When we embark on the road to trading, we’re usually determined to learn as much as we can about, for example, technical analysis, the practical things about how markets work, and ways that we can ‘predict’ what price is going to do. It is the same for most people – it was the same for me.
It takes us some time to truly understand that we cannot predict the future – no matter how much analysis we do. We tend to look for a strategy that gives us a logical and statistical edge. We might even build our own strategy and use historical data to back-test it. But whenever we trade that strategy in accordance with our set of rules, we still seem to keep losing.
We then seek out other, better strategies. This is a dangerous trap. Because while the knowledge quest is a good thing and should be never-ending, it takes us a long time to realise that the problem isn’t with the strategy. Rather it’s that we’re sabotaging ourselves.
As humans, we have two primary drivers: fear and greed. Think about it: Every single emotion that we as humans feel can be traced back to one of these two primary emotions. We love, ultimately, because we want to feel fulfilled. (Sometimes we marry the wrong people because we are afraid of being alone.)
This might be an extreme example, but it illustrates how these emotions subconsciously dictate our choices throughout life. More on topic though, these two emotions cause us to make sporadic or illogical choices that are not always in our best interest.
Like the choice to trade the bear flag before it’s broken out of the formation. Or the choice to not execute your stop-loss because you believe that the trade will still work out in your favour. The choice to trade five contracts instead of one. The decision to stop out and put on the opposite position, only to be wrong again. And to then again stop out and put on the opposite position… over and over. It’s a collection of small, subconscious decisions that make us break the rules of our strategy without even being consciously aware of it.
If we hope to make it as traders, we have to make time for some introspection. We have to understand our own emotions and how they influence our decisions. We must learn to literally get up from our desks and walk away for five minutes, especially when we feel emotional, upset, excited, or sad – or any emotion other than calm, disciplined, logical and patient.
We must learn to will ourselves into a state of mind where we accept that what we are doing is unpredictable and we will sometimes lose money. It’s okay – as long as we followed the rules exactly. Our desire to make money, and our fear of losing it, causes us to make poor decisions. We must learn to recognise when those emotions are in charge and we must allow them to pass before we make any decisions.
The truth is that even the simplest of trading strategies can make us money if we follow it absolutely. Even just using some basic principles like identifying the trend – and never trading against it. Or making use of stop-losses. Or making sure that every trade has at least a 1:2 risk-reward ratio. But when we’re actually sitting down and doing it, we get caught up in the swirl of subconscious drivers that fuel mistakes.
There are a few principles that can help us maintain the discipline to act logically when our heads start to swirl:
- We cannot predict what is going to happen. We can only ensure that our strategy provides a high probability of our ‘forecast outcome’ happening.
- Even if our forecast outcome is highly probable, it doesn’t mean that it will happen.
- It takes many trades for a strategy to generate returns. It is inevitable that some trades will be losers.
- If we follow our strategy exactly, there will be winning trades.
- If we follow the ‘risk management rules’, even if we only have winning trades half the time, we will make money.
- It’s okay to miss a trade when you’re not in the right mindset. There will be another opportunity.
- If we feel like making a trade that does not meet all the requirements of our strategy exactly, we must walk away.
There is more to this, of course, but the first step is to make sure that we do not make emotionally driven mistakes.
Petri Redelinghuys is a trader and the founder of Herenya Capital Advisors.