Trade Stocks Without Emotion
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Trading psychology and coping with emotions.
We’ve covered many aspects of trading, from trading setups through to risk reward and risk management, but we only loosely cover mindset, psychology, and thinking in terms of probabilities. Arguably the most important components of becoming a successful trader.
Many different character traits appear through the career of a trader, from fear, anger, confusion, despair, through to over confidence, but the key trait for a successful trader is to trade without emotion. Technical and fundamental analysis will only take us so far, being able to adopt the right mental state and therefore trading with a zen like mentality, is the differentiating factor.
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When this engrained false expectation materialises into a string of unexpected losses, true emotions begin to appear. Positivity turns into heightened focus, and then disbelief, anger, and finally despair.
On the other hand, the casino owner embraces the fact that the gamblers could have a winning streak, this could result in the casino having a losing day or even a losing week, but the casino has a confirmed edge, and over a large volume of bets placed, they know they will win, losses are just part of the business.
The same principle exists in trading. Every trader is aware that when a trade is entered there is an element of risk, either the full position, or the stop loss portion. But does every trader really accept the risk or even think they will lose money on this new trade?
The expectation of most traders is for price to continue its trajectory whilst making money. in reality however, the opposite often happens.
When these failed trades happen several times consecutively in a short period, the trader becomes disillusioned, and realisation confirms a psychological gap, from assuming they accepted the risk, to disbelief when a series of failed trades occur.
The best traders in the world know that the next trade is a random event, therefore a sequence of random events could lead to a sequence of losing trades. But like the casino owner, they understand this is just part of the business.
The hard cold reality of trading is that every trade has an uncertain outcome. Unless you learn to completely accept the possibility of an uncertain outcome, it will be very hard to succeed as a trader.
You must accept the following to achieve a zen like mentality:
“Anything could happen in the stock market”.
“You don’t need a psychic ability for the very next trade in order to make money”.
“There is a random distribution between winning trades and losing trades that ultimately define a statistical edge”.
“An edge is simply an indication of higher probability over a sequence of events”.
And finally.
“Every event in the stock market is entirely unique”.
Once these points are fully accepted, the trader can face the markets evolving uncertainty with a feeling of calm, they become unnerved by periods of drawdown and can therefore trade with zen.
There’s a term, commonly referred to as the ‘Gambler Fallacy’, this refers to an erroneous belief that a statistically independent event is influenced by a previous set of events.
Let’s take a coin toss for example, we know there is a 50% chance of the coin landing on heads or tails, but what if the coin is tossed a total of 4 times and heads appears 4 times in a row, do you think the next toss is likely to be heads or tails?
The answer of course is that there is still a 50% chance of either. The coin has no memory, the previous coin tosses had absolutely no relevance to the next coin toss. On this occasion, the gambler who loaded his stake up on tails would have lost, and despite his belief, he did not have an improved probability on the next toss to justify a larger stake.
This fallacy often finds its way into the stock trader’s mindset, not only is the trader surprised his 1st trade was a losing trade, but he is left in disbelief that all his 5 trades were losers. He assumes his selection process was wrong, or the market is rigged against him.
Conversely, all his 5 trades could be winners and he then feels he has the perfect trading method. In either scenario, the sample size is too small to make any judgement on the long-term success of the strategy.
Take my strategy for example, I have had losing periods, but over the longer term my edge always materialises, losing trades in the short term must be accepted and should be factored into a foundation of expectation. A previous video takes this concept a step further.
The key message here, is that regardless of the outcome of the previous event or events, there is no influence whatsoever on the very next event. Every singular event is completely independent of one another. You must fully accept that the very next trade is completely random, a trait that is inherently difficult to comprehend.
Expecting a random outcome however, does not mean that with discipline and practice you can’t improve your probability of success. Combining focus and regimentally following your process can lead to hitting your target more often than not. Just be prepared not to risk too much on each trade, an inevitable losing run will come and could blow up your account if the stakes are too high.
At this point you have fully embraced the market from a probabilistic perspective.
You know that the very next trade or series of trades could be losers.
You also know through your edge, that over a larger volume of trades (placed consistently) you are likely to make a profit, you therefore size your positions accordingly to enable your edge to materialise.
It’s important to note that carefree means confident, but not euphoric.
When you have a zen like mentality, you won’t feel any fear, hesitation, or desire to do anything, because you’ve effectively eliminated market information as being threatening.
When you have accepted the risk, you will be at peace with any trading outcome. You are now trading with zen.
There are several principles that allow your carefree state of mind and statistical edge to play out, and therefore become a winner.
Firstly, objectively identify your edge. For example, your back-testing process may have identified a breakout strategy whereby 3 pivot points form a resistance line, thereafter the price is seen breaking through the resistance. This could be classed as an ‘objective’ reason to place a trade.
Next, you must predefine your risk, perhaps by placing a stop loss within the breakout channel, again, often established through your back-testing study.
Thirdly, you must completely accept the risk and not be surprised if the trade loses.
You act upon your edge or strategy without reservation or hesitation.
You win only if the market allows, you can’t force a trade.
You continually monitor and accept your ability of making errors.
And finally, You understand the principles of consistent success and therefore you always follow them.
Author of Trading In The Zone, Mark Douglas, says:
“Ninety-five percent of the trading errors you are likely to make causing the money to just evaporate before your eyes will stem from your attitudes about being wrong, losing money, missing out, and leaving money on the table. What I call the four primary trading fears.”
Fears of this nature will inhibit your carefree state of mind and prevent you from trading with a zen like mentality
Free your mind from the beliefs that prevent you from trading without emotion, and remember, anything can happen, embrace the unexpected.
Trade consistently without fear, embrace risk, understand probability, let go of your fears and developing objective discipline.
If psychology is something you struggle with, why not join our group where we discuss the market and the thought process behind all my trades. Thanks for listening.
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