Trading Psychology: The Enemy Within

Fast money without risk, who wouldn’t want that? In the search for the “holy grail”, however, this is often underestimated, although we traders are our greatest opponents.

The search for the holy grail

But of course all this sounds easier than it actually is, since it ultimately requires us to change ingrained and deeply rooted patterns of behaviour. If it were that simple, there would hardly be such a large market for diet guides and fitness courses, which seems to live largely from the fact that people are constantly chasing new hypes, which promise them again and again that this time it will finally work out with the body of their dreams or losing weight without effort. And in trading, in search of the proverbial “holy grail” in trader circles, the indicators, strategies and markets are constantly being changed, in the hope that this time it will finally be something with the fast wealth without risk. The mistake here, however, seems to lie more in the fact that the mistake is sought in the system rather than in the subject. After all, the difficulty is not knowing what to do or not to do rationally – this can be read quite quickly or even taken from YouTube videos. Rather, many fail to put this knowledge into practice and to adhere consistently to the chosen principles and intentions – especially against (primarily self-imposed) resistance of all kinds. In a word: discipline.

Overcoming the inner pig dog

In any case, the importance of discipline in trading should be beyond doubt, as its central importance is tirelessly stressed by the professionals. But it is also clear that few people are overly blessed with this – after all, everyone carries their “inner pig dog” around with them. In the following parts of this series of articles we will present possibilities for working on oneself and developing oneself in this respect.

Diziplin alone is not enough

Of course, discipline is relatively worthless in itself, and can even degenerate into doggedness in an exaggerated form. It might be more reasonable to understand discipline as a characteristic feature that is not an end in itself but must be expressed, realized and proved in concrete activities and contexts. If the activity and context in question is trading and the markets, it should not be overlooked, however, that strict discipline alone is not enough, but that a number of other high-level skills are required here, which are also not natural, but must be developed through practice and experience. This is evident from several points. Speculative trading is the following of strategies, i.e. of rules that dictate what is to be done in which situations and in which way to achieve a certain goal. Trading is clearly different from gambling (opening positions by feeling or out of hope for luck – although it should be noted that professional gamblers, unlike simple gamblers, also follow strategies which, like trading strategies, are designed to be methodical, to control risk, etc.).

The question of why must be clear

First of all, these strategies must first be understood, and not only in terms of their correct application (“What does the rulebook require?”). – which is quite demanding for more complex strategies), but also in terms of their justification and functioning. Anyone using a strategy should first of all have understood why the strategy exists, why it is designed the way it is and why it could lead to success. If, on the other hand, you blindly follow trading strategies just because they have been advertised to you by someone, you actually don’t know what you are doing.

Dealing with complexity

Secondly, strategies must be applied, i.e. they must be related to and contextualized in concrete market situations. However, the market situation is always very complex, and it is important to deal with this complexity and to apply technical precision.

Assessing factors correctly

Thirdly, the trader must have the ability to assess whether the conditions of the strategy deployment are sufficiently fulfilled in a specific situation. The same applies to whether, for example, despite the fact that the conditions are fulfilled in a given market situation, there are other factors not provided for in the strategy that require the trader not to enter the market, even if the rules and regulations would actually require this.

Advantage engineering judgement

In the competence related to these three points, called judgement, lies the decisive advantage that an experienced trader in the market has not only over a beginner, no matter how well read in theory, but especially over automated computer trading systems. Using a strategy does not simply mean to stubbornly execute an algorithm. Traders are not computers and will not be able to do many things that are already possible with software algorithms today. But in their ability to reflect lies a great advantage that humans will continue to hold for the foreseeable future. Computers can follow rules, but they can’t decide whether or not this makes sense in individual cases.

“The best strategy” does not exist

Therefore one may well answer the question about the holy grail in trading: If anything, it is not “the best strategy”, but rather a specific personality structure, experience and competence – one could say: the trader personality. As far as further technical and manual skills in trading are concerned, it makes sense to organize the field in an overview. It is obvious to distinguish between cognitive and emotional abilities. We will introduce both of them only briefly in the following, then explain them in more detail in the second part of this series of articles and finally ask in the third part about the possibilities of their development and deepening.

Cognitive abilities

Cognitive abilities are understood as intelligence and rational thinking in the broadest sense. They play a role in trading essentially in three concrete manifestations: Firstly, as a perceptive faculty, i.e. the ability to absorb and process information, which includes analytical skills, mathematical thinking, visual skills (such as pattern recognition), etc. Secondly, in dealing with complexity, i.e. reducing or overcoming complexity: Ability to abstract, generalize, etc. Thirdly, as the ability to contextualise and reflect on knowledge: systematic, holistic and critical thinking.

Understanding emotions and keeping them in check

Emotions include euphoria, fear, anger, frustration, greed, etc. Emotional abilities are then understood to mean abilities to deal with one’s own emotions, from their perception, analysis and evaluation to their control and utilization for certain higher purposes. As is well known, emotions are originally used to control behaviour, but this is what makes them so problematic in trading. The emotional side of the trading novice usually appears in the form of constraints or obstacles, and this is where active countermeasures must be taken. However, emotions are not bad per se, this is true in trading and in life in general. Emotional competence therefore certainly does not consist in simply suppressing the emotionality within oneself. This again has several reasons: Firstly, we can at least partially attribute the non-conscious, non-cognitive intuition to the emotional side and this fulfils an important function in trading. Secondly, and this is a central point for one’s own development, desirable behaviour can be effectively anchored by making use of the emotional side of a person.

The preceding remarks are not intended to discourage, but to motivate. Discipline can be strengthened and the relevant technical and manual skills for trading can be acquired, developed and deepened through targeted work. Learning trading should therefore be understood from the outset to a large extent as a school of personality. At the same time, it should not be concealed that this is a hard school, where hardly anyone has ever lost the famous apprenticeship fee.

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