Trading Psychology | Mind Games for Profitable Trading

trader psychology

Trading psychology or mind games that shape your beliefs?

Once money and ego are involved, all well laid plans are rendered mute…

Trust me, you are not the exception. We all have an inner voice that can help us or lead us to doubt what we see.

We must do our best to recognize when our self-talk is in control and swaying us from our perfectly designed trading plan.

I have yet to meet a trader who hasn’t canceled a stop-loss as it was about to get hit. The fear of exiting a losing trade or avoiding the ego bruise of “being wrong” makes us do strange things.

In spite of the grip these demons have on us, I have developed some solid techniques to wake myself up when I am making poor decisions.

What to Do When You Lack Conviction in a Position

One of the classic trade management scenarios is not being sure if an open position is still a good risk. You start to doubt the position.

Usually we start to justify the trade and build a brand new scenario (mind games). This happens because the trade is not producing a result (one way or the other) in a perceived reasonable period of time.

The goal here is to get yourself a straight answer about the risk/reward. Here is how I handle it.

Ask yourself this question and believe your first answer, don’t rationalize, simply believe the first thing that comes to mind.

If I didn’t this trade would I want it?

This immediately snaps you out of the emotional fog and gets you to assess the trade from a fresh set of eyes.

What to Do When You Are Holding a Losing Trade too Long

Everyone is guilty of this and we all know it’s an account killer.

We spend days and months building the perfect trading plan but it all goes out the window if we don’t follow the rules.

The mainstay of any good trading plan is accepting a specific dollar amount and sticking to it. This is the only way for the probability of your edge to play out. The only way for the odds to work.

Why do we do it? Why do we hope our losers come back instead of taking the right action? There are plenty of answers but to me there are only two that make sense.

  1. You can’t afford to risk the money so you don’t want to take the loss hoping the price action will come back in your favor.
  2. You have a giant ego and you can’t admit your brilliant analysis is wrong.

Either way you are thinking wrong. You are messing with the odds. Here is a funny but very effective technique I have used to overcome this common challenge.

Say the following out loud to yourself. “I must hold this losing trade past my accepted stop loss and deal with the emotional stress of holding a losing position because there will never be another opportunity for me to earn money as a swing trader.”

Trust me. Say it out loud. You will exit the position immediately.

How to Correctly Manage a Winning Position

Too often we get ants in our pants when we have winner. We want to ring the register.

We feel good when we book a winning trade, it validates our skills and hard work. The problem is we needs some bigger wins to pay for the accepted small losses. Those small losses are the cost of doing business.

You are spending money to make money. The numbers work when you treat your capital as inventory. You will have some small wins and losses it controlling the big losses and holding the winners that make it rain.

Sometimes we lose sight of why we made the trade in the first place. This is where we need to go first when we want to make ourselves feel good by taking a small profit. We need to go back to the original trade scenario and get away from making a P&L based decision.

Here is how I do it. Ask yourself the following;

Has the reason for taking risk or the potential to earn money changed?

If you honestly assess and review the reason for the trade and nothing has changed, hold on to your guns and trust your strategy. There is a reason you set profit targets, so you can only risk capital when the risk was worth the reward.

If you have big one on the line. Hold on until you see a reason to reel it in.

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Leave a Reply 11 comments

Passion4Trading Reply

“The mainstay of any good trading plan is accepting a specific dollar amount and sticking to it”– exactly—this is “R”…& amount should be calculated based on not only what our emotional fortitude can easily handle, but also on total trading capital & protection against big picture “risk of ruin”…which ensures we always live another day & stay in the game.

    pete renzulli Reply

    Absolutely correct. Most traders however never accept a dollar amount. This is proven by moving or cancelling a stop loss the moment it is about to get hit. IF you accepted the dollar amount yu wopuld ahve accepted the fact you are risking that dollar amount as any entrepreneur would accept buying inventory or spending money on advertising.

Passion4Trading Reply

With 1R INITIALLY at risk on each & every trade—developing a system of dynamically assessing CURRENT odds on hard right edge (current price & stock/general market conditions NOW) allows for one to OBJECTIVELY determine trade mgmt. When odds drop significantly–but well prior to area INITIALLY proven wrong on chart—exiting trade early makes sense (aka –less than 1R loss… ie– .25R…. .44R…etc) because over statistically meaningful number of trades under these conditions –MORE OFTEN THAN NOT FULL LOSS IS AVOIDED—which is HUUUUUUUGE in maintaining a positive expectancy over the long haul. Moral of story: Edge is not only knowing when to enter…but when to exit :-).

    pete renzulli Reply

    Great point Lou. Trade management is where the money is.

Passion4Trading Reply

P.S.– Alternative to hard exit for smaller R loss would be remaining in position…yet moving stop to new chart based area proven wrong…with a slightly higher “less than 1R – multiple loss”–yet allows for nonetheless an immediate risk reduction…but also some “wiggle room” for chance that the perceived lower odds may end up being some negative noise–and that in the end one’s thesis was still intact. Moral of story: Either way-if our decisions are ALWAYS BASED ON PROBABILITIES–we cant trade any better than that :-).

    pete renzulli Reply

    Probabilities are everything Lou. You are right. If you don’t believe you have an edge you should never take on risk.
    One quick thought about determining the probabilities. Let’s talk relative strength and probabilities.
    Situation A: You have a solid uptrend in your stock. But the market is flat or in a down trend.
    Situation B: Your stock in a solid up trend, other stocks in the industry are strong but the market is weak.
    Situation C: Your stock, related stocks in the industry and the market are all strong.

    Clearly situation C deserves more attention. More money is “on the same page.” If anyone disagrees with that they are flat out wrong. Situation C has better odds to follow-through.

    Risk/reward analogy: You can have 3 Aces or a full house and betting more is the right call, but, that is not a guarantee you will win the hand. The concept is relevant but the difference is a bad trade doesn’t end like a poker hand. However you can adjust and reduce risk as you mentioned. If you don’t “win” with a more aggressive trade or bet it doesn’t make it the “wrong” play.

    This is a core skill to learn and takes time. The reason it becomes so difficult for many traders is they never commit to a strategy.

Passion4Trading Reply

Pete–u touched on it briefly–and I’m sure u plan on going into it more–but a huuuuge void I have found overall by the masses in trader education is failure to truly explain what conditions need to exist for “high risk to reward” setups. All too often–traders will either arbitrarily rationalize “ok–my stop is .25 away…therefore my target will be 1.00 for 1:4″…without regard to what the chart says….or a key level on a chart is identified as a target that meets high ratio criteria—yet total disregard is is given to various obstacles along the way to that target.

As a suggestion–going into nuanced detail of true/high quality risk:reward criteria will set u apart from the crowd 🙂

    pete renzulli Reply

    Hey Lou great context for this topic. I love it. thanks for contributing.
    From my experience one of the biggest problems we have as traders is wanting to fit a static idea into a changing market.
    A static idea being risk/reward. Most traders never understand their initial assessment of risk does not need to be your final risk adjustment of the trade. (especially if you are a day trader in today’s computer driven market)

    Great traders adjust risk until a trade either follows through or it doesn’t. This is a fundamental skill to develop that never gets discussed because too many educators want to tell you “only take trades with 3-1 risk reward ratio.” This sounds great on paper but when do you recommend a re entry if you are stopped out? This is a must! Getting stopped out doesn’t necessarily invalidate the idea. (although it could)

    If you want to become a great trader you need to adjust and accept risk. Assuming a trader will never make adjustments after a trade is like saying “I am going to drive 55 today because that is what I did yesterday.”
    Sometimes we get on the road and it’s wide open and sometimes it’s stop and go.

    I am not implying to start a trade with more leverage but to develop the skill to identify when the odds are greater and if you get the follow through the odds imply you can and should increase leverage to capitalize on the scenario. My point was to learn to recognize when the odds are stacked, not to trade more size simply because the odds have a higher perceived edge.

    Great comment! Keep em coming!

      Passion4Trading Reply

      Awesome Pete–great stuff!

      I always remembered a mantra of yours that applies here– “Right idea…wrong time”.

      I have found the “Re-Entry concept is extremely powerful–& typically has higher odds than the 1st trade–due to significant factor that didnt exist on initial entry—MORE INFORMATION (which will either confirm or invalidate original thesis).

Richard Reply

nice discussion….. cutting losers is always a tricky one, but in my opinion the lack of profits is much more problematic, not least since profits also bring a profitable, successful mindset that more easily disregards losses…. losses are losses… even the guy at the fruit market ditches the last tray of apples on Saturday afternoon for a small loss…

the hardest thing is holding the position…. not just to be right, not to lose the valuable profits, not to lose the success, to take a break or relax for the weekend etc….

sitting in position is where the money is at…. even in retail… if a shop cuts their prices, they kill their profitability terribly, even if more customers come and buy… .

    Pete Renzulli Reply

    Agreed Richard.
    Holding the good ones longer is a skill to develop.
    I think exiting too soon hurts more than taking an accepted loss.

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