This is the first of several trading articles I shall post and looks at the psychology of trading.
Before I set out on my career path in the computer industry where I started as a computer analyst/programmer in the Civil Service and ultimately started my own company (this was years before I started trading) , I wanted to be a psychologist.
I applied to read psychology at Lancaster and Bangor University but my grades fell a little short of their exacting demands and I was rejected.
Rather than scratch around looking for a place, I decided to get a job and abandoned my aspirations in this field but I’ve retained an interest in the subject and still read books and papers, especially anything related to the psychology of trading.
This is worthwhile because trading messes with your head. Big time.
If you’ve got the best trading method the worlds ever seen, you’re still going to lose money unless your head’s in the right place.
Let me ask you a question. Have you ever done something, anything, not necessarily related to trading, jut anything that you immediately regret doing? You do something and you instantly ask yourself “why did I just do that?”.
Have you gone to the shops to buy a few things, picked up a jar of something you’ve never tried before and say to yourself “I think I’ll buy that” and you buy it only to throw it out 6 months later unopened, wondering why you bought it in the first place?
Have you decided you need something and you know you can get the item on ebay or Amazon but you can’t wait 2 or 3 days, you have to have it NOW! so you drive to 20 miles to the shopping centre and pay twice the price for it only to leave it on your desk for 3 days before you open it?
We’ve all done it.
We all do it.
The Chimp Paradox explains in simple everyday language why we do things like this.
I urge everyone to read this book. You will understand yourself and others far better if you recognize your inner chimp.
To briefly explain. Professor Peters claims that the brain is in fact 3 separate and independent entities, two of which think independently of each other and the other is a depository for information. Professor Peters calls these the Human (resides in the frontal lobes) , the Chimp (your emotional machine living in the limbic area) and the Computer which is spread throughout the brain.
The Human is how we all behave on a day to day basis and its the version of us all that is on show. The Chimp , however is far more powerful than the Human and has the ability to hijack the brain and take control either spontaneously or over a period and can either be your friend or your worst enemy.
The Chimp is particularly active when you trade and traders need to be on constant alert because the Chimp is NOT your friend when you trade. In fact its your mortal enemy and I believe that people who can control their Chimp will succeed at trading whereas those who cannot will not.
The problem is the Chimp will look to sabotage your trading at every opportunity and then convince you that you’re right. I’ll give you an example.
You’ve correctly identified that the GBP is due a significant bounce after weeks or even months of selling off. You’ve come to this conclusion through sound technical analysis. The R.S.I. on the higher time frames are moving out of oversold and the 200 day moving average is leveling off. You’re BUYING the GBP/USD at support and you’re closing the trade at resistance. Everything is working out nicely and you’ve had several nice winners.
At 09:30 the GBP GDP numbers are out and you’re LONG GBP/USD and GBP/NZD with a tight STOP on both trades. You want a positive print. The numbers come out and its a green print – expected 0.5% actual 0.6%. You’re delighted and expect your positions to improve.
But this is FX.
Expect the unexpected.
The GBP sells off and your stops are hit. You curse. You can’t believe it. You’re convinced the price should be going up not down, after all, the print has beaten market expectation and when that happens the price goes up not down.Right?.
DANGER – your Chimp is now taking control!!!.
You begin to trade on emotion, you want revenge. Price moves down to support but the set up is all wrong. The RSI is falling on the higher time frames and on the shorter time frames the price is nowhere near over sold. You go LONG anyway convinced the price will turn in your favour because you’ve decided the price should be higher rather than believe the evidence. You don’t place the tight stops you’ve been using successfully because you have to win this trade and you want to be right. The price sinks. You’re 20 pips down , then 30 pips, then 40 pips and you’ve now in danger of giving back to the market all your successful trades from the previous 3 days…………and still the price falls and still you hold telling yourself that the price will find support and turn in your favour. Remember (you tell yourself) – a losing trade is not the same as a lost trade. You continue to hold. You look at the H1 chart and the price is crossing over down. Your Human tells you that this is a SHORT opportunity but your Chimp has you LONG. You continue to hold. 60 pips down, 80 pips down. Its late and you’ve stared at the position for hours , willing the price to go in your direction . It doesn’t. You go to bed fearful, knowing what’s going to happen when you turn on your platform in the morning. You pray for a miracle. It doesn’t come. You look at the position and you’re now 150 pips down. Why didn’t you put a STOP on the position? Why didn’t you accept that if good news hasn’t boosted your trade then the BEARS have taken control of the price. This is basic trading. Its lesson one. Why have you put yourself in this position AGAIN!
We’ve all done this and even the most successful traders on the planet will fall into this trap.
We are all emotional. Our emotions make us. You can’t hide from them. We are governed by them. You will NOT be able to control your emotions every time – only robots can do that but if you can control your emotion most of the time you will be more likely to be successful than not (if you have a sound method of course).
You will not get rich quick trading. If you think you will, you’ve already lost because its an unrealistic attitude and you’ve already heaped pressure on yourself to succeed. If you need to win you wont win because you’ll gamble and as soon as you start gambling when you trade – you’ve had it.
There are three emotions you need to always be aware of when you trade. Fear, revenge and elation/greed.
If you have a trading method that works and has worked over an established period of time then trust it. If you have a run of defeats then reduce your lot sizing by 50% or more. Reduce it by 90%. Trade with lot sizes that won’t hurt you. Then,when (if) you start making pips (note – pips – not money) then increase your lot sizing gradually until you’re happy that your method is sound and you have confidence in it. If your method is not sound, this will keep you in the market until you re-evaluate your method and either modify it or abandon it.
Q. How many traders have seen their 40/50/80/100 pip STOP hit by 1 or 2 pips only for the position to reverse and head your way?
We all have and its hard to take. It becomes personal. We think the market is out to get us. Its not of course, but it feels like it. The Chimp loves this situation. You want to get even. You want to win…………………..and this is a key psychological element of trading. You trade to make money. You don’t trade to beat the system. Its not a fight between you and the markets. The markets cannot be defeated because they don’t fight. They are inanimate. You are at your most vulnerable when you adopt this revenge attitude and you will abandon your strict methods and jump on any trade you think “looks” right. This is your Chimp in action. You become reckless in the pursuit of a win. Money management goes out of the window. You increase your lot sizing to get back what you lost in half the time you took to lose it and guess what happens? Yes. You lose again.
All traders love successful trades. Its why we trade. We’ve made money and we’ve beaten the market (you haven’t really – it just feels like it). You’re on a roll. 5 winners on the bounce. You should stop now and don’t give your winnings back. Do you stop? No of course you don’t. You scour the charts looking for another trade to make some more money on. You find a trade. Its not ideal. It doesn’t fit it with your strict method but hey, I’m on a role – this games easy. Again – what happens. You lose. So what do you do now? Close your platform and turn the TV on? No you look for another trade to get back the money you’ve just lost.
Casino’s rely on this emotion. They rely on greed. If you’re spanking the house the last thing the casino wants is for you to stop playing and cash your chips. They want you at the tables for as long as possible because they know eventually your luck will run out and you’ll give it back.
One of the finest gambling movies you’ll ever see that really drives this point home is the excellent Owning Mahowny starring the late lamented Philip Seymour Hoffman. Watch it and watch the inner Chimp take control.
Good traders know when to stop.
If you’ve had a good day, accept it. Bank it. Walk away happy. If you’ve made 100 pips that day and you have a couple of positions that are running with break even stops, you will have the sleep of angels knowing you cannot lose. If you’ve made 100 pips and you have a couple of trades that are each under water 40 pips and you have an 80 pip stop on both of them, these trades will haunt you as you try to sleep. If you’re lucky your positions will have recovered and you’ll either be at break even or in the money, realistically, we all know that most times we won’t get that break and you’ll be crushed. How often have you had one or two trades running with large stops and no take profit and you turn your platform on praying just to see one or two open positions only to see no open trades and you realize you’ve started the day with a big loss?
Beware the Chimp. The Chimp is out to get you. He can be kept in his cage if you follow rules and trade without emotion. Your attitude and mindset is key to trading. Never impulse trade. One tip for novice traders is to never place a trade that’s more than 20 pips away from the 200 day simple moving average on the 1M chart. This is a simple technique to maintain discipline and will stop you impulse trading.
The 200 day sma is the greatest indicator there is and should be on EVERY traders chart in thick black. It should certainly be on every novice or would be traders chart.
The price of every instrument returns to the 200 day sma on every time frame eventually but on the 1M its never away from it for long. If you want to go LONG and the price is 40 pips above the 200 sma then WAIT. When the price returns to the 200, the price will bounce off it and you can place your LONG trade with a STOP below it. If the price falls through the 200 and sits 40 pips below the 200 and you still think LONGS are in play then go LONG at support with a STOP under the support level.
The reverse applies for SHORT trades*
This is just one way where you can keep control of your emotions and keep control of your Chimp.
Be warned though – trading is difficult because its not that easy to exercise the discipline you need to stick to these rules but if you want to succeed at trading its imperative you maintain discipline.
- I shall elaborate on this method in future posts