Trading psychology Part two

Psychology

This is in continuation with the previous post on psychology and subconscious mind. There were some interesting messages in twitter after I posted the first blogpost on psychology. Here is the link to the previous post.

Trading psychology and the role of subconscious mind

In this blogpost, I would like to highlight the similarities between trading and other common psychological issues/observations. To make the concept richer, I will give it a try again on the same topic with a different flavor.

Trading and Sports

We all understand that to trade the markets, we need to learn how to trade. That is the baseline. If we believe that trading is a skill based competitive endeavor, then it follows that psychology may have a part.

Like any sporting endeavor, psychology can’t make up for us being crap in the first place. So, no point getting a sports psychologist to attend our first golf lesson. On the other hand, let’s say we have a 15 yard put on the 18th hole this shot and if we putt it right, we win the tournament (plus a cool 10 crores prize money). Fluff the shot and share 2nd place with five other folks. As we line up for that shot, our visits to a sports psychologist could make or break us.

Think about it – this is an easy shot we took a million times. But now there is so much riding on it, can we just saunter up to the ball and pop it in the hole? Or will we be deliberate, think things through too much, not rely on just letting our body do its thing in taking the shot (use of muscle memory). In short – will we f*** it up?

With any skill, our performance can degrade under pressure. We need skill before this will show up in my opinion but anyone that has played a sport competitively will know that feeling of pressure that mounts as the outcome becomes more important. This is our mind/psychology in full play.

Trading and primitive fight/flight response

When we trade the markets, lot of traders feel that that markets are there to prey on them. In fact, market does nothing to affect us individually but our brains are primordially built to handle adversarial situations. Hence, we do things like making “revenge trades”, which is treating the market like a contest between people. That is equivalent to curve fitting data so that it fits our trading idea, but we are fitting the market onto how our behavior and natural responses are designed to interact with people and predators.

Evolution has effectively given us a dumb brain and a smart brain. The smart brain runs the show unless a threat is present and then the dumb brain takes over, because the dumb brain is faster at making simple decisions. This avoids people taking a long time to arrive at a conclusive decision (whether to fight or flight) only to find that it is too late and they are in the jaws of a predator. This can create a problem in trading as our natural responses can be inappropriate and the way we view/assess information changes when the dumb brain takes over.

When we practice trading in a non-stressful situation (read it as ‘demo trading’), we evaluate our success based on how our smart brain handles the situation. Under stress, in real trading, we may find that we fail to notice things that are obvious when we look at the same information after the stress has passed. This is why demo trading is so deceiving.

Trading and owning up for our actions

Some people like to say psychology has no place. We are either a skilled trader or we aren’t. Maybe that is true if we are an Android or computer, but as a human, we have emotions. Our mind plays tricks on us. If we don’t believe that to be true, then we need to do some more research on how memories work with the human brain and it would be wise if we do some research on why wall street employs trading psychologists for millions of dollars to train hedge fund managers.

When we put all these things together, “the psychology of trading”, we come up with a collective of reasons that can explain away why we held on to that losing trade, even though our trading plan said to get rid of it. This is both a good and a bad thing.

For most, it is a good thing when we finally realize that our poor trading performance is a direct result of our own actions. Too many traders never get this far. They blame the market, indicators, vendors, platforms, data feeds, family, neighbor’s dog, phone calls and myriad number of reasons. But never themselves – Zero accountability.

When we finally realize that it was our own actions that caused us to mismanage a trade,that is progress. When we realize that it was our own actions which made as a ‘failure’ trader, that’s real progress as well. But why did we do it? We know we did it, but why?? I call this the psychology of trading. Why do we as humans want to be right? Why is it our memories fault us, convincing us of something in order for us to be right, when in reality we were wrong? This is a really important point to ponder.

Trading and stress/emotions

Am sure many of aware of backtesting a trading idea. But here is the question. When we all can see ourselves as multi-crorepatis in backtesting/demo trading, what happens in real trading? The moment that real capital is put at risk in trading, everything changes. Trading goes from a scholarly exercise where loss is theoretical/on-paper/not personal to a primordial experience where potential loss deranges the rational mind and primeval emotional responses take charge of the trading mind. After experiencing real losses, the emotional brain even starts anticipating potential losses (rather than gains) and hijacks the trading mind (and consequently, disabling it to take decisive actions) If one has dealt with fear of entering a trade or fear of pulling the trigger on a perfectly good set-up, he has experienced the incomprehensible power the emotions have over sane thought.

Others are primed for over trading when their desire to experience the feeling of winning big (and to feel that drop of dopamine creating euphoria in the brain – lot of research has been done on how the brain gets addicted to gambling) transforming the coherent trading mind into the gambler’s mind. All these inexplicable behavior during real trading can be termed as ‘trading psychology’ too.

Unless we have won the genetics lottery (to get to be in nirvana stage from age 2), the brain/mind we have brought to trading is simply not equipped to produce success in trading. It was not built to deal with uncertainty.

Final thoughts

In stock markets, riches are made in a matter of weeks and lost in a matter of minutes. This pattern recur itself as each new generation of traders hit the market. Most of us have been raised hearing (through our kith/kin or media) that rich people are immoral/unethical and downright dirty. Once we grew up and become a trader, whenever we reach that mental threshold in trading and we start feeling rich, our subconscious mind will start to help us to adjust that behavior. It pretty much helps us to push the button when we shouldn’t and so on. It is about that much-hyped (pun intended) self-image we carry inside of us. The outer world is mirroring back that to us. If we feel bad one day, our trades are going to be bad as well. This is so relevant to ‘discretionary traders’. Why? Simply because we’re actually not trading the markets really, we are trading ourselves. So, it is prudent for any trader to keep the mind and body sharp, in that aspect.

We can exercise our body (to keep both mind and body healthier) but only if we believe that mind is important in trading, we can exercise the mind as well.

Happy trading!!



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