money I dumped. This was incredibly important to my trading. The only way I could keep my competition going was to execute my trade setups the same way every time. I did this in blocks of 25 trades. This had the added benefit of removing much of the importance from any trade I happened to be in at the time. It was just “trade 13 out of a series of 25”— no big deal. Any time I deviated from a standard setup, I marked this down in my trading journal as an “impulse trade.” I kept track of my performance on these, too. After about six months of tracking my impulse trades (wow, this market is going higher; I must get in), I realized that they weren’t making me any money and were in fact preventing me from making a living as a trader. Yes, they were fun. But they weren’t helping. (See Figure 2.1.)
In working with other traders, I see impulse trading as one of the most common reasons for people getting their heads handed to them. They don’t have a plan. They just get long when that feels right, and they get short when that feels right. Or they just get bored. I’ve literally had traders in my office who have visited to work specifically on their impulse trades—only to sneak in orders when I wasn’t looking. The urge to jump in and be a part of the action is that powerful. It’s like a drug addiction, and like most addictions, it never works in the long run.
My method for dealing with them is to simply sit next to them and watch them trade—and to do exactly the opposite of what they’re doing. At the end of the day or the week, we compare our profit-and-loss (P&L) statements, and that usually tells the story. This is a win/win situation because it is a great lesson for the impulse traders—there are actually people out there doing the exact opposite of what they’re doing and making money—and it is a mostly profitable exercise for me.
The cure for impulse trading is patience and understanding integrity—a topic that we’re sneaking up to shortly. Patience is such an important quality for a trader—both in learning what setups best work for you, and in waiting for those setups to occur. Impulse traders who cannot own up to this bad habit need to stop trading and go to Las Vegas. The end result will be identical—they will lose all their money. But at least in Las Vegas the drinks are free.
If people are stuck in a relationship with an individual who berates their best efforts and undermines their dreams, then it’s time to leave this individual and move on. It was in this vein that I “broke up” with my impulse trading. I liked my impulse trading. It was fun. It made me feel good, feel alive. It was exciting. But the bottom line was that my impulse trading was undermining my potential and preventing me from realizing my dreams of being a full-time trader. Once this realization took hold, I took immediate steps to cut that cancer out of my life. This included a reward-and-punishment system that I discuss later in the blog, in the post on formulating a business plan.
In the end, I stuck with my friends who believed in me—the setups that worked when I gave them half a chance. Once I was able to follow my setups consistently, exactly the same way every time, I was able to make the transition to trading full time. A large part of my transition was mental and developing what I call a “professional state of mind.”
Oh, and by the way, it wasn’t until years later, when I was doing a talk at a Traders Expo in Las Vegas and telling the story about the “Minnesota Stupid House” that my wife actually learned of the event. She was sitting in the audience, and I’d totally forgotten that I’d never told her. Everyone around her started asking, “Wow, how did you handle that?!” Afterwards she came up to me with a sweet smile and a few blinks of the eyes and said, “So what else haven’t you told me?”
First, traders must understand the psychology, and then they can learn about the setup. Initially newer traders don’t care about the psychology. “Just show me the setup,” they say eagerly. Then, after the market has its way with them, they come back and start digging into the psychology, if they have the financial and mental capacity to give it another go. It’s like two pieces of a puzzle, and these two pieces have to snap together snugly in place before a trader can expect to trade for a living without repeating the same mistakes over and over again. I’ve shown many traders setups that work. The ones who don’t get the psychology part always screw it up eventually. Remember, the process is deceiving because it doesn’t mean every trade is screwed up. Far from it. It just takes one nasty psychological downward spiral to throw it all away. Usually this takes place right after the first time they have three losing trades in a row. “I wonder what would happen if I added a MACD (moving average convergence divergence) filter and changed the settings of this moving average. I bet if I’d done that, I wouldn’t have been stopped out.” And a good setup dies an early death as the trader heads down the path most traveled—that of the never-ending tweak, the search for the magic potion that doesn’t exist.
I’ve spent a lot of my career focused on trader psychology—not only working on myself, but working with hundreds of other traders in person, and thousands of them online and through webinars. I’ve spent a lot of time in large trading rooms with hedge funds and proprietary traders, executing orders right alongside hundreds of other traders. I’ve watched the fear, the elation, and the greed permeate a room of a group of traders like a disease. I’ve literally seen money from accounts on one side of a room flow into the accounts on the other side of the room as each group of traders focused on different setups and parameters.
In addition, I’ve worked with hundreds of traders who have come up to my office to sit beside me and watch me trade, and to have me look over their shoulder while they trade. I’m the first to say that I’m not a psychiatrist, but let’s just say that my experiences have left me with a clear road map of the process most traders go through when they first start to trade. Every person is unique, but when it comes to money, the differences are quickly stripped away. Doctor, lawyer, surfer, or engineer—it doesn’t matter. A herd of thirsty cattle will quickly drop all pretenses and stampede to get to water.
In addition to my experiences in working with other traders, it shouldn’t be surprising to hear that I learned a lot of this firsthand from the best teacher that the market has to offer: extensive personal pain and suffering. By the time I was a senior in high school, I’d saved $1,000 working a $4 an hour job slinging cookie dough and sodas at the local mall and running my own very small mail-order business, buying rolls of wheat pennies in bulk and selling them individually through newspaper ads.
My stepfather, Lance, noticed my stash of cash and my entrepreneurial spirit. He said, “Have you thought about putting your capital to work?”
I had no idea what he meant, but he was a Morgan Stanley broker, and I watched him meet with his friends every Sunday night as they visited and mapped out their Monday morning buying-and-selling strategies. When they told me they were going to buy Intel call options and asked me if I wanted in, I said, “Sure,” even though I had no idea what in the hell a “call option” was. But I was and always have been a risk taker, so, shortly thereafter, I spent my entire $1,000 savings on 10 Intel calls for a buck each. Four days later, my stepfather told me to sell, and I did . . . at $1.80 per option, earning an 80 percent profit of $800, less commissions. I never went back to that cookie store again, at least not as a boy flipping cookie dough for $32 a day, less taxes. I was hooked on putting my capital to work.
For the next eight years, through college and through my first corporate job, I maintained a routine of staking myself with $10,000 in order to buy and sell low-priced stocks and options until I increased my portfolio to the $120,000 to $130,000 range. During those eight years, I repeatedly did a smart thing, followed by a stupid thing, whenever I ran my account up that much. The smart thing I did was when I had built up my account to over six figures, I would withdraw $20,000 to $30,000 of profits to invest in single family homes and duplexes that I would rent out.
This is an old Las Vegas saying that applies equally well to the financial markets. Having a system gives people a sense of security—nothing can go wrong. Every time I walk into Mandalay Bay or Bellagio in Las Vegas, I am reminded that all these fabulous structures were paid for by people who thought they could beat the blackjack tables. The owners of the Luxor borrowed $550 million over 20 years to build their place. They were able to pay it off in less than three years. Tell them at the front desk that you have a system, and you’ll most likely get a presidential suite and a private table.
Why don’t systems work in Las Vegas? The reason for this is twofold: the house has an edge with percentages, and as soon as the system falters a couple of times, the human mind gets to work trying to tweak it to make it perfect. This eventually screws up the entire process. In casinos, as in trading, it takes only one stupid bet to blow your whole wad. Casino owners know this, and this is why they sell the strategy books right there on the property, prominently displayed in their own gift shops. This elevates the concept of the fox guarding the henhouse to a whole new level.
Craps is a great game for studying the trading mind-set. The board is set up to encourage more of the “stupid bets” as the game goes on. Instead of just focusing on the higher-probability pass and no pass bets, participants get sucked in and start betting the hard ways and all the other exciting, low-probability bets. It’s a crowd mentality case study right before your eyes. Guess who wins consistently in the end? And that’s why the drinks are free.
It’s the same process with the markets. The odds are against the trader surviving because the market has an edge: it doesn’t have any emotions. Like the river making its way to the ocean, the markets ebb and flow with total disregard for the objectives of the people who are hanging on for the ride. Humans have a tendency to try to imprint their will on the markets. This is like trying to get a tornado to shift course by yelling at it, or trying to convince your wife that making returns to the department store is not the same as saving money.
Trading is the most deceptive profession in the world. Do you know anyone who has recently walked into an airport, jumped into the cockpit of a jumbo jet loaded with passengers, and taken off down the runway without any prior training? Yet people will routinely open an account and start trading without any guidance whatsoever. And that is equally insane. Little do they know that their emotions and the natural functions of their brain are against them right from the opening bell. They’re the freshest of meat.
Just as a chatty masseur is the enemy of a relaxing spa treatment, emotion is the enemy of successful trading. Remember, the markets are set up naturally to take advantage of and prey upon human nature, moving sharply only when enough people get trapped on the wrong side of a trade. This sweeps a burst of fear, frustration, and rage into the markets—and creates fabulous trading opportunities for the prepared trader. To head into this adventure called trading (note that it is called “trading,” not “guaranteed income”) without having a firm grasp of how human emotions move markets and how human emotions can sabotage your own trading is like trying to hail a taxi in Manhattan during a thunderstorm. In other words, the odds are overwhelmingly against you.
The whole idea of this post is to lay the groundwork for the setups we discuss later. With this foundation, traders will be able to understand how to control their “inner demon” with respect to trading. This is the creature that mentally blocks them from following the parameters of a particular setup once they are in the trade. It is very similar to the brain freeze that occurred during the river-rafting incident discussed in the Introduction and to Joe Trader in the TASR trading example in Chapter 1. It is also important to remember that every trader has different dominant personality traits that he or she uses to absorb information and relate to the world around him or her. Some traders are more visual, others are more auditory, and still others are more kinesthetic—they relate to the world based on how events make them feel on the inside. These three traits can have a big impact on a person’s trading.
Traders who are dominantly kinesthetic are doomed from the outset—until they realize that this is how they relate to the world and the impact that it has on their trading. If you buy a stock only when you feel good about it, you are a kinesthetic trader. Your best entries will be the ones that are scary and make you feel nervous. If you buy only when you feel good, the stock is probably near the top of a move. Think about it.
In addition, the trader needs to realize the importance of utilizing a specific methodology for each setup, because each setup takes advantage of a different aspect of human emotions.
A trader cannot apply the same trading rules to all setups across the board.
This is one of the biggest mistakes I see newer traders make. A two-point stop in the E-mini S&Ps can work well with one setup but for another, 10 points works better. In fact, one of the quickest ways to fix most win ratios is to double your stop loss and cut your position size in half. You’re still risking the same amount of money, but you’re giving the trade enough room to work itself out. Putting 20 percent of your capital into one option trade can work well with one setup and strategy, but can be devastating with another. By understanding the psychology behind the trade, the individual will also then understand the right parameters and the right allocation to use for each setup. Each setup really is unique, and it has to be treated that way.
The purpose of this post is for you to develop what I call a professional trading mind-set. Although we discuss setups for most of this blog, traders have got to have the trading psychology nailed down or their trading experience will be short-lived and painful. The other option, of course, is to go to a purely mechanical system and have your computer trade for you. Although this sounds like a good idea, I’ve found that traders who don’t understand the psychology start tweaking the system every time there is a losing trade, which negates the whole idea of having an automated system. The bottom line is that if you understand the trading brain, you have a distinct advantage over (1) those individuals who don’t and (2) those large funds that are trapped in larger positions, which will take them days or even weeks to liquidate.