Greetings traders and welcome back to another Survival Guide.
Chris here, bringing you some more information, and today, that
information is going to pertain to trading psychology. That's
right, we're going to dive into the mind of a trader because
ultimately, more often than not, it is the psychology and the
mindset of a trader that determines whether or not they're
going to make it and be profitable in the long run or unfortunately
fizzle and die out. So if you plan on passing the Gauntlet Mini,
then listen up because you need every advantage that you
can muster in order to make sure you have what it takes to pass the exam.
But without further ado, let's go ahead and dive on into
that material and get on going.
Trading psychology is just as important to an investor as
their knowledge of the fundamental or technical analysis
that they're using to analyze the market. If we strip away
the various layers of the trading mindset, we can sum it up
in really one phrase. That phrase is, "how do we cope with
the risk-reward ratio?" Many people will automatically assume
that traders are just simply risk takers, but this is not
necessarily the case. Really, we want to be masters of risk
as traders and not just simply risk takers. Discipline is just
as important as the ability to spot an opportunity and go for it.
Trading psychology can be described as the mental and largely
emotional thought process that influences a trader's decisions
to execute orders in the market. When we talk of trading psychology,
there are numerous emotions and skills to consider described
as two sides of the same coin.
For example, a trader has to be quick-witted but also needs
to have thought through their next move before they execute it.
They need to exercise a degree of discipline and appreciate
that gut feeling that might come
around about a particular opportunity that they're investigating.
For every emotion associated with trading psychology, there
is also an exact opposite to consider. Many people attribute
the success of top athletes to innate talent but much of
that is actually well-deserved skill. The training and discipline
is a huge part of what makes anyone good at anything. Not
all investors are born as a perfect trader out of the gate
and in fact, most of them are not in large. They generate these
skills through honing their understanding of the markets
in conjunction with understanding of their own mind and the
psychology that involves trading. Let's talk about what makes
trading psychology so important to us as traders. As traders,
we need to be decisive with the ability to act immediately.
But at the same time, we also need to be able to stay calm
so we can think clearly. We need to be risk takers,
but we also need to exert some degree of caution
as we are taking those risks. At first, this almost seems
counterproductive, but the reality is about finding that
delicate balance between all areas and being fine-tuned with
both your emotional aspect that gets involved and triggered while trading,
as well as your logical brain that is going to guide you
through the logical thought process behind why you might
be interested in something to begin with.
There are many different emotions associated with good traders
and elite traders. Two of the more commonly discussed emotions
are fear and greed. The relationship between fear and the
risk-reward ratio is one of the commonly talked about trading
psychology topics. That's because, unfortunately for many
traders, fear is an emotion that can quickly dominate their
mindset and in turn it dictates their actions.
This emotion could see traders closing down a profitable
position too early, thereby generating
a substandard return. They tend to focus too much on the
actual return instead of continuously adjusting the risk-reward
ratio. At some point,
this may indicate that there is a significant upside remaining
for relatively little additional risk. While it is never wrong
to go ahead and take a profit,
there is also another saying in the market. That saying
is, "run your winners and cut your losers." Those who are not
disciplined, focused, and have not fully delved into investing for too long,
often do exactly the opposite of this however. They very
often run their losing trades entirely too long with pride,
often to their detriment, while cutting their winners too
early so they can lock in some profit after experiencing a string of losses.
This can be a very damaging mindset to reinforce and to allow to continue.
Another mindset is the relationship between greed and the
risk-reward ratio. Someone with sound trading psychology will
generally appreciate the changing risk-reward ratio as futures
contracts or other asset prices move up or down in their
favor. They will leave something for the next person
so to speak, which at first can sound a little bizarre.
This means that the experienced traders would be happy to
sell just before the top of the market, and before the bottom
of the market as those sellers start falling out and the market
begins to rise again. Those who don't fully appreciate the
ever-changing risk-reward ratio will try to squeeze every
last dollar out of their investment, even if the additional
reward is not worth the risk. Greed is a mighty strong emotion, and it can be the
nemesis of many traders, especially in the retail world.
Remember, we always want to remember that there is a direct
correlation between the risk and the reward. If there was
no risk, then there really wouldn't be a reward.
It's that simple. We need to understand the relationship
between the greed and the risk-reward ratio, as well as the
relationship between the fear and risk-reward ratio.
There are common mistakes that traders make on a daily basis
that, if they were aware were mistakes to begin with, maybe
they wouldn't make them.
Let's go ahead and address some of the most common ones out there.
The first one is finding information to match your theory.
What I mean by this is looking for things that you want to
see and ignoring information that does not fit in with your
beliefs. As an experienced trader,
you would see both sides of the argument. As an inexperienced
trader, you might only look for to validate what you're already
wanting to do. This means if you're looking to buy, you're
only going to look for things that substantiate that idea
that a buy would make sense, and you'll ignore any of the ideas
that say maybe a buy is not so good right now because there
might be some bearish activity to come. Another mistake that
traders make commonly is the fact that losses can play heavy
on their heart. While the prospect of a loss should never
be taken lightly, it all needs to be judged in relative terms. If we took out
an option on the market and it turned against us, but we sold
on the first downturn, than in relative terms,
we made the right decision.
And yes, we may have taken a loss in the short term, but
it could have been a lot worse and we should allow ourselves
to be satisfied with the fact that we made the best of an
unfortunate situation. We don't want to think of it in the other angle, and go
well, "hey, we lost this money and this is just going
to ruin our day," which then snowballs into other losses. Another
mistake that traders make is the mind over matter mistake.
What I mean by this; History does repeat itself regularly
and it does so in all walks of life.
It's more relevant in the markets than most other areas of
life, but when drawing the correct conclusions and taking
this into consideration, it's important to understand that
just because history did something in the past does not mean
that is going to do it again positively 100% in the future.
We want to take everything logically
and think about it from a common sense type of standpoint.
We don't want to become blinded just because it occurred
a certain way in the past and think that it has to occur
that way in the future.
We need our mind to be powered by logic, and not by emotion
and what we want to happen. Another huge problem that traders
seem to encounter in the trading psychology landscape is
following like lambs to the slaughter.
This could be really exemplified by what we just experienced,
depending on when you're watching this video,
with the GameStop surge. Now, I'm not going to advocate for
or against what happened, I'm going to only use it as an example
to showcase how quickly the "follow mentality" can take hold
and traders can go along. Let's switch over here and look
at a graph of what happened here. When the coronavirus pandemic
had a huge impact on company sales at GameStop, the share
price was in the single digits with the expectations being,
by most, that there was a whole lot of bearish future ahead
for GameStop. Not good. And as such, the hedge funds took out
a large number of short positions, they actually opened more
shorts than was even theoretically possible. They made their
short positions known, and essentially what happened was Reddit
and the Wall Street Bets Community, which is a subreddit,
decided that they were going to fight back and prove a point
against the Man. The idea here is, with the way that the shorts
work, if the shorts were unsuccessful in pushing price lower,
than the hedge funds would in turn have to cover their positions,
which means, they would have to buy, which would in turn ideally
push the market higher.
The concept here was that if enough lambs went to the
slaughter, it would actually overpower the person doing the
slaughtering in this case, which was the hedge funds.
Unfortunately, at least in today's day and age, it does not
look like it had any long-term life, and it as such
retraced quite heavily despite bumping the price quite higher
than it was before the gate.
Now how this will play out, time will tell. But the idea to
be aware of and the thing to take away from this, is just because
we are told by the masses, whether it's on one side of the
coin being the hedge funds or on the other side of the coin
being the Reddit thread Wall Street Bets,
it may not be an intelligent choice to dump our entire life
savings in with a decision from either side of the coin. We don't want
to jump in just because other people are doing it.
There has to be a more logical reason behind it, and usually
in the case of stocks,
we prefer it to be a more fundamentally sound reason behind it.
There are many ways that trading psychology can help
us avoid a lot of the errors that we talked about.
The first is to make sure that we're always looking at the
pros and cons of every investment.
This means that we want to understand the reasons why buying
make sense and the potential reasons why selling might be
a good idea. That way we can take a balanced approach, not
just a biased, one way thinking when we jump into something.
It's important to always do this with whatever it is that
we're doing, whether it be a stock
market play, or whether it be a futures contract that we're
looking to take advantage of. We want to play both sides of
the coin out in our head and then see how we feel about the
position from a more well-rounded area instead of just always
looking, "does this make sense to buy?", never even considering
why someone might be interested in selling, and just selling
without ever even considering why perhaps someone else might be ready to buy.
We also want to make sure that we don't let our losses dictate
our future decisions. We want to cut our losses and we want to run our winners.
It sounds easy, but the concept is usually a little bit more difficult to apply in reality,
But this is something that we want to strive to achieve.
We can go further into this particular comment by
saying that we don't want to let the losses of the past, often
uncomfortable experiences as another way to word them, allow
us to lose sight of our risk-reward ratio that we're looking
to maintain. Successful traders don't forget their losses, but they also don't let them cloud
their judgment as they go forward.
We want to think of it as a clean slate after each and every
trade. The brain is a powerful organ.
Now what this means is that the mind over matter, the history
repeating itself, these are the common thoughts that are swirling around
our minds. A successful trader will create a balanced opinion
on a particular position, taking on the pros and cons in front
of them today. An unsuccessful trader will ignore the facts
and the figures in front of them.
They will generally revert back to those anecdotal evidences
of the past week showing a particular result around
a particular level, and as a result, they will make an underinformed
decision that is really biased by the short term
and not so much by the logical process that a trader should
be experiencing when they analyze something to begin with.
Also, the trend is your friend until it changes.
It's important to understand that yes, going on
the side of the trend is widely accepted to be a much less
risky decision as any type of investment idea supports
because we're riding with the momentum of whatever it is
that we are looking to invest in. Naturally, if we're going
in the direction that something is already going, the amount
of change that has to occur on the market for us to maintain
a profitable position is less so than if we go directly against
where the market is currently going. Now, this is important
to understand because if we know that riding in the direction
of the trend is what we want to do, we need to understand
that the trend can change. Even if we made a good decision
and got in with the correct analysis of the trend
in the beginning, it is possible that the trend changes during
our position and we don't want to become so married to it
that we can't get out, or refuse to recognize, that the trend
has changed. If we got in with a buying opportunity because
we witnessed a strong bullish trend, and then all of a sudden,
we've witnessed a bearish trend, that is not a good time to
keep our position open. We can always close our position out,
let the market fall, and then enter again if we only want
to go with a buying mentality, or we can close the position
out, and if we're confident that the trend actually has changed
to a bearish degree, then perhaps we can sell and take advantage
of the downturn that we are now expecting as we have witnessed
the trend change. Let's take a look at the difference between winners and losers,
as far as trading psychology goes. With the winners,
there is no emotional connection with an investment.
Whereas with the losers, they're making investment too personal
and getting emotional too often. With the winners,
there's a visualizing the end game for each trade mentality.
Whereas with the losers,
they're usually failing to recognize their entry and exit
strategies in a full picture. With the winners,
we like to talk about the opinions of others
and consider how that could potentially affect our trade.
Whereas with the losers,
we just blindly believe that we know everything and we don't
care if anyone else disagrees with us because they must be
wrong. With the winners,
we usually have the courage to cut our losses and accept
them while they're small. The losers,
however, usually have a failure to accept them and usually
snowball their losses to a great degree. The winning mindset
usually encompasses blanking the emotion of panic from their
mind. That means they were removing panic
as an option to feel to begin with. The losers act in haste
and they usually repent at leisure. The winners will entertain
a diversification strategy where they're making sure that
what they're doing is covered before they go in.
Whereas the losers are usually jumping in with no logical
coverage and they're keeping the risk at an all-time high
every single time that they're executing.
The winners will usually have the courage of their own convictions,
meaning they know that they did the homework and they're
comfortable with outcome whether, it's positive or negative
because they know they put in the correct work. The losers
will be overly influenced by third parties, and even though
they may have done some homework, they may not feel confident
that they did enough, and as such, they let other people's opinions
influence whether or not they should open or close a position.
The winners will stick to what they know, while the losers
will blindly follow the trend. The winners will maximize their
profits without being greedy, while the losers will continue
to chase that last-hour profit, and oftentimes give away a
surplus of profits at the expense of chasing a single dollar.
The winners will take a realistic approach to their investment
returns, whereas the losers have an expectation of something
that may already be unrealistic and really potentially unachievable.
In summary, trading psychology is something that is relatively
easy to understand, as far as why it's important, yet it's
quite curious because many traders don't take it serious
enough when it comes time to actually employing it. A lot
of traders will come out and say, "yeah, yeah, yeah, I got that." But then,
they succumb to a lot of the different mistakes that we talked
about in this video. So what can you do? Well, you can make
a conscious effort to give your very best and try to employ
some of the fixes that we talked about here that can allow
you to avoid some of those mistakes along the way. If you
avoid less mistakes along the way going forward than you
did before watching this video,
then you've already done yourself a favor, not just doing one for me.
I wish you the best of luck as you continue your trading
career. Take your time and try to remove those emotions from
the factory and see how it treats you.
I will see you all very soon.
Good luck on your Gauntlet Mini experience, and please if
you haven't already, click that like and subscribe button
down below. See you soon folks.