Trading Mindset

Psychology and Trading

How does psychology even play in trading?

Trading is a very unique profession, and is unlike any other that you know of. It is against the normal beliefs that we have in our life.

As we grow up, we learn and are taught that the more work you put into something, the better you will do and the more reward you will get. The longer hours you put in, the bigger your check is. The more work you do, the better the results. Don’t try to apply the same mindset in trading. The market doesn’t care how many hours you put into it.

You may have spent dozens and hundreds of hours studying all the technical chart patterns and fundamentals of a currency pair, just to open a trade and close it at a loss. It can be difficult to accept this. There will be times where you will put in a massive amount of work yet still lose a trade.

For a lot of people, trading is very emotional. Seeing your hard-earned money go down the drain in front of your eyes isn’t something you hope to live for. Watching your weeks and months of gains of profit just getting wiped out from one bad trade can really skew your mindset. At the same time, experiencing incredible gains can have huge effect on a person’s emotions and behaviors.

What also make trading unique is that fact that nothing is guaranteed. Making a lot of money today and losing it all the next day is something that is unique to trading. Accepting this uncertainty is crucial. No matter how good of a technical analyst you are, you will never be able to predict all the moves of the market correctly. Nobody is always right, yet it is still possible to make money with trading.

How To Develop The Winning Trading Mindset

There are 5 truths that you need to stick to:

  1. Anything can happen
  2. You don’t need to know what is going on to happen next to make money
  3. There is a random distribution between wins and losses for any given set of variables that define an edge
  4. An edge is nothing more than an indication for a higher probability of one thing happening over another
  5. Every moment in the market is unique

These truths assume that you already have a trading strategy and plan. If you don’t have a plan and don’t know what you’re doing, you shouldn’t be trading.

If your reasons for entering a trade is inconsistent, so will be your results.

Anything can happen

The market is just a collection of thoughts made by people based on their view of an asset. Some people think will think a currency pair or a stock will increase, so they buy and vice versa. Anything can happen next. People, banks, hedge funds, and corporations can influence the price.

The market does not have any set rules. It doesn’t have to behave the way you think it should. It just happens. You as a trader will just have to react to what happens next in the market.

While it is true that anything can happen, the probability of certain things happening is different. It’s possible that a currency pair or a stock will double within the next week but that does not mean it’s likely to happen.

You don’t need to know what is going to happen next in order to make money.

Since the market is uncertain, you can’t possibly know where the market will go next. Like stated before, it is a collection of thoughts of millions of people. You can’t possibly know what all those people are thinking and how they are going to react with the market.

However, this doesn’t mean you can’t make any money in trading. If you have a trading strategy with a true edge, it doesn’t matter what is going to happen next.

Casinos have a true edge. They make sure all of their games are slightly in their favor. For example, when someone plays the roulette, the casino knows that the odds are in their favor. They do not know what is going to happen next, nor is it important to them. To them, losing money on the next game is fine because they know that the odds are in their favor and so they will always make money in the long-term.

The same principle applies to trading with a trading strategy that has a real edge. A trading strategy that is proven to be profitable in the long run. You don’t need to know what will happen next as long as the odds are in your favor.

There is a random distribution between wins and losses for any given set of variables that define an edge.

Just because the odds of something will happen is in your favor does not mean that it will happen. A casino already knows that the chances of making money on a single roulette game are in their favor. Still, it is still possible that they won’t make money on a single roulette game because there is a random distribution between wins and losses. Casinos may not make money 100% of the time and they are fine with this because in the long run, they will end up being profitable.

With a 85% winning trading strategy, you may lose your first 15 trades but the rest will be winning trades. In the long run, you still have an 85% winning rate. Even with a 51% winning trade, you still end up profitable in the end. That extra 1% is what gives you the edge.

An edge is nothing more than indication of a higher probability of one thing happening over another

Having an edge means you have a higher chance of winning than losing. It doesn’t mean that you will always be profitable, but what it means is that you will be profitable in the long run.

Every moment in the market is unique

Anything can happen in the markets. What happened before doesn’t have to happen again. With a great uncertainty in the market, this creates a problem for humans. With endless possibilities, a trader can have endless ideas where the market can go next. That is why is important to have a trading plan and stick to it.

A key component of a trading plan is defining your risk. If you actually believed that you don’t know what is going to happen next and that anything can happen, you would always define your risk and protect your capital.

If you believed in your trading strategy and all the truths stated above, why would you not stick to it? Why get emotional and try to double up to make back the losses from a previous trade? Does a casino feel emotional pain because it lost a single game of roulette? No and neither should you.

You need to have a trading system with concrete rules to become a consistently profitable trader. You should be able to precisely write down what rules your trading system has.

Trading is uncertain and it can mess with your mentality. If you have a profitable trading system yet somehow can’t manage to be consistently be profitable with it, maybe because it’s your mindset.