Learn How to Trade Profitably

By John Pontikas and Brian Dibbins

Chapter Four

Mindset and Trading Psychology

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This chapter is one of the most important in our eBook as it covers mindset and trading psychology. A trading system provides an edge in trading but it is how the trader implements that system that will determine how profitable they will be.

If they are not able to manage their emotions, then a sequence of losses will result in doubts, and their decision making will become influenced by fear and greed.

Mindset and Trading Psychology

Our trading system gives us an edge.  It states that when ‘X’ happens, ‘Y’ usually follows.  At times it may not, but the majority of times it does.  Our trading system helps us to identify high probability trades, we enter those trades at the right point, we protect our capital by setting stop losses, and we let our profits run.

 We implement and use the system that is right for us, and we feel comfortable using it.  We are consistent and disciplined.  We do not break any of our rules.

 Trading is not a nine-to-five job.  We have good days and we have some bad days, but with our strict trading rules, money/risk management and discipline, we expect and achieve more good than bad days.

 We realise that every trade is one of many, and we do not let a losing trade get us down.  We watch our language when we trade.  We do not have losing trades, we have “non-progressive” trades.  We realise that every business has expenses.  Our non progressive trades are just part of our business expenses.  Trading is a business.  It can be an extremely lucrative business because the overheads are so low.

 Part of our job commitment as a trader is to follow our trading plan.  Our trading plan is written down and is situated next to us whilst we are trading.  Our trading system consists of entries, exits, risk/money management, and trading psychology.

 Our objectives as a trader are to; follow our trading plan, to preserve our capital and to make that capital grow.  We never risk more on any particular trade than our money management strategy allows.  If we have five consecutive losses in a row, we stop trading for a week and we re-evaluate what (if anything) we are doing wrong.

 We do not become emotional with our trading.  If we are experiencing an emotional day, we do not place any trades.  If we have experienced a non progressive trade and another opportunity comes up to enter the market on the same day, we enter the market again.  If our second trade has not progressed and the third fails to progress also, we stop trading for that particular day, and we come back the following day.  This is a great method of preserving our capital.  We realise that the market is always right, and some days are just not supposed to be trading days.

 Every trader, beginner or advanced makes mistakes.  We learn from our mistakes and do not repeat them.  We keep a trading diary of all our trades.  We are particularly interested in our non progressive trades.  Why did they not progress?  Is there is a common factor involved?

 We always backtest and paper trade every stock/market that interests us.  Our backtesting and paper trading allows us to verify that our trading system would work successfully on that stock/market and would be profitable.  It also assists our subconscious and gives us faith and confidence in our system.

 We have a realistic figure in our head as to how much money we want to earn per week.  Once that figure is achieved we stop trading.  This way we can ‘buy’ ourselves time to do the things that we enjoy.  Time is the most precious commodity one has.

 Most traders neglect the most important aspect of trading; the psychological aspect of trading.  The successful traders recognise that their mental approach to the market is the determining factor in their success or failure.  It is often not the trading system that fails traders but their lack of discipline in applying it.

 A trader may have a great trading system but still manage to lose money.  They may backtest and paper trade; spending countless hours behind a computer screen in preparation, until eventually they feel ready to trade.  Perhaps their first trade is a loss, but confidence is still high.  Their second trade may also be a loss (remember not every trade is a win).  At this point emotions are running high, and doubt and confusion have set in, and they ask themselves “does this system really work?”  Another entry signal appears but this time the trader decides not to take it.  However perhaps this third trade was the one that would have made back the losses from the first two trades and given a nice profit.

 The trader may then start doubting themselves and wonder “is the market against me personally?”

 The answer of course is “no”.  Every trader will experience a draw down, and every trader will experience a sequence of consecutive losses.  Successful traders realise that not every trade will be a winner, and that in order to take profits from the winning trades they will also have to take draw downs from ‘non progressive’ trades.

 Successful traders understand that they need to; stick to proven, backtested and paper traded systems, to be disciplined, and to follow their rules.

 There are hundreds of successful trading systems, but a trader needs to ensure they only trade those systems that suit their personality and risk profile, as well as allow them to sleep comfortably at night.  They need to be able to implement and follow their system’s signals without doubt or hesitation.

 Once traders become emotionally out of control, they let their losses run and they limit their gains.  They become emotional about a losing trade and stop following their rules.  They let what should have been a small loss turn into a massive loss.  When they are in a winning trade, they once again become emotional and cut the trade short, along with their profits.  The reverse needs to take place.

 The purpose of backtesting (with dead data) and paper trading (with live data) is to test one’s trading system.  With backtesting and paper trading one can experience the big gains, the hopefully small losses, the possible consecutive draw downs and the different emotions that traders experience.  The trader becomes aware of all the possible scenarios, so that when its time for the real thing, they have hopefully adopted a positive mind view to cope with these situations.

 Traders should not take each individual trade personally.  They must learn to respond appropriately and not simply react emotionally to what the market presents to them.  They must take the approach of 'winning the war, not every single battle’.

 All negative thoughts must be out of a traders mind whilst trading.

 As mentioned before, trading must be seen as a business, a potentially very lucrative business with very low overheads.  Losses should be seen as an expense and every business has expenses.

 Traders should visualise themselves as a successful trader.  One who; follows their system, plans their trades and trades their plan.  One who; executes their trades at the appropriate place, trades with their stop loss/exit strategy in place, and always trades in the direction of the trend.  Visualise these elements.

 Successful traders don’t let fear and greed override their emotions.  They will cut their losses (non progressive trades) once their stop loss has been hit, and they take their profits when their system tells them to.

 The worst thing a new trader can do is to chop and change their system after 3 or 4 losses.  This clearly isn’t long enough to determine the long term success of any system – this is what backtesting and paper trading is for.  It is important to allocate a period of time and stick to that system, take every entry and exit, as the system states, and not change it on the basis of an unfortunate short series of non progressive trades.  This is easier said than done because we are humans and not machines.  Successful traders have to train their minds to become disciplined (if they are not already).

 Actions become habits, so the more often a trader follows their plan’s entry and exit rules (whether it results in a winning or non progressive outcome), the less emotional they will become when the next signal appears to enter or exit a trade, and the easier they will find it to implement their system.

 One must try and become emotionally detached to money.  The best way to do that is to only trade money that one can afford to lose.  This is stated as a risk warning in all trading courses, books and financial institutions.  Do not trade with ‘scared money’ because one’s decision making could be clouded.  If one starts trading with limited funds, fear will creep in and bad decision making will follow.  Remember all traders will experience a string of non progressive trades.  One must have sufficient funds to allow for that, otherwise profits will inevitably be cut short.

 Keep a trading journal of all trades.  Over time this may show a reoccurring pattern regarding both the winning and non progressive trades taken.  A journal can be a very useful method of ironing out possible mistakes and/or faults with one’s trading system, belief system and discipline.

 Traders should be true and honest to themselves when it comes to trading.  When they enter their office (workspace) to trade, they should treat it as though they are entering a boxing ring.  They are there to “kick butt”, because if they don’t, theirs will be kicked instead.

 They should ensure they work in an environment where they will not be interrupted.  Their trading deserves their full attention – remember, this is a business.

 Learn from other traders mistakes, because mistakes in the trading world can be very costly.  This document will help you to benefit from our mistakes and experiences.

 There is no holy grail to trading so stop looking for it.  Even a system that is only successful 50% of the time can make a trader a lot of money providing they remain disciplined.

 Traders must fully understand the system they intend to trade.  If there are any questions regarding implementing any aspect of it, they must be asked, researched and in some way answered before placing any live trade.  All situations that may be encountered should be factored into the trader’s trading plan; it should therefore contain the answers to any questions that may arise.  With a well written trading plan, a trader should rarely need to ask themselves “now what should I do here?”  New traders in particular should find this greatly increases their confidence, while also removing a great deal of stress caused by indecision.

 To summarise: Successful traders must implement strict management rules and follow their system mechanically.  They must get in the habit of trading what they see and not what they think; eg, don’t think, just respond.  Traders must be disciplined, stay in control and not let either fear or greed rule them.  They must cut losses short, maximise gains and most importantly of all; protect their capital.