Trading Psychology: Mistakes in a Trading Environment

Trading Psychology: Mistakes in a Trading Environment

When it comes to trading, one of the most neglected subjects are those dealing with trading psychology. Most traders spend days, months and even years trying to find the right system. But having a system is just part of the game. Don’t get us wrong, it is very important to have a system that perfectly suits the trader, but it is as important as having a money management plan, or to understand all psychology barriers that may affect the trader decisions and other issues. In order to succeed in this business, there must be equilibrium between all important aspects of trading.

In the trading environment, when you lose a trade, what is the first idea that pops up in your mind? It would probably be, “There must be something wrong with my system”, or “I knew it, I shouldn’t have taken this trade” (even when your system signaled it). But sometimes we need to dig a little deeper in order to see the nature of our mistake, and then work on it accordingly.


When it comes to trading the Forex market as well as other markets, only 5% of traders achieve the ultimate goal: to be consistent in profits. What is interesting though is that there is just a tiny difference between this 5% of traders and the rest of them. The top 5% grow from mistakes; mistakes are a learning experience, they learn an invaluable lesson on every single mistake made. Deep in their minds, a mistake is one more chance to try it harder and do it better the next time, because they know they might not get a chance the next time. And at the end, this tiny difference becomes THE big difference.
Mistakes in the trading environment

Most of us relate a trading mistake to the outcome (in terms of money) of any given trade. The truth is, a mistake has nothing to do with it, mistakes are made when certain guidelines are not followed. When the rules you trade by are violated. Take for instance the following scenarios:

First scenario: The system signals a trade.

Signal taken and trade turns out to be a profitable trade.
Outcome of the trade: Positive, made money.
Experience gained: Its good to follow the system, if I do this consistently the odds will turn in my favor. Confidence is gained in both the trader and the system.
Mistake made: None.

Signal taken and trade turns out to be a loosing trade.
Outcome of the trade: Negative, lost money.
Experience gained: It is impossible to win every single trade, a loosing trade is just part of the business; our raw material, we know we can’t get them all right. Even with this lost trade, the trader is proud about himself for following the system. Confidence in the trader is gained.
Mistake made: None.

Signal not taken and trade turns out to be a profitable trade.
Outcome of the trade: Neutral.
Experience gained: Frustration, the trader always seems to get in trades that turned out to be loosing trades and let the profitable trades go away. Confidence is lost in the trader self.
Mistake made: Not taking a trade when the system signaled it.

Signal not taken and trade turns out to be a loosing trade.
Outcome of the trade: Neutral.
Experience gained: The trader will start to think “hey, I’m better than my system”. Even if the trader doesn't think on it consciously, the trader will rationalize on every signal given by the system because deep in his or her mind, his or her “feeling” is more intelligent than the system itself. From this point on, the trader will try to outguess the system. This mistake has catastrophic effects on our confidence to the system. The confidence on the trader turns into overconfidence.
Mistake made: Not taking a trade when system signaled it

Second Scenario: System does not signal a trade.

No trade is taken
Outcome of the trade: Neutral
Experience gained: Good discipline, we only need to take trades when the odds are in our favor, just when the system signals it. Confidence gained in both the trader self and the system.
Mistake made: None

A trade is taken, turns out to be a profitable trade.
Outcome of the trade: Positive, made money.
Experience gained: This mistake has the most catastrophic effects in the trader self, the system and most importantly in the trader’s trading career. You will start to think you need no system, you know better from them all. From this point on, you will start to trade based on what you think. Confidence in the system is totally lost. Confidence in the trader self turns into overconfidence.
Mistake made: Take a trade when there was no signal from the system.

A trade is taken, turned out to be a loosing trade.
Outcome of the trade: negative, lost money.
Experience gained: The trader will rethink his strategy. The next time, the trader will think it twice before getting in a trade when the system does not signal it. The trader will go “Ok, it is better to get in the market when my system signals it, only those trade have a higher probability of success”. Confidence is gained in the system.
Mistake made: Take a trade when there was no signal from the system

As you can see, there is absolutely no correlation between the outcome of the trade and a mistake. The most catastrophic mistake even has a positive trade outcome, made money, but this could be the beginning of the end of the trader’s career. As we have already stated, mistakes must only be related to the violation of rules a trader trades by.


All these mistakes were directly related to the signals given by a system, but the same is applied when getting out of a trade. There are also mistakes related to following a trading plan. For example, risking more money on a given trade than the amount the trader should have risked and many more.


Most mistakes can be avoided by first having a trading plan. A trading plan includes the system: the criteria we use to get in and out the market, the money management plan: how much we will risk on any given trade, and many other points. Secondly, and most important, we need to have the discipline to follow strictly our plan. We created our plan when no trade was placed on, thus no psychology barriers were up front. So, the only thing we are certain about is that if we follow our plan, the decision taken is on our best interests, and in the long run, these decisions will help us have better results. We don’t have to worry about isolated events, or trades that could had give us better results at first, but then they could have catastrophic results in our trading career.
How to deal with mistakes

There are many possible ways to properly manage mistakes. We will suggest the one that works better for us.


Step one: Belief change.
Every mistake is a learning experience. They all have something valuable to offer. Try to counteract the natural tendency of feeling frustrated and approach mistakes in a positive manner. Instead of yelling to everyone around and feeling disappointed, say to yourself “ok, I did something wrong, what happened? What is it?


Step two: Identify the mistake made.
Define the mistake, find out what caused the mistake, and try as hard as you can to effectively see the nature of that mistake. Finding the mistake nature will prevent you from making the same mistake again. More than often you will find the answer where you less expected. Take for instance a trader that doesn’t follow the system. The reason behind this could be that the trader is afraid of loosing. But then, why is he or she afraid? It could be that the trader is using a system that does not fit him or her, and finds difficult to follow every signal. In this case, as you can see, the nature of the mistake is not in the surface. You need to try as hard as you can to find the real reason of the given mistake.


Step three: Measure the consequences of the mistake.
List the consequences of making that particular mistake, both good and bad. Good consequences are those that make us better traders after dealing with the mistake. Think on all possible reasons you can learn from what happened. For the same example above, what are the consequences of making that mistake? Well, if you don’t follow the system, you will gradually loose confidence in it, and this at the end will put you into trades you don’t really want to be, and out of trades you should be in.


Step four: Take action.
Taking proper action is the last and most important step. In order to learn, you need to change your behavior. Make sure that whatever you do, you become “this-mistake-proof”. By taking action we turn every single mistake into a small part of success in our trading career. Continuing with the same example, redefining the system would be the trader’s final step. The trader would put a system that perfectly fits him or her, so the trader doesn’t find any trouble following it in future signals.


Understanding the fact that the outcome of any trade has nothing to do with a mistake will open your mind to other possibilities, where you will be able to understand the nature of every mistake made. This at the same time will open the doors for your trading career as you work and take proper action on every mistake made.


The process of success is slow, and plenty of times it is attributed to repeated mistakes made and the constant struggle to get past these mistakes, working on them accordingly. How we deal with them will shape our future as a trader, and most importantly as a person.

I think it is worth to learn....

Trading psychology can be learn... let your system work as robot, without interference of your think and wish, hope etc... emtion.....

Hi,

Well structured post - very insightful.

In my experience (which is a mere 21 years) I would add that to achieve the psychological stability for trading, one has to get to know thyself and bring any type of trading method employed in tune.

For the simple reason that for many, the worst part in trading are the losing trades. Not only because they lose (as you have correctly put it) but because it makes the trader question him/herself and moreover doubt in his/her ability - unfortunately only indirectly because the first thing to be blamed is the "system".

If one gets comfortable with the idea (and its not only an idea, its given unchangable fact) that trading involves losses no matter what, than that is a step forward. Not all ways of trading are the same and different methods allow for different types of expectancies (expectanciy = positive or negative outcome in terms of cash balance in a big enough sample series of trades based on MM, pos. size and model used).

If you know that your model has a positive expectancy, it will be easier to "accept" losses as a part in trading and you will not associate them as a failing part on your behalf.

As I said, there are methods with positive expectancy which still differ in win/loss ratios, i.e. some are based on a relative small amount of winners which are relatively large and compensate for the bigger amount of losing trades; other methods are based on a larger number of smaller winning trades which still involve losers that have to be much more controlled in order not to erase the better part of accumulated profits. Again others are more balanced.

Now, if your personality is that of a perfectionist, you can very easy get yourself in trouble because any losing trade will most likely make you question any method you empoy and try to mess with it to eradicate losing trades to an extend that could make you stop trading completely since you identify possible flaws pretty much everywhere.

You will have to accept in the first place that the market prices themselves are a mathematically imperfect construction in terms of how "fluid" they are.

Knowing (by knowing I mean knowing yourself and learning the expectancy of the model you are trading) that despite losing you can ultimately win in the long run is what should improve confidence and trust.

Hope this helps.

regards
daytrading

The day I finally got that through my thick head was the turning point in my trading career.

Nice post too BTW joldas.

Thumbs up to the both of you.

1) System works and profitable
So you've got a winning system, you get confidence and start using more lots/risk so that you can make use of a winning system. Boom! The inevitable loss comes one fine day and you lose a big chunk of your profits because of higher risk/lots used. Now you would either a)continue trading, b)change system or c)try to get even with the market by using more aggressive lots

a)Your profits seem to be small and you lose patience to catch up with the earlier loss, so you either do (b) or (c)

b) If the new system is profitable, you would do (1) or (a). If it is a loser you would still do (1)

c) You would do (b) and (c), either, way very likely you would blow up your account

Hi,

How can what you describe above be a system if you haven't figured out the average winning AND losing trade as well as the frequency of the losing vs the winning trades?

If you would have done that to a degree which is essential to the development of a method, the loss and its extend would not come as a surprise. Furthermore, your position size at any time would be such that even if the (to be expected) loss would exceed its value by 10%, it would still not harm the overall positive expectancy of your system.

In short, if you don't know what your method's average loss will be, your method is not complete; if you don't know the average ratio between your winners and losers, your method is not complete. If you don't know your average potential winner, your method is not complete.

I say "you" without being personal here - just to aid the understanding of the thread.

Hope it helps.

regards
daytrading

Agreed, but the mistakes were essential to train me to think this way. Now my systems are pretty profitable

it is really worth learning.

Thank you, Mr Lopez, for taking the time to post at FF.

I figured it was either a copy-and-paste or someone with a multiple personality disorder. If you're going to quote somebody else, then at least give reference to them.

Thank you for the post.

I know there are people who do this, and who are profitable, and I say good luck to them. But I think this is actually an awful way of trading. It was downrivertrader who opened my eyes to this. You've an instinct for a reason. Blocking it off leads to frustration and angst. And in fact, blocking it off is a way of not dealing with yourself. You need to train get to know yourself, your instincts, and that will lead to mistakes. But in the long run, it's a lot less stressful.

whatever it is, the point is to follow the system signal, right? so, your dream could be realised now - a holy grail exists on your tail

No - that's the point. Don't blindly follow any system but instead use your discretion - instinct - which in turn requires you to break the rules of your said system when the time is right.

same page then. but, how does one know the right timing?

Instinct! I know that sounds like a cop-out, but your subconscious picks up far more than you can articulate or know consciously. If you allow it to - by that I mean trade when you feel like, how you feel like, it learns from mistakes and errors and becomes better. It's actually the complete opposite to Mark Douglas et al. I used to think his book was great, but now I think it has some very counter-productive ideas in it.

This isn't to say you should trade without knowing what you're doing or be sloppy about it of course.

I wouldn't say that it's a cop-out, but IMO one would need to be a very experienced trader, in order to have a sufficiently 'educated' subconscious. If the subconscious mind has somehow trained itself to recognize profitably timed entries that occurred in the past, then that might indeed be helpful. But otherwise I'd have to say that it's fortuitous guesswork. I think that's an important distinction.

As a relative newcomer, when I see a chart, then depending on my focus, and possibly my prevailing mood, I can have voices in my head telling me to buy, and voices telling me to sell, both at the same time. For example, when I see a healthy pinbar in an uptrend, one voice says "aha, reversal!" and while another voice says "nah, it's probably just profit-taking, trade with the trend". Then I might spot some nearby S/R that supports one view, while a recent news announcement tends to support the other. And so on. I'm kept sober and humble by the thought that when I decide to open a trade, there's a trader somewhere else whose equally convinced by his own analysis to take the opposite position. Granted, that's an oversimplification, but the bottom line is that any market requires both a willing buyer and a willing seller, in order to function.

So I would have to say that my instincts are not sufficiently educated to be helpful, and hence I find the only way for me to trade is according to very concise principles: principles and patterns that I believe (or hope!) will continue to give me a winning edge.

But every individual is different. Each to their own.

well said, hanover, trading is a probability game, as long as probability involves, there is no right or wrong answer at the point of time before the PA becomes its history, even educated instinct couldn't make such determination. however, I would agree an educated instinct may improve one's winning hits,that will be a good dimension for newbies to put effort.

Eloquent reply as ever Hanover. Not sure you're that much of a relative newcomer now are you? 3 years or so?
Someone brighter than me said that trading is about instinct, but until you've been trading for 2 years, you don't deserve one. Too true.

I agree with you, and yes, initially you're going to see a lot of fortuitous guesswork, but this is how you train your instinct. I don't think you can shortcut that process, but I think you can lengthen it significantly by religiously following the rules of a system (any system). Worse still, taking the advice of Mark Douglas - and I can't remember exactly his words, but I remember he says "most systems are profitable if you follow the rules" and essentially suggests that traders who fail end up searching for more information, switching systems, when they should just repeat their system and accept it's all a game of probabilties.

Again, instinct is all here. Your subconcious is trying to seek out more information, and he's advocating no, stop that, focus on what you're doing. I know what he's saying, and maybe in the first few months it's a good idea to have a plan to adhere to while you're finding your feet, but beyond that, as a trader, this kind of rigidity is lethal.

What if you took every trade your instinct told you? You say you have two voices, so what if you chose the first one that comes into your head? What if you took every lead your instinct told you to follow up (read this, find out about that)? Because it's a hard way of learning (you can lose actual money when you lose on top of being wrong), a lot of people give up and then read Mark Douglas which is quite comforting. I know I thought it was great when I first read it. Now, I really, really don't!

David

This reminds me of a post by ubeee in which he describes a way of "educating your subconscious".

It is an interesting idea from an under rated poster.

http://www.forexfactory.com/showpost...8&postcount=38