Trading Psychology. It's More Important Than You Think!

Trading Psychology. It's More Important Than You Think!

Tom Gentile, ProfitStrategies.com
August 25, 2009

With the markets trading at mind boggling ranges, it really makes sense to discuss a part of trading that won't be found on most charts" and that's called Trading Psychology. It's one thing to have a trading plan and system, but actually following it, especially when things aren't exactly going your way, is something else entirely. Following the key trading success rules can help you improve your plans when it comes to real life trading.

Losses
Let's face it: losses are part of any business-especially trading. Losses have to be accepted before a business even begins its operation. Here are a few things to remember about losses and how you can make them part of your trading business.

Remain mentally and emotionally focused while trading.

Losses are part of all systems; knowing when to take losses is important.

Always try to be extremely disciplined, and exit your losing trades when your system requires you to do so.

Not taking losses when indicated is dangerous.

Riding losing trades for too long usually results in larger losses and risk of ruin increases.

It's not a good idea to keep changing stops to avoid a loss.

System traders use stops consistently.

Separate yourself as a trader from yourself as a person.

No system can trade the markets without taking losses at times.

Clumping can happen on the losing side as well as the winning side.

Your ability to take losses quickly is a great asset to your trading.

Discipline
Now this is vital to trading success. Imagine a person trying to become a pro athlete, but he or she sleeps in every day, eats excessively, stays up late and parties every night. Is this person going to become an elite athlete or not? The answer is no, and the reason why has everything to do with the amount of discipline. Discipline, in my mind, is like homework, only it's homework that pays off in dollars in the trading industry. Here are a few rules that I use when it comes to discipline in my life as a trader:

Good trading discipline is vital to my success.

My three successes to the market are: doing my market homework, following through, and using my stop losses.

I train my mind every day to be disciplined and focused.

I see myself every day doing my market homework and following the signals, setting stops.

I track my system exactly as it dictates.

If my system gives me daily signals, I follow them every day.

If my system gives me intraday signals, I follow them during the day.

I do not allow outside influences to affect my discipline.

Placing my orders correctly as my system dictates increases my odds for success.

Discipline to follow through with my system is my friend.

A system without stop losses puts me in a position of unlimited or unknown loss.

I understand that a major aspect of being disciplined is using stops.

Negativity
Negativity is in all aspects of life. I got enough of them in my family. I remember when I told my family that I wanted to be a trader. Now they didn't call me stupid or an idiot-the rolling eyes said enough. The ability to think positively and block out negativity is key to having consistent profits. The biggest thing negativity can do in your trading business is to keep you from taking that next trade, which, ironically, could be a grand slam in profits. Here are my rules to fighting negativity.

My best tool against negative influences is my system.

Being consistent in my trading means following my rules.

As a consistent trader, I place my orders each day at the same time.

Through consistency, negative influences go away.

I follow through on scheduled assignments, such as order entry, exit, and adjustment.

I plan my trades and trade my plans to facilitate consistency.

I use a trading partner to achieve consistency in my trading.

Fear and Greed are the enemies of consistent trading.

My commitment of consistency blocks greed from my goals and objectives.

Keep goals and objectives realistic to combat fear and greed.

Focus
The ability to focus in any business is important. The ability to focus as the president of your own business is vital to its success. This is true in Trading because your report card reveals your focus in daily account statements. Here are a few things that I believe will help your focus as a key to success:

Focus is the opposite of distraction.

Choose to stay on the winning path by focusing on the markets during your market time.

Environment can cause distractions, so remove all distractions such as noise, visual distractions, and clutter from the workplace.

Self discipline, follow through, and consistency are the keys to trading success.

An organized workplace can keep away distractions.

Focus on one trading aspect at a time in small bites.

Success
Success in your trading business is contagious. Having a plan for success, as well as following through and readjusting your goals over time, is highly important. Here are my rules for success:

Success in trading is achieved by working on goals that are specific.

Success is comfortable and positive, not exciting and emotional.

The past is over and done with. I move forward!

I complete trades according to the rules of my trading system. Doing this achieves success in my trading.

Success means seeing my profit goals as well as my security in stops, and I know where my trade will be closed out at any time.

I visualize myself as a master of market skills and as a profitable trader.

Avoiding Bad Habits
You might think this falls into the negativity category, and it will be if you don't block out bad habits and follow the rules below:

Have the capability of reversing any bad trading habits that you may develop.

Accept the fact that as a human, you may fall victim to bad trading habits.

Remember that you can change losing and destructive trading habits.

Know exactly what your bad trading habits are, make a list of them, and refer to them often.

Keep a checklist off all your trading rules and follow all procedures each and every time.

If you are unclear about a trade, simply do not make the trade.

Keep a diary of all your trades and what rules you follow, and follow up on both the winners and losers.

If you have an emotional day, no matter if it's high or low, don't trade that day.

Many errors are subtle, so keep a close eye on your errors and fix them ASAP.

Getting Cocky and Overconfident
Overconfidence can soften your focus and throw you into a state of mind where nothing can go wrong. It is at this stage in trading that everything can go wrong. Really learning the following rules will help you avoid falling into the trap of being overconfident:

Understand that overconfidence can occur if you have too many winning trades.

Catch yourself when you have thoughts that your trading system can do no wrong.

Catch yourself when you say you need to leverage up because you are "never wrong."

Catch yourself when you think you can guess the direction of the markets.

Do not allow overconfidence to cause you to overtrade and bring about losses.

Overconfidence can lead you to a fantasyland of 100% profits, and that leads you to lose your discipline.

If this happens, stop trading and redirect your mind to your trading system.

Live in the reality of your trading system. If you have many winning trades in a row, remember to check the long term results of the trading system, including losses.

Winning Attitude
Following the rules above is great, but it's not enough. Developing a Winning Attitude will stop negative thoughts from creeping in, and outside influences from changing your plan. Here are my thoughts about developing a winning attitude:

A positive attitude enhances your market performance.

Don't dwell on losses if they are part of the system's performance.

Attaining a goal starts by having a goal. Avoid setting goals that cannot be achieved. Achieving your goals means sticking to your system each day.

Achieving your goals means doing the homework before the market opens.

Achieving your goals means placing all of orders ahead of time.

Understand how your system is constructed and its maturity before you take the first trade.

Achieving your goals means following through from start to finish.

Focus on the next winning trade, and leave the last trade behind.

Be organized, consistent, set goals and follow through.

Trading Psychology, in my mind, accounts for half of my trading profits. It doesn't matter how good your system is or how great your trading strategy might be. If you cannot follow both the winners and the losers, then you will not be able to duplicate the system's success.

Learning and following the rules above will help you follow the rules of your system, and that will help you stick to them.

Tom Gentile
Chief Strategist
Profit Strategies Group, Inc.

A key life skill that schools don't teach

 Financial literacy is one of the most important skills an adult should have. -BT 

 Mon, Aug 17, 2009
 The Business Times 
By TEH HOOI LING
 SENIOR CORRESPONDENT

A FRIEND from my university days called to say that she and her husband had committed to buying a second property and are finding their finances a little tight despite having two incomes. Then she asked a question that I get rather often: 'Got any good stocks to buy or not? Any inside information?'
'No,' I said. 'I never get any inside information! You go do your own analysis!' She said: 'You mean you do your own analysis when you buy stocks? I buy on 'tips'. Anyway, I don't know how to analyse stocks. Where did you learn how to do that? In school ah?'

Yes, I did. My studies in Business Administration and Applied Finance and the CFA programme did equip me with some of the principles of investment analysis.

I told her that financial literacy is one of the most important skills an adult should have and that it should be taught in schools. Increasingly this is being recognised, and such courses are being offered as part of enrichment programmes.

But for those of us who didn't have that privilege, there is no lack of material available out there if one really takes an interest in the matter. I have friends from non-financial industries who through years of reading the 'how to' investment books, have become very savvy investors. A number of them came to know me through this column.

One of them is from Penang. He used to run his own construction business and is now retired. He said he was an ignorant young man in the 80s and had lost money investing in a fund. He then resolved to educate himself on investment. Like most value investors, he idolises Warren Buffett. He bought a few lots of Berkshire Hathaway shares some years back, with the intention of leaving one lot each to his grand kids as their education fund.

But he sold some near the peak in 2007, sensing the frothiness of the market. Earlier this year, he bought into Citigroup when it sank to around US$1. He has sold some to get back his capital. What's left in the stock now is all 'free money'.

Having experienced and seen the results of wise investments, this friend is very fervent about convincing others of the importance of learning that skill. At 60-plus, he still buys and reads books like Trump Strategies for Real Estate: Billionaire Lessons for the Small Investor and Accounts Demystified by Anthony Rice.

Some months back, he asked me to help him edit a two-pager that he had penned on his investing experience. He wanted to share it with his friends, particularly the younger ones. I think many readers can benefit from his advice as well. Here's what he wrote:

'I have no money to invest in stocks! - This statement is wrong! Why? Because one can always start small. Below are two real life examples. Case 1: With her monthly salary of less than RM200 back in 1958, a 'poor' Chinese primary school teacher (my friend's cousin) managed to put some savings away every month. In the early 1960s, she started to buy stocks as investments.

She did the 'right' thing in investment. She chose the 'good' stocks - companies with good businesses. She held on to the stocks for the long term. Over the years, she bought more of the stocks with her additional savings as well as the dividends received. Her stockholding also grew as the companies distributed bonuses and issued rights.

Thirty years later, she had become a millionaire. She managed to send her kids to England to study. Despite her wealth, she is still very careful with her money. As a retired civil servant, she receives a pension of RM1,000 a month. But dividends from her stocks come to RM3,000 a month. Case 2: In 1985, a young 'ignorant' young man (my friend himself) invested $500,000 of his hard-earned income/savings in a fund managed by a bank. He didn't know much about stock investing. He thought the bank's fund managers would be in a better position to help him invest. But over the next one to two years, his invested fund decreased in value. He lost about $150,000! He lost confidence in the fund managers, and withdrew what was left of his money.

The lessons from the examples are: One, it's not true to say one has no money to invest. Two, even if you have money, without sound knowledge of investment, it is 'useless'. People will try to take away your money. Three, it is better to start learning how to invest when you are young so that your 'good' investment can enjoy the 'magic of compounding' over a longer time frame.

The compounding effect is such that the longer the time, the bigger the money will grow to! For example, a $100,000 invested with a compounded return of 8 per cent a year, will: in 10 years grow to $216,000; in 20 years grow to $466,000; and in 30 years grow to $1,006,000!

It's never too late to start. And from your own experience, you can pass on to your next generation the 'correct' way to invest their hard-earned money.

Also, it is not true that we have no time to manage our own investment. This is the misconception that so-called 'experts' perpetuate to mislead us, so that they can slowly take away our money through the 'clever' knowledge of investment! Remember Bernie Madoff? (How cleverly he cheated his clients!)

It is not a time factor, nor a cost matter. It is a matter of focus and priority. So equip yourself with good knowledge and attitude of investment. There are a few good books to teach/guide us.

•The Richest man in Babylon;
•Rich Dad and Poor Dad;
•Who Moved My Cheese?
•The Intelligent Investors;
•Beating the Street;
•Common Stocks and Uncommon Profits;
•Books on Buffett's investment strategy, including The Warren Buffett Way; Buffettology; The New Buffettology.

You can finish reading these books within one year and they will cost you less than $2,000! This is another way to self-study an Investment MBA course.

Yes, it is simple but yet not so easy. It needs determination and belief that this is the right and only way. 'Yes, you can!' as Mr Obama would say.

Good luck and have a happy life. It's achievable if we choose the 'right' track. Laziness and greed are the biggest enemies! And no 'quick money' mentality, please!'

Well put indeed. To readers who have written in to ask which are the good investment books, perhaps the list above is a good place to start.

Along the vein of 'experts' trying to profit from the uninitiated, another friend pointed out to me what he deemed to be the latest instance of that - the just launched POSB's MyHome Fund.

Managed by DBS Asset Management (DBSAM), the fund will invest in two exchange traded funds (ETFs) - namely the DBS STI ETF and ABF Singapore Bond Index fund. Both ETFs are listed on the Singapore Exchange. Depending on risk appetite, investors can choose from two portfolios offered which differ in their allocation to the two ETFs.

Why pay DBSAM a fee of 0.5 per cent when investors can buy both the ETFs directly from the market, he asked. Some observers see the MyHome Fund as a ploy by POSB - a unit of the DBS Group - to raise funds for the DBS STI ETF which hasn't attracted that much monies since its launch earlier this year.

Another friend cheekily said they could launch their own 'Milk the People Fund'. 'That's why learning to invest or at least understanding the gist of it should be rated as an essential life skill in this world of sharks that we live in,' he said.

'Sadly, most laymen will not be able to pass it down to their kids. And these kids will grow up wondering how to invest, read the ads in the papers and end up enriching those guys selling trading programmes or courses but still end up nowhere.'

Also commenting on the MyHome Fund, the website The Book of Wise Investors concluded: 'Finance companies, insurance companies and banks are not benevolent donors to your wealth. The most important fact in growing your hard- earned money is really more financial literacy and not paying unnecessary expenses for nothing.'

But to be fair, as pointed out by financial adviser Martin Lee of Den of Lion Investors, MyHome Fund investors don't have to incur costs rebalancing their portfolio. For investors who want to do regular investments of $100 to $1,000, the upfront costs will be lower via the fund.

Also, according to him, if MyHome Fund manages to attract a big pool of money, its manager - DBSAM - may be able to get the manager of the DBS STI ETF, also DBSAM, to create units at net asset value. Hence, investors would save on the bid-ask spread, a cost that someone who buys the ETFs directly from the market will have to pay.

My take on all these is: Do your own research, and weigh the costs and benefits of any investments you intend to make. Then decide for yourself whether they suit your needs. Nobody else but you should be the most diligent in safeguarding your hard-earned money.

The writer is a CFA charterholder
This article was first published in The Business Times.

10 ESSENTIAL RULES FOR NOVICES WHO WANT TO BE FULL-TIME TRADERS

1. Don't get emotional. Adopt an objective view of wins and losses.

2. Build a trading plan. Put together some rules. A trading plan is similar to a business plan. Do's and don'ts are essential but most important are risk management.

3. Collect statistics for review. Record performance measurements in a diary. Put on the hat of an employer and ask yourself if you would fire or hire the person described in the diary.

4. Formalize your trading activity. If you find that you cannot resist breaking the rules, try to make the trading activity as formal as possible. Give it a business name and involve your spouse or best friend to manage your business so that you can't 'hide' your losses and destructive activity.

5. Don't over trade. Don't trade late into the night or for long hours. This is because fatigue can cloud judgment. As part of your trading plan, you can establish trading hours and keep to them as a routine. This will give you time to rest and maintain psychological well-being. It will also make your 'business plan' formal.

6. Walk away from bad deals. Trading is after all really a business so the trader has to look at reward to risk proposition.

7. Admit mistakes and terminate them. Conviction and determination may pay off in other professions but not trading. That's because the market is always right so staying in a bad trade doggedly is a bad idea.

8. Recite trading rules frequently. Remind yourself of the rules before the start of daily 'business' to recall do's and don'ts. This is useful for stubborn or people who refuse to quit.

9. Find a part-time job. It might make you feel more secure by meeting some daily needs. If nothing else, it keeps one from over-trading.

10. Set expectations right. Set realistic targets. Targets that are over-demanding compel the trader to over-trade or jump into bad deals.