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PsychologyThe MarketNerd’s take on trading psychology

Trading psychology relates to the mental and emotional state that play an integral role in a trader’s success or failures. The psychological aspect of trading is arguably more important than the technical and fundamental analysis, on which traders often focus exclusively. Numerous obstacles on a trader’s path usually originate from the emotional and mental habits regarding one’s behaviour in the market. The two biggest hardships traders face in regard to their psychology are greed and fear. These emotions are very broad, but I will attempt to describe how they can influence your speculative performance, and moreover how you can handle them better. 

            People oftentimes have the general misconception that trading is all about being able to analyse the market and make the right decisions consistently. While there is some truth to the preceding statement, we must not fail to acknowledge that due to human nature itself, emotions play a crucial role in a trader’s decision-making and overall performance. Fear, for example, might prevent you from entering a trade that is objectively consistent with your execution criteria. Fear usually drives decisions that appear to avoid risk and generate little return. In a market where risk is always present, being fearful has a lot of drawbacks. Contrastingly, being overconfident and lacking fear is also detrimental to a trader’s performance. 

Another factor heavily associated with trading psychology is greed. As mentioned in the MarketNerd’s free lessons, there is theoretically an unlimited rate of return that can be gained on every single trade. 

Traders are subconsciously affected by greed and the desire to gain unrealistic rates of return in a short time period. Greediness usually ‘convinces’ traders to enter trades that aren’t optimal, or hold profitable trades longer than they had rationally planned. ‘Rushing’ an entry might also be the result of ‘FOMO’ (fear of missing out). Greed might also cause improper position sizing, which simply means risking more than you should on a given trade by using a higher lot size. 

            In conclusion, successful trading is a function of multiple factors. A trader will struggle to become profitable in the long run, if he is an expert of technical analysis exclusively, or if he has just mastered his emotions and market behaviour. Competence on a combination of these elements is what shapes someone into a consistently profitable trader. Each trader has his own psychological challenges when participating in the market. In order to discover your weakest and strongest psychological attributes, you must first document and journal every single trade you execute. After doing so, you will start to notice negative behaviour patterns that might be related to fear, greed, or any other emotion. I have included a list of trading psychology books below. These books have helped me notice some of my emotional flaws in relation to trading, furthermore finding solutions to them and becoming an objective trader. I am confident that these books will assist you too. 

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Trading Books

Trading in the Zone – Mark Douglas

It is probably not the first time you have seen this recommended in lists of must-read trading psychology books. You could say it is almost indispensable to trading success and simply being a successful trader.

This is a book that you will find totally changes your trading mindset as a beginner trader. Newbies usually come to trading thinking it works one way, and after reading this book there is often a big ‘ah ha’ moment to understand it works another way completely. There is a big emphasis on probability theory.

A note to complete trading beginners, this book should not be your first stop. The examples given in the book, of what often stops many aspiring traders from becoming consistently profitable, requires some trading experience to understand and appreciate.

Market Wizards – Jack Schwager

Each chapter of this very popular trading book is an interview with some of the most famous hedge fund and CTA traders, all of whom have a long and proven track record of success. Trader interviews include Paul Tudor Jones, Ed Seykota, Marty Schwartz and many others.

Although the interviewees all provide different insights, Schwager is looking for the  factors that are common to all of them to help determine what is most important for trading.

There is a slight bent towards trend-following in the book that Schwager correctly notes is one of the best recipes for long term success in trading and investing. But more than that, Schwager notes that all the successful traders put a huge amount of importance on risk management, and controlling their downside. To do this, they establish trading systems – a process that many hopeful investors fatefully miss.

The Disciplined Trader – Mark Douglas 

This book compliments Trading In The Zone exceptionally as a guide to understanding the psychology of self-discipline and the personal transformation required by your average social and school-indoctrinated person in order to become a successful trader. Published in 1990, it was one of the first books to buck the trend of focusing on methodology – and focused instead on the role that healthy psychology plays in a trader’s success. After all, you can have the best methods in the world, but if you have poor trading psychology, you’ll find some way to screw it up. The book speaks to you in a conversational tone, rather than an academic tone. It’s written as if Mark is talking directly to you, not to an audience. If you’re struggling with any part of your trading then it’s very likely that reading this book will trigger several light-bulb moments and epiphanies about yourself and why you struggle with whatever you struggle with. It almost has a spiritual undertone, and I have no doubt that Mark was a spiritually enlightened man who understood the profundity of human experience better than most. He was certainly a man with ideas far ahead of his time. The book actually touches on a few rather esoteric subjects such as dissecting what is experience itself. But it’s done in a grounded way that is intuitive to understand, and contains ideas and tactics that are practical to implement in your own life. It has definitely earned its place on this list.

The Daily Trading Coach – Brett Steenbarger

Steenbarger is a psychiatrist by training but by happenstance became involved with trading when he was hired by some top Wall Street firms to try to help their traders and investment bankers.

Realizing the important role trading psychology plays in the profits and losses these traders made, Steenbarger went on to specialize in the area of psychology in financial markets, acting as a full-time ‘trading coach’. His years of experience directly helping professional traders and establishing the best day trading rules bears out in the quality of this book.

The book provides a very practical 101 lessons to help traders coach themselves into better trading methods, including morning routines, setting daily goals and trading psychology techniques to include in your daily trading strategy.

Steenbarger is also the author of ‘Trading Psychology’.

The Art of Thinking Clearly – Rolf Dobelli

Written by Rolf Dobelli, this book presents its content in a concise manner across 99 chapters, each only two to three pages long. The chapters provide examples of psychological pitfalls that anyone—not just traders—can fall into. 

With 99 pitfalls discussed in the book to be aware of, many readers will learn something about choices that can stifle their development and growth. Some of the chapters include:

  • “How to Relieve People of Their Millions”
  • “Murder Your Darlings”
  • “Don’t Take News Anchors Seriously”
  • “Why Watching and Waiting Is Torture”

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