Master Trading Psychology

If you’re reading this blog, it’s probably because you’ve already had a reasonable about of success with options trading, and perhaps you’re considering doing this full-time. 

For many option traders, day trading seems to be esteemed in high regard. This may be due to how this profession has been portrayed in movies or social media. However, few traders understand the amount of work that goes into learning to day trade profitably. This blog is the first in a series of three to identify what we believe are a few of the key differences between successful and unsuccessful traders. 

Why are most people unsuccessful at trading?

Stastiscailly speaking, more than 90% of traders lose money in the markets and stop trading. Conversely, only 10% of traders are successful after one year, and that number continues to get smaller after three years. Why is that the case? Certainly, there are many reasons for this that we can’t consider in this blog, so we will focus on what we believe are some of the main contributing factors.

Psychology- One of the most significant determining factors of success

According to some psychologists, psychology may account for up to 60% of a trader’s likelihood of success. What are some contributing psychological factors that cause traders to perform poorly and lose money?

Making trading decisions based on emotion

Many traders think about the outcome of the trade in terms of what it will provide for them materially. “If this trade is profitable, I’ll be one step closer to buying that new _____” (fill in the blank). And when they lose a trade, they think about what that money could have done for them.. “I could have paid off my student loans for three years with that single trade; I can’t believe it didn’t work out… I’m such an idiot.” What do these two scenarios have in common? The trader isn’t thinking about the setup; they’re thinking about the money. 

Here at Simpler Trading, we have a saying, “trade the setup and not the money.” Thinking about the outcome of a trade instead of listening to the charts is a fool’s errand. Why is that the case? To illustrate this point, consider the expression “seeing the world through rose-colored glasses.” This saying refers to people who have the tendency to see everything in a positive light, sometimes unrealistically. When traders project their emotions onto the market, they tend to only see what they want on the charts. 

For example: If a trader had a bearish nature, they might believe that the market is far overdue for a correction. In 2020, traders who held this view probably saw this flash crash as a vindication of their long-held beliefs. However, if they had adopted that mentality into their trading, they would have continued to lose money for the last two years. 

Entering and exiting trades

Using emotions to make trading decisions, like when to enter a trade, results in taking trades based on fear or greed, neither of which makes for a great technical setup or exit strategy, for that matter. 

Traders who end up trading on emotions have a hard time identifying when to exit a trade. They either think it will go higher or turn back in their favor. Ultimately they end up chasing the market, no matter what side of the trade they’re on. It is implausible that anyone who approaches the markets with this mindset will be consistently profitable. 

Position Sizing

Another way that emotions can destroy a trader’s account is position sizing. Often, traders will be so sure that a trade will work in their favor that they risk much than they can afford to lose. In doing so, they drain their account as fast as the market can take it. We like to say that traders should never risk what they’re not willing to lose, as trading is inherently risky. However, trading is substantially more dangerous to a trader’s financial well-being if trading decisions on based on emotion. 

Hindsight is 20/20

Inevitably, traders are confronted with a harsh reality after substantial losses: the markets are equal opportunity dream crushers. For many, it is only after the fact that traders recognize the error in their ways. This is often a pivotal point in the path of a trader. Those who choose to fix the problem continue along their trading journey. And those who don’t are doomed to repeat until they have no more capital and write trading off as a lost cause. 

Although it’s understood that most traders learn this lesson the hard way before becoming profitable, we encourage all traders to adopt a healthy view of trading from the outset of their trading journey. Trading is wrought with psychological landmines. Successful traders understand this, equip themselves with well-thought-out trading plans, and do not deviate. 

Best tools to develop trading psychology

We recommend starting with two books that discuss the importance of psychology in trading. Although there are dozens of books that cover these subjects in detail, both of the books listed below cover some of the most crucial points and how to apply them in your own trading strategy.

 

Mastering the Trade

Third Edition by John F. Carter

We feel this is an overall balanced go-to guide for launching a career in trading, and it has been fully updated for today’s turbulent markets. Successful trader and founder of Simpler Trading, John F. Carter has made his popular guide more relevant and effective than ever in his latest edition. This new edition of Mastering the Trade, Third Edition includes the essential content that has made it a bestselling classic and includes new information to help traders make the best trading decision in every situation.

Mastering the Trade combines insightful market overview with strategies and concepts, where Carter provides: proven setups, with optimal markets and non-negotiable trading rules, exact entry, exit, and stop-loss levels for swing and intraday trading, and seven key internals, from Skew to VIX, a pre-market checklist for analyzing recent market behavior, scanning techniques for pinpointing high-probability setups, effective risk control techniques, and techniques for predicting market corrections.

Tips that run the gamut from valuable hardware and software to market mechanics, pivot points, and position sizing are covered as Carter delivers a suite of tools to teach traders how to beat the competition regularly. Mastering the Trade, Third Edition builds your expertise in knowing what’s working for you and what’s working against you.

Trading in the Zone: Master the Market with Confidence, Discipline and a Winning Attitude

by Mark Douglas 

We feel this is one of the best day trading psychology books. In Trading in the Zone, Douglas uncovers the underlying reasons for the lack of consistency and helps traders overcome the ingrained mental habits that are costing them money. He takes on the myths of the market and exposes them one by one, teaching traders to look beyond random outcomes, to understand the true realities of risk, and to be comfortable with the “probabilities” of market movement that govern all market speculation.

The main contents of Trading in the Zone are dedicated to one goal – to become a consistently successful trader. According to Douglas, the majority of aspiring traders does it wrong when they study the behavior of the market rather than considering what is inside their own mind and understanding their traits. There are five “fundamental truths” about the market at the core of the “right” trading mindset:

• Anything can happen.
• You do not need to know what will happen to earn money.
• The distribution of winning and losing trades is random.
• An edge means a higher probability of a winning trade than a losing one.
• Every instance of the market is unique.

Anything that can happen means that the market is composed of traders, and there is no way any traders can know with certainty what the other one is going to do. Some technical, fundamental, or sentiment indicators strongly forecast some movement, but the real outcome could be completely different as it may take only one trader to affect the prices.

This book also tops the list of best day trading books available on audible.

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