When you believe in a trade, it’s easy to take a position. There’s little or no fear, and usually a bit of excitement as you anticipate a winner.
When you don’t believe in a trade, it’s quite unlikely that you’ll put on the trade even if everything you know intellectually tells you this is where you should get in right now.
Our beliefs, our feelings, our emotions, cause us to violate our rules. Fear of missing out, jumping the gun, hesitating and chasing, moving stops, averaging down…all these trading no-no’s are most often the result of trading what we think rather than what we see.
Satan’s Kittens was the nickname of a fighter squadron formed during WWII and my mentor sent me a story about one of their very experienced pilots who ended up landing on the wrong carrier one day despite multiple clues that he was on the wrong path. This part of the story stands out for me as an example of what can happen while trading with a bias for the outcome of individual trades:
“Although it seems amazing that a pilot could fail to recognize at least one of the glaring clues that he was approaching the wrong carrier, many have done it. The high level of excitement that a pilot experiences in the final seconds of a carrier landing approach can block out the normal signals that should trigger recognition that something is wrong.”
I recall many times being on the wrong side of a price swing or a strong trend. When I put on the trade I was certain that price would do X, so certain in fact that I wouldn’t even bother with a stop loss. When I was taking heat on the trade, instead of re-evaluating what I was seeing in front of my eyes, I’d look for validation of my belief about the trade. Every pullback in the trending move was proof that my thesis was correct, and every continuation in the direction of the trend simply made it more likely that the turning point was coming soon! Sometimes I’d even add to a losing position.
I was blinded by my bias. I'd even occasionally note in my journal something like "key support broke today and I have a bad feeling about this one". That was the rational part of me describing what I saw, not what I thought. And that was nearly always my last chance to get out for a small loss, because once the loss became larger, closing the position meant I had to face the larger loss as a reality. Closing the position was the death of hope.
Sometimes I was able to escape with a small profit or get back to even; but more often I'd puke up the position at a ridiculous loss, and experience a sense of relief that it was over. As soon that happened, I could see all the signs of a trend: the consolidation, the breakout, the orderly pullbacks to a rising or falling trend line or moving average, and resumption of the trend from there. Had I accepted a small loss when the first clue appeared that my thesis was suspect (or fully invalidated), I would’ve been free to see pullbacks as value entry points, and the continuation of the move as validation that the with-trend thesis was correct. Or I could simply sit on the sideline and wait for a reversal signal if I was uncomfortable joining a strong trend.
The Big Rule of Profitable Trading is to “Cut your losers and let your winners run”.
If you find yourself doing the opposite, chances are you’re trading based on your belief about what will happen next instead of based on your belief that over each N series of trades entered and managed according to plan, the outcome will be positive.
I recommend only trading in a demo account and recording (written or audio) your thoughts and beliefs about each trade you’re about to initiate. Work toward the ability to think in terms of probabilities, rather than letting the outcome of each individual trade be the source of your joy or misery. Know in advance of placing an order the price at which the reason for the trade would no longer make sense. Have an exit strategy. For some it’s a fixed stop loss; for others it’s the breach of a level and a subsequent plan for scaling out or switching sides.
The important thing is to have a trade management strategy planned in advance so that in the trading environment of risk and uncertainty, you know what you’re supposed to do when your ego starts feeding you a fairy tale, which it loves to do.
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The first step to becoming a consistently profitable trader is to develop a thoroughly tested trading plan that, if followed, meets or exceeds your income goals. Most aspiring traders never reach this level. Either they don’t believe it’s possible to trade objectively, or they don’t take the time necessary to develop a plan, or they come up with plans that are ill-defined and leave them feeling confused at the hard right edge of real-time trading. Always take the time to develop a plan that eliminates confusion. Once this is done, there are plenty more hurdles to overcome!
Having ample experience with the thought processes of both consistently profitable traders and frustrated struggling traders, I offer you the following comparisons between the two:
Accomplished Trader = A
Frustrated Trader = F
F) “Oh man, it was so close to filling my order and now it’s going without me! I gotta get in now or I’ll miss the entire move!”
A) “Almost got filled, but now it’s more than halfway to my projected target. The risk:reward is no longer in my favor, so I’ll cancel the order and wait for the next setup.”
F) “Whoa, this pullback looks like more than just a pullback, price is falling fast. I’m cancelling this buy order.” A few minutes later: “Sh*t, I’m an idiot, I woulda been filled a couple pennies from the turn and it’s already broken the high. I better buy now because this thing's gonna run all day!”
A) “That was a quick strong pullback, looked like it was gonna break right through support. What a bounce! Good thing speed of price movement isn’t a part of my plan.”
F) “How come this isn’t breaking down yet, it’s a downtrend, why won’t it break out of this range? This feels like accumulation now. I think the trend's going to reverse.... Screw this, I’m switching to a long.”
A) “Ahhh, narrow range consolidation. The shorts get nervous and bail, the longs get lured in by a small stop loss. This pattern leads to a quick measured move way more often than not.”
F) “Three trades and three losses! That’s not right. Maybe my edge is going away.”
A) “Wow, three losses in a row. I can’t remember the last time that happened. Well, I’ve followed all my rules, so let’s see what the rest of the day brings!”
F) “Whew, finally back in the green again! If I close out now I’ll have a profit on the day. No one ever went broke taking profit!” Minutes later: “I can’t believe I didn’t hold! I left almost $500 on the table and it’s still going! I’m getting back in!” Minutes later, stopped out for a loss: “I’m cursed!”
A) “It sure would feel good to close with a profit here after those three losses, but there’s no overhead resistance until that upper channel I’m targeting.” Minutes later: “Best trade of the week!”
Keeping a real-time trading journal (or recording your thoughts while trading) helps you become aware of the negative or irrational thoughts and feelings that sabotage your ability to follow a trading plan. Take time afterwards to write rational revisions of these thoughts so next time they creep up you can replace them with the revised ones.
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