Trading Psychology? Who Needs It?

“But Louise - why is Trading Psychology important? Surely your success as a trader is just due to your trading methods?... new traders say to me, with their head on the side, looking like a confused Labrador.

When we dive into the wild world of trading, we often believe it's all about finding the perfect trading system. We jump into trading with stars in our eyes, imagining a utopia of endless profits and happy days. Our optimism bias kicks in, fooling us into thinking we'll be the next trading superstars. Research suggests “when it comes to predicting what will happen to us tomorrow, next week, or fifty years from now, we overestimate the likelihood of positive events, and underestimate the likelihood of negative events.” 

We conveniently ignore the possibility of losses, sweeping them under the rug like they don't exist. But it’s not long before reality smacks us in the face and we realise that our mindset plays a huge role.

When I first started trading, I’d just completed my psychology and business degrees at Uni. It was way back in 1990 - long before I’d written my 5 best-selling books on the sharemarket - I was practically a cautionary tale. Whenever the markets went up, even by a tiny amount, I’d dream about how my life would be maybe in just a year or two. I was so sure that pretty soon, I’d be able to dump my job, tell my boss to take a hike, and buy New Zealand with all of the profit I would make. 

Then… the next day, when the markets dropped, I would be crushed. I’d envisage that I’d be living in poverty, homeless and a bag lady. Researchers even call this ‘bag lady syndrome’. Sure, the term is a bit offensive, but it’s pretty descriptive, hey. And it’s more common than you think. In a 2013 Allianz study of 2,213 women with household incomes of $30,000 or higher, 49% of respondents, and a third of those with incomes of $200,000 or more, said they "often" or "sometimes" fear losing all their money and becoming homeless.

This is called catastrophising - the art of turning molehills into mountains. Catastrophising is “an exaggerated negative "mental set" brought to bear during painful experiences.” 

We have this quirky tendency to envision worst-case scenarios, conjuring up disasters in our minds when the reality might be far from it. We take everyday events and sprinkle them with a heavy dose of drama.

The Wrecking Ball Pendulum

As a trader, especially when you start out, you’ll swing from being overly optimistic, to catastophising, like you were a little pendulum wrecking ball.

Interestingly, only humans have the ability to think about the way they are thinking. We can use this ‘metacognition’ to improve our lives, maximise our performance, and recover from adverse life events. The more sophisticated we can become at examining our own behaviour and motivations, the less our unconscious can play havoc with our trading results. Two traders can trade exactly the same system but get different results. The difference comes from the way they think about money, the markets and themselves.  

Here's the thing: we have the power to grow and bounce back, even in the face of daunting challenges. I like to call it psychological fitness, the ability to flex those mental muscles and stay resilient when life throws us a curveball. 

My late friend and fellow author of our book ‘Let the Trade Wins Flow’, was Dr Harry Stanton. Let me tell you how I got to know him … and eventually have the honour of writing a book with him on trading psychology. 

Way back when, I was an unruly, surly 15 years old, ready to fly off the rails and run away from home - at the urging of my sister Valerie, I read one of Harry’s books. His words soothed me and made me feel less alone. His book spoke to my heart. Suddenly, I knew what I needed to do with my life. After the first three pages of his book, I knew I had found my calling. I became determined to study psychology at university, so I could gain an insight into how people’s minds worked... and how my mind worked. Little did I know that many years later, Harry would become my friend. In 1997, my broker introduced us. I was overjoyed to meet Harry, and we clicked immediately. Harry shared his views about options and candle charts with me, and our friendship deepened.

Harry summed up my tendency to become ecstatic on minute, and to plunge into the depths of despair the next, beautifully. It’s so easy to be on a joy/despair roller coaster, when in reality, the best decisions are made using a more level-headed approach. The key to high performance, Harry told me, was to be less volatile with my emotions, develop objectivity, and take a pause before making big decisions. Good trading advice, but also good life advice.

The Awful Truth

You see - the majority of traders are likely to fail. This isn’t just my opinion. The research backs this up over time. One study by Brad Barber and Terrance O’Dean is even titled “Trading is Hazardous to Your Wealth”. You can’t get much clearer than that, hey. Also, I’ll include in the information below this video links to all of the research I’m using so you can read further. 

Here are the facts. Upwards of 80% of traders consistently lose money and only 1% achieve predictable, long-term profitability. An individual's trading career will often be brief and expensive. Academic studies focused upon the length of time new traders remain active show that nearly 40% last one month in the market, and only 7% remain active after five years.  

This finding has been replicated in many different studies. 

So, just what can you do to be in the minority of traders who excel in the markets?

I have some good news for you. There is hope.

Studies have shown that the 1-2% of traders who achieve long-term profitability account for 12% of all day-trading activity. This relationship illustrates that successful traders have found a method of conducting trade that creates an "edge" that can be applied repeatedly to the marketplace. Through consistent and calculated action, these traders are able to regularly prosper.  

So, if I can help traders stay in the arena for longer, they’re more likely to be successful.

But is this a learned skill or is it an innate skill – because if it’s innate, then no matter how much training you do, it still won’t help. Luckily for all of us, the research strongly suggests that you can learn how to control your own psychology. 

What you need is a Growth Mindset

According to Carol Dweck's book "Mindset: The New Psychology of Success," individuals can generally fall into two categories: the Fixed Mindset and the Growth Mindset. Let's take a closer look at each:

The Fixed Mindset person:

• When faced with CHALLENGES, they tend to shy away from them.

• They are quick to quit when they encounter OBSTACLES in their path.

• They view EFFORT as futile.

• Instead of embracing useful negative feedback or CRITICISM and adapting their behaviour, they ignore it.

• They feel threatened by the SUCCESS OF OTHERS, perceiving it as a blow to their own abilities.

On the other hand, a person with a Growth Mindset:

• Welcomes CHALLENGES as opportunities for growth and development.

• PERSISTS in the face of setbacks, seeing them as learning experiences.

• Recognises that EFFORT is the key to mastery and improvement.

• Learns from CRITICISM, using it as a chance to enhance their skills.

• Finds inspiration and valuable LESSONS in the success of others, rather than feeling threatened by it.

So, the Growth Mindset is all about embracing challenges, persisting in the face of obstacles, valuing effort, learning from feedback, and drawing inspiration from the success of others. It's a mindset that fosters personal growth and achievement. When you have a growth mindset, you believe you can gain the knowledge and skills necessary to succeed - which makes every challenge a learning opportunity. 

But why should we improve our psychological fitness?

There are four reasons why traders should strive to improve their psychological fitness:

• Expanding Horizons: Developing psychological fitness encourages a sense of adventure and a willingness to explore new fields. It fuels a desire for continuous learning and growth.
  

• Resilience and Perseverance: Psychological fitness enhances resilience, reducing the likelihood of giving up easily. Traders with this mindset embrace challenges, persist in the face of setbacks, exert greater effort, and draw inspiration from the success of others.
  

• Humility and Self-Awareness: By cultivating psychological fitness, traders remain humble and avoid becoming overconfident. Overconfidence can lead to poor trading decisions and lower profits.
  

• Learning from Mistakes: Psychological fitness enables traders to learn from their past mistakes. By staying in the trading arena long enough to course-correct, they increase their chances of achieving success over time.

Improving psychological fitness not only expands horizons and builds resilience but also fosters humility, self-awareness, and a continuous learning mindset, leading to more informed trading decisions and long-term success.

In fact, emotional discipline may be even more important than having a good system. Writing in his very popular book The New Market Wizards, Jack Schwager put it this way:

“If there is a single theme that keeps recurring in this volume, as it did in Market Wizards, it is that psychology is critical to success at trading. In order to achieve success in life, you must have the right mental attitude.

If trading (or any other endeavour) is a source of anxiety, fear, frustration, depression, or anger, something is wrong – even if you are successful in the conventional sense, and especially if you’re not.

You have to enjoy trading, because if trading is a source of negative emotions, you have probably already lost the game, even if you make money.”

Entertainment anyone?

Sometimes, you can be your own worst enemy, especially when the market knocks you down. It can be tough to gather the courage to get back up and give it another try. Ironically, you often engage in counterproductive behaviours like procrastination, blaming others, and self-sabotage without understanding why you act that way.

Interestingly, research has revealed that for a significant number of traders, being actively involved in the market is more important than making profits. They find excitement in the market's action, prioritising the thrill over profitability. Activity rather than the consequences of that activity is often more important to the trader. But let's be honest, most of us entered trading with the goal of making money, not merely seeking entertainment.

It's important to recognise our tendencies for self-sabotage, focus on the ultimate objective of financial success, and strive to make informed and disciplined trading decisions. By understanding our own behaviour and motivations, we can better align our actions with our goals and increase our chances of achieving long-term profitability.

As traders, we are often drawn to action-oriented metaphors that evoke a sense of excitement and dynamism. However, it's important to recognise that in certain situations, the best course of action is to pause and reflect before making impulsive decisions that could harm our trading outcomes.

Taking a moment to sharpen our skills and strategies, rather than rushing forward without considering the potential consequences, can be a wise move. It's like pausing to sharpen an axe before chopping down a tree, ensuring that we're well-prepared and focused.

In The Disciplined Trader, Mark Douglas puts it this way: “The traders who can make money consistently approach trading from the perspective of a mental discipline”’.

The research is clear. Traders who work on themselves as hard as they do their own trading systems are more likely to be more profitable, as well as stay around long enough to work out how to be a winner at this trading game.

So, are you ready to light your match?

I love this quote from Laura Esquivel, a Mexican novelist, screenwriter and politician. She said "Each of us is born with a box of matches inside us but we can't strike them all by ourselves."

Isn’t that beautiful.

I want to give you the tools - and with my support, you’ll improve your psychological fitness and your results as a trader.

I want you to work on yourself and your trading plan as hard as if you were studying to be a surgeon. Only then will you get the results in the markets you crave. And I’ll be with you every step of the way.

I’m aiming to strike a match within you and fan that flame with care, so that you can live the life you choose. Stick with me, and I’ll help you develop your psychological fitness, so that you can come out on top in the markets.