Lecture 16

  Trading psychology

This lecture is devoted to a discussion about trader’s working psychology and his actions psychoanalysis. The human behaviour psychology is the key to understanding the current situation in the financial markets. You can be a perfect analyst, able to count the price and time orientation points till the ticks, but that does not mean that you are a trader. All ordinary and everyday feelings and aspirations emerge in severe market conditions, as well as a chemical solution on a litmus paper. All senses inherent to us (such as fear, greed, hope and etc.) in a fast stock exchange tempo sometimes exert a crucial influence on the trader’s behaviour. Weak and self-confident, extremely greedy and sluggish — all these people categoties are fated to be the market victims. The market crowd impact is able to transform the trader — from an outsider into a winner, and from a lucky one — into vanquished. Knowing of your own abilities and preferences, positive and negative features can help to avoid the collapse. If you add to this an adequate valuation skills of  psychological state and the proper market participants behaviour, then a success is guaranteed to you.

Thus, the main motivation, which makes you take part in the speculative markets operations, is greed (strange as it may seem). If your greed is inconspicuous you will make not many deals, missing a lot of good moments. But if your greed is endless and huge, then you will try to make as many deals as possible, putting your head into the lion’s mouth. In the first case it is recommended to get on with more calm business, in the second one — it’s better play in casino. A greed must be under cultivation not as a drawk, but as an useful plant. Therethrough, you will be able to lead it in a string. The main thing is that the greed musn’t hinder you to make decisions while driving the bargains. The outcome from the greed action will be a motivation while making the deals.

Two types of motivation:

  • Rational motivation. Usually, it is peculiar for the beginning traders prior to the first market intromission and also for the professionals. Expressed in a cold mercenariness while making decisions.
  • Irrational motivation. Expressed in the player’s hazard and peculiar almost for everyone, although, some can control this hazard, others are the slaves of their emotions and almost weirded to fail.

The next factor prompting the trader to make deals is a hope to gain profit. Naturally, any job target is earning money. However, when the hope supersedes the calculation, you are risking to overevaluate your possibilities during the situation analysis and make a mountain – dream out of a molehill  – reality.  You have to control your hope taking into accout a calculation and greed. Exactly a big HOPE leads the beginners to the collapse.

A trader, who relies only on hope — is doomed.

A hope determines the trader’s behaviour just in two cases:

 

  1. a) at the moment of accessing the market (only hope of making profit can make a person act in a certain way in the financial market);
  2. b) at the moment of loss making, when appears a hope of the situation to change for the better.

If in the first case everything is clear, in the second one — a hope passes over three steps of its development and existence. At the first step, when losses are not so significant, the hope is inevitable and may be reasonable in some measure, if you are following a certain scheme worked out in advance. At the second step, if the stop loss is cancelled or isn’t set up with rising losses, the hope touches its peak. At that moment it is the hardest part for a trader to distiguish his hopes from real market actions. A solution — is to close the loss making position or let it sweat — mostly, it will depend on how strong the trader’s mind controls his desire and if the trader is able to evaluate the situation adequately. The third step is characterized by critical losses, when hope leaves the trader and it is replaced with despair. This frequently comes out with weak and beginning traders. A great many of market participants including successful ones know such sense of emptiness, when it seems that the whole world works against you. But nobody knows about you, so the market malignancy is too exaggerated. Although, certainly, you can not miss that fact that the main trader’s goal is to earn at expense of another trader. A person who had overcome the last step of hope outpouring can entitle himself as an accomplished trader. Perhaps, at further trading the third step events will appear as a market fright.

In order not to face either despair, or fear it is necessary to bear responsibility for decisions that you make. Remember that our weaknesses is a mental food for srtonger players in a figural and ordinary sense.

The following risks can be poited out:

  1. a) A human being tends to come under the influence of crowd and take communal                        non-individual decisions.
  2. b) The decisions taken by crowd are provoked, as a rule, by the most unclever participants.
  3. c) Strangely look the references to the analysts, making much less money, compared to the banks and individual investors.

 

Keep in mind one of the rules, which will, probably, help you to evaluate the situation in a proper way:

The absolute majority of the financial analytics begin massive publications about the current trend continuation at the moment of its strong correction or its ending.

It may occur because the most analysts are the employees of the financial establishments, which always (or almost always) follow the rule: trend — is the trader’s friend. But, on the other hand, there may take place an intentional disinformation, as the part of accumulated strong currency needs to be throwed off.

Needless to say, on one hand, you musn’t go against the crowd, as it shapes up the main market trend. But, on the other hand — you musn’t follow the crowd’s opinion, as most likely, it would be wrong. Tracing the crowd’s actions, you have to puzzle out: are you at the winners meeting or are you looking at the crowd of vanquished people. The winners can be seen because of the increasing deals volume and rising ADX tendency. Other technical analysis indicators (such MACD,RSI etc.) move sharply along with the price. It is different with those who lost. Hereby, you have to distinguish for yourself one essential rule:

Taking part in the market and speculative trades you must always leave those who lost and join to the winners.

A trial to apply knowledge will, possibly, lead you to a contradiction with other traders and analysts. These contradictions are caused not by our vision of events, but by the psychological discomfort concerning that other traders and analysts don’t support your point of view (despite they base on the same knowledge). To handle out with this question bear in mind one of the main trading psychology rule:

DON’T AFRAID TO EARN «INCORRECTLY» FROM THE VIEWPOINT OF TRADERS AND ANALYSTS!!!

Before we pass on the psychoanalysis, you should also remember one more important remark, which was found out by testing the traders:

We are inclined to risk, when a venturousness is so high, but we afraid to risk when there is no any threat.

A psychoanalysis of the trader’s actions serves for educing your own weaknesses and help to get rid of them. In accordance with well-known statistical data, more than 90% of individual traders finish their careers at the very beginning, not achieving any results. Applying to the theory of probability, this indicator appears to be too overstated. A theoretical size of «loss making» traders can not exceed 50%, even excluding the traders with zero activity effect. What is the reason of significant contradiction of theory and practise? The most abortive traders blame the small deposit sums for their mistakes, the absence of qualitative information from the aspect of speed and volume, malignancy of the counteractants — brokers or dealers, comissions and spreads etc. Partly, these traders are right: reasons listed above don’t help to make money for sure. Though, the main reason of losses is in us — it’s our «Ego». Unfortunately, you can test the real «Ego» qualities without a professional psychoanalyst only amid «military» market conditions or other extreme conditions.

 Unfamiliarity with your own «Ego» – the main risk factor.

Educing of real person’s qualities, his «Ego» can take several years. An individual investor has no time for this, that is why he has to call on professional psyhologist or enter the market as «unstudied» trader.

To bring to light the psychotype, above all, you should find out if it is an active or passive trader in front of you (even if it is you).

Prior to the position opening everybody are equal. They are so sure in their rectitude that they are ready to persist in their opinion vehemently. Others are quiet. They listen to somebody’s opinion, but act as they want to. The thirds can discuss whatever you like and whenever you like, talking for 24 hours day and night.

After a little while the position opening (5-10 minutes for a short term position and the next day — for the long term position) it becomes clear — was the deal carried out right or wrong. And «right» not only from the aspect of position opening direction, but also the price and timeframe of its execution. As you know, the outcome can follow just 3 scenarios: profit, loss or zero result. Among them, only the first one considers positive emotions, and two others are charged with negative energy. Thus, in a short time, it can be difined how the trader behaves obtaining positive and negative emotions — agressively or passively. Finally, you can complete the following table for each trader:

 

The trader’s reaction to an event Passive Active

(agressive)

Making profit
Sustaining losses
Zero result
Total (reaction amount):

Trader’s active reaction consists in sharpness of movements and opinion alertness regarding the current situation. A passive reaction shows itself in lasting inaction, some kind of movement framework whatever happens. The result of this table completion will be the first component determination of the final table.

The second element — is the behaviour causality, i.e.: instinctive, intuitive or intelligent trader:

Trader’s behaviour reasons Instinct Intellect Intuition
While a position opening
While a position closing
While a position maintenance
Total:

Now, we are going to trace briefly how these characteristics appear.

Any initial action of the trader is considered exactly as an instinctive wish to cater different material interests. As trading — is a work (it emerged that it is psychologically hard), you have to make to deals to earn money. That is to say, we can conclude that the trader’s instinct makes itself evident in the fact that at work you have to work not just sitting in front of the screen.

The trader’s intellect consists in ability to comprehend logically what is happening with him and with the general situation around him and in reference to this take the most simple and beneficial decision. If the instinct acts unwittingly using some generic memory: the teachers’ advice, simple rule set, then the intellect tries to understand this advice and rulesin accordance with his own world view and changed external conditions. It is intellect, which can help to look for the wayout from a possible dead end, where you can find yourself following the old rules. The intellect can also give its own financial markets view and thus, survive within it more successfully.

And, finally, the third «and» – intuition. In philosophy the intuition is explained as person’s ability to penetrate in things essence not by means of inference or logical thinking, but due to momentary and inconscient enlightenment. In reference to our theme — it is a trader’s ability to work and see the market «not by mind, but by heart». One of the most famous speculators George Soros juxtaposes his intuition with the technical and fundamental analysis, and if the suggested theory is affirmed, he increases the agression pace in the direction of the market movement.

The causality table filling-in involves awareness about using which data or conclusions is carried out the deals opening/closing  and the orders motion within the position during the transaction. If there are no objective causes or you will not get a reasonable answer, then it is instinct- or intuition-oriented trader in front of you. Herewith, for an instinctive trader is essential an orientation to the physical causes of its fulfilment and reference to preceding experience and market behaviour. Intuition-oriented trader can not explain his actions reasonably referring to foreknowledge. If the action is explained logically, it is an intellectual trader type. At first thought the last one is more preferential. However, excessive rationality is often a fear covering ahead of the market uncertainty, deal making fright.

In followup of two previous tables filling-in, we can (more or less) ascertain the trader’s psyhotype and look through the recommendations.

Trader’s psyhotype Active (agressive) Passive
Instinctive Negative: excessiveemotionality;

Strong susceptibility to sense of fear, hope and etc.

Positive: very resilient.

Recommendations: calm down and take your time.

Negative: downcast emotionality;

contumacy;

reticence.

Positive: merit factor of actions.

Recommendations: take it easy oftener;

«touch and go» (concerning the deals closing).

Intuitional Negative: stress-susceptible;

needs permament control.

Positive: good reality apprehension;

able to make decisions amid full uncertainty.

Recommendations: incessant control;

take it easier,

Negative: too strong failure susceptibility;

Ability to accumulate the negative energy;

meditativeness.

Positive: «keeps hair on».

Recommendations: outdoor activity;

make deals more often;

discuss your actions with other traders, but adopt a decision by yourself.

Intellectual Negative: gets tired fast;

needs long rest;

disruptive reaction to the fundamentals.

Positive: able to take objective measures quickly;

self-analysis ability.

Recommendations: practise hardiness;

At first signs of attention easing – have a rest.

Negative: very high lentitude;

contumacy; thinks too long;

«self-analysis» inclination;

excessive sensation of fear influence;

diffidence.

Positive: «scores twice before  cuts once»;

insistence in goal  achievement .

Recommendations: accelerate the pace and calm down;

Treat with caution to others recommendations.

Concluding the discussion about psychoanalysis worth noticing that it is almost impossible to change an adult person, as a matter of fact, by the time we are 5 years old the core of our «Ego» has formed. However, it is possible and even nessecary to educate and correct some character features needful for trader. Therefore, the primary objective of trader’s behaviour psychoanalysis — is psychological deficiency outcrop, which can lead to financial losses, and also removal of disadvantages. If the trader’s negative features evade  the correction, then it is better to recognize that trading in the financial markets is not for you, the chosen way was wrong and try to self-actualize in other activities.

The recommendations given below will help the beginning traders to avoid a lot of mistakes and wrong actions operating at Forex market.

Inspect your motives. Think over your real aspiration to trade. Discrepancy between your motives and kind of activity results to conflicts. If you can not make up your mind — the game is up before it has begun.

Matching between the trading method and your individuality. It is crucial to choose the method which suits your individuality and convinience level. If it is unbearable for you to lose a significant part of current profit in the opened position, than the long-term approach suggesting the trend movement will turn out to be catastrophic for you, as you will never be able to follow it. If you don’t want (or can not) to sit in front of screen with the quotations all day long, don’t try to practise the intraday trading methods. If you don’t stand the emotional pressure while adopting the trading decisions — try to develop the automatic system for market playing. The method used must suit you and you must feel yourself comfortable.

Control your emotions. From time to time, all traders rub through stress and suffer losses. Worry, disturbance, depression and sometimes despair is the part of market job. The part of risk management is ability to control your emotions. Don’t let emotions handle your trading. Focus on the matter, which you are busy with. Trade on the basis of informative rational decisions, not emotions and imaginations.

Communication with other traders is one of the ways to control your emotions. Other traders understand the problems which you have faced and they can provide you an essential moral support when you lose courage. This helps to see that you are not alone and that others had faced such problems and managed to sort them out.

Your trading methods must be profitable on average. You can not win even having the best financial management skills in the world and the strictest discipline if your trading methods are loss-making on average. If you don’t have a trading prevelege, then all that money management and discipline can give you is — a guarantee of that your bankcruptcy process will roll on slowly. If you don’t knpw what is your trading prevelege it means that you don’t have it.

Create a method. To have a trading advantage you have to have a method. The type of the method is not important. Some supertraders use only the fundamental analysis, others play by reference to the gragh examination, some traders use mixed approach. The main thing is the method to be profit-making.

Craft or hard work. The general rule is that absolute efficiency reqiures native ability, as well as hard work allowing to externalize the potential.

If a native talent is not enough, hard work can develop a professionalism, but it won’t be perfect.

The same principles are applicable for trading. Practically, everyone can become a trader making profit, but just some of them have a native talent, which allows to be a supertrader.  For this reason you can learn a succesful trading craft, but to a certain level. Be realistic in your goals.

Discipline. Discipline is absolutely necessary to manage the risks effectively and to use your method not hesitating about which deal to handle. A beginning trader has no protection from bad trading habits, and the best that you can do is to inhibit them. As soon as you become lazy and negligent they will come back.

Be aware of your responsibility. The responsibility for results rests with you. If the losses were suffered due to broker’s advice, advisors recommendations or bad system respond — finally, the responsibility will rest with you, as you decide to take it to heart and do an act.

Independence. You should think by yourself. Don’t let yourself fall for crowd hysteria. Besides, the independence means individual decision making. Never hold by others opinion. Even if they help with one or two deals occasionally, at long last it will cost you money, needless to say about that it changes your view of the market.

Confidence. Strong confidence in your own ability to win in the financial markets appears to be a universal quality among successful traders. Their peculiarity is an assurance that they «will win the game before it has started».

Losses — is the part of the game. Great traders recognize in full measure that losses is the element inherent for the game called trading. This fact recognition strengthens their confidence in themselves. As outstanding players are sure that they will win in a long term, separate loss-making deals, which turn out to be a necessary evil, do not frighten them. There is no shorter way to the downfall than the loss phobia. If you don’t like to lose, than either finish trading, sustaining big losses or miss great trading opportunities — each of it is enough to wipe off any chance for success.

Advice search. A wish to get an advice means a lack of confidence. As said Linda Rashke: «If you feel temptation to know somebody’s opinion regarding the deal, usually, this signals that you should better leave your position».

Patience power. Expectation of favourable opportunities raises the success probability. You don’t have to be in the market all the time. As explained by Edwin Lefevre in his classical book «Reminiscences of a Stock Operator»: «There are usual fools, who act wrong at all times and in all places, but there are Wall Street fools, who think that they must trade all the time».

arrival and outgo from the market. There is no need to open or close the whole position simultaneously. The position can be increased or contracted gradually, that makes your trading more flexible and gives you a space for manoeuvre in case of unexpected market situations. The most traders sacrifice such flexibility without meditating due to desire to be the right one, that is common to everyone. A lot of traders notice that the stepwise market outgo method allows them to keep the part of long term winning positions much longer than in other case.

Being right is more important than being a genius.Think about your gainings, not trying to be a hero. Forget about attempts to evaluate the trading success by reference to how close to the minimum did you buy, it is better to draw attention to how often you choose the deals with favourable ratio of profit and risk. The result of the trading is essential, not  impeccability of some deals.

Do not be afraid to look like a fool. Don’t claw hold to your preceding wrong forecasts. Recollect all your forces to revise the situation afresh and take the right decision.

Sometimes, the action is more crutial than circumspection. Wait for price correction to open a position — sounds charily, but more often it is wrong. If your analysis, technique or  inner sense says that you must buy not waiting for the correction — do it.

It is also nice to catch the part of movement. Even if you have missed the first part of a new trend you still have an opportunity to earn in its middle part (if you are able to determine the reasonable point of protectional stop).

Learn to be disloyal. Never keep loyalty to a position. Often, a beginning ttader is too loyal to its initial position. Hoping on the best, he will ignore the signs of market situation changes and lead the deal to huge losses. More versed trader realizing the risk management importance will leave the market quickly as soon as it will be clear that the deal is to fail. However, really experienced trader will be ready to make a 180 degrees reversal, changing the position to the opposite one, if the market behaviour points to such operation method.

Fix the part of profit. Take the part of earnings from the market to protect the trading discipline from regeneration in complacency.

Hope — is a spoke in wheel. Hope makes trader stickle while dropping out the loss-making position, that doesn’t let him enter the market in expactation of correction for opening a position at better price. Often, a hope for correction leads to loss of potential profit from huge market movements. Don’t rely on it — open a position in accordance with trend as soon as there is an opportunity to define a proper protective stop level.

You can not win if you are obliged to. There is an old proverb in Wall Street: «Scary money never win». The reason is rather simple: if you risk money which do not presume to lose, all emotional traps of trading become much more dangerous. The market rarely absolves the levity concerning the deals, which comes out of despair.

Searching for adrenaline buzz in the market — is too expensive. Adrenaline buzz is related to the market trading, but that does not mean a success in the market.

Identify and exclude the stress. Stress during the trading — is a troubling sign. If you feel stressed, think why and then do something to sort out the problem. For example, you have found out that the main stress source is uncertaincy of closing the unprofitable position. One of the ways to settle this matter — is to start setting up the protection stop order every time you open a position.

Give attention to your intuition. Intuition — is a gathered experience, which lies in the subconscious. The market analysis objectiveness made up rationally may be compromised by other people suggestions (for instance, regarding the current market position, inwillingness to change the previous forecasts). Subconscious is not restrained by such pressure. Unfortunately, we are not able to push through our underself easily. However, when it emerges as intuition, the trader should pay attention to it.

The prices are not occasional — it is possible to win in the markets. Bringing to mind the academicians trusting in occaisional nature of market prices, Monroe Traut, futures trading adviser with one of the best histories of risk and profit ratio says: «Perhaps, that is why they are professors and I earn money doing that I used to do.»

Don’t lock yourself into the market. There is something but the trading in this life. Totalizing the whole course of lectures, we can say that successful and effective work can take place only in case it includes 4 the most essential elements:

  • «Price forecasting» is used for determining the further market direction (upwards or downwards). It is the first crutial step prior to decision making. The price forecasting helps the trader to be defined concerning his actions tune. In other words, if he works at upturn or downturn of the prices. The upcoming market development pattern gives the answer to the main question, which faces the trader: which way to enter the market — long or short. If the price forecast turns out to be wrong, all previous and further efforts will go to smash.

 

  • «Trading tactics» determines the certain moment to enter and leave the market. Its role is especially crucial while operating at Forex market, as the marginal loan is rather low and consequently, the «lever effect» is high, this gives the trader a right to make some slips. Often happens when the decision regarding the movement direction is right, but due to a delay of deal making the trader suffers losses. As  a rule, the trading tactics has exclusively technical performance. Thus, even if the trader prefers the fundamental approach, then at some steps of his market work he will have to use the technical instruments to determine the certain points of going in and out the market.
  • «The capital management» means the corpus of questions concerning the trader’s funds investing. This includes: optimal «portfolio» formation (for significant amounts), diversification, investment size estimation to the certain sector, with account of risk (for significant amounts), using the stop orders, correct measuring of possible profit and loss ratio, choosing a behaviour tactics after success and failure periods and certain workstyle: conservative or agressive.
  • «Psychological preparation». For each of us are peculiar our own character features, emotional singularity and habits. Cognition of yourself, correction or, in other words, adaptation of your «Ego» to the market requirements appears to be one of the most essential factors for prosperous trading. A trader can achieve good results in forecasting, develop a perfect trading scheme and capital management strategy, but the absence of discipline, fear of market and lack of self-confidence may knock out all achievements not giving a chance to obtain the looked-for result.

 

Probably, to «make the riffle» it is better to follow the wisdom such as: – «The winner is that who had won himself in the battle, but not who had won one thousand people.»

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