Know your enemy!
So far we’ve concentrated on looking at how fear and greed can affect a traders ability to follow their trading plan, and then we started deconstructing those fears piece by piece.
In this post you’ll find some more strategies for dealing with the fears that may be sabotaging your trading.
Lets continue reviewing those example fears from the first post in this series.
Fear: We fear that our trading system doesn’t work, or that the tip we were given was a dud.
Response: Again this is an extension of the fears we reviewed earlier about our trades resulting in losses instead of profits.
In this case it demonstrates a lack of confidence, and I would suggest that this is at least partly due to a lack of ownership over the trade.
If we start blindly following a trading system developed by someone else without backtesting it, we have only their word that it will help us to trade profitably.
That is why it is so important to backtest and paper trade our trading plan on every stock or market we want to trade. We need to do our backtesting over several years so that we can get an idea of what win:loss ratio we might expect from trading that specific stock or market using our trading system.
We need to do that backtesting in all market conditions; bull, bear and congested (sideways) markets, and understand that not all stocks and markets are the same. Just because a system works well on one stock, does not mean it is going to work as well on another.
With that backtesting and paper trading comes not only confidence that the system will work on that particular stock (or market), but in the process we also learn how that stock (or market) moves over time.
When we follow someone else’s ‘hot tip’ it is the same thing as following a trading system that we haven’t personally tested; we are placing our faith (and money) in someone else’s trading ability.
If, or rather when, one of those trading tips starts to go bad we may be left wondering what that other persons strategy is to manage that trade. Should we do the same thing? Have they already taken some action that we don’t know about yet?
This leads us to the last of the example fears we are reviewing.
Fear: We fear that we don’t know enough and so won’t know when or even how to respond to the markets movements.
Response: This is essentially a fear of the unknown - we fear what we don’t know.
But with a backtested and paper traded trading system and a money management strategy that is designed to preserve our capital we shouldn’t have too many ‘unknowns’ to concern us.
The more we develop our overall trading plan so that it provides clear responses, instead of emotional reactions to any market changes, the easier it will be to implement.
The answer to any “What if…?” question should be “What does our trading plan say?”
In “The Art of War“, Sun Tsu had the following to say:
“If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.”
Now replace the word ‘enemy’ with ‘markets’ and ‘battles’ with ‘trades’ and read the above paragraph again.
The lesson here, as has already been suggested in previous posts in a different way, is that just knowing a strategy for trading the markets isn’t enough.
We need to make sure our mindset isn’t also our enemy, or as the saying goes “We have met the enemy and he is us” (Walt Kelly, “Pogo”)
There is more to trading psychology and developing a trader’s mindset than just working on controlling fear, so stay tuned for part 4…
Happy Trading
Brian Dibbins
Trade Profitably © 2006 - 2007
8th July 2007
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