Just as investors have a mandate of sorts, including everything from goals to timelines to industries they’d like to be invested in, all traders should have a good trading plan.
One of the worst habits a trader can have is trading impulsively or without any guidelines − taking the time to draw up a plan will increase your odds of success.
Then it’s important not to develop bad habits. Some traders may exit winning trades too quickly or let losses run for longer, in contradiction to their own plan.
Put a plan in place and stick to it
To break bad trading habits, traders need to base the success or failure of each trade on how well they stick to their trading plan – and not simply on whether they make or lose money.
If you make a bad trade (that is, an undisciplined trade; one not part of your trading plan) but make money on it, you still have to view that as a failure.
You cannot congratulate yourself after breaking the rules. By congratulating yourself, you are rewarding yourself for doing something incorrectly.
Similarly, if you make a good trade (one that fits your trading plan perfectly) and you lose money on it, you have to view it as a success.
Unfortunately, in instances like these, it is usually more likely that you berate yourself even though you followed your trading plan. In other words, you punish yourself for doing what you were supposed to do!
Discipline remains key
If you lose money on disciplined trades, you can analyse the trades to see if your trading plan can be improved.
But if you continue to reward yourself for undisciplined trades, it will be very hard to change your habits – you are essentially conditioning yourself to make trades that do not fit into your trading plan.
On top of this, punishing yourself for trades that result in a loss but fit within your trading plan makes you even less likely to follow your own rules.
As a trader, you need to be honest with yourself and avoid accepting undisciplined trades, no matter how profitable they prove to be.
Making money on a bad trade – holding a massive losing position, only to have it recover and leave you a profit – is one of the worst moves a trader can make. Tendencies such as these destroy traders over the long run.
Don’t let one-off wins set you off course
With such behaviour, you can come to believe that next time you hold a losing position it will also come back. Unfortunately, if this fails to happen just once, it could wipe out your entire account.
You may also falsely believe that because jumping in and out of the market recklessly made you money yesterday, it might also work today. This is a risky way to trade the market.
Traders must erase their selective memory. In other words, you must remember the times when not sticking to your trading plan hurt you, and view those spontaneous trades as failures.
By instigating a mild form of punishment for breaking with your trading plan, you will soon realise that not sticking to it is a losing proposition over the long run.
When you make a trade that does comply with your trading plan, you should pat yourself on the back, even if you lost money. You can always go back and adjust a plan, but the more ingrained a faulty process becomes, the harder it will be to change your behaviour over time.
*Shaun van den Berg is head of client education at PSG Wealth.