HOW IMPORTANT IS TRADING PSYCHOLOGY?

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vermante

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Saturday, February 25, 2006 - 08:02 am:

To obtain a degree in most academic disciplines requires a study period of approximately 3 years,with some exceptions like medicine extending to 5 years.

How long should it take to master T/A(including pattern recognition) and identify suitable entry and exit points.

Given that there a many smart people who which to profit from trading , the above task should be achieved within 1-3 years. In addition there are sophisticated software tools that can assist in technical analysis. I think most would agree that T/A is not rocket science , it is a discipline easily learnt .

Yet most fail ! -

One could then conclude quite reasonably that the T/A is not the primary solution to profiting from the markets . The solution to profiting from the markets is hidden and not easily identified .

It has been said that Trading is 60% Psychology , 30% money management , 10% T/A.

In pursuing trading excellence and the road to financial freedom , time and effort spent should be heavily skewed towards mastering trading psychology and money management .

Cheers

Vermante

ingot54

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Saturday, February 25, 2006 - 09:10 pm:

Indeed complex, Vermante, when it should be simple.

Colin advises here that market risk is 66%, Sector risk is 24% and Stock risk is 10%.

So we can exclude that as a reason for failure. There really is no reason to select poor stocks consistently.

And your source said trading is 60% Psychology, 30% money management, and 10% TA.

That being so, it is now obvious where the educational effort should lie - or is it?

My path has taken me from the acute excitement I experienced when I discovered MACD, to a place where I now do not even look at it. I have made a study of most of the popular indicators, and discarded them.

And I have gone from FA to TA to a blend of both. Today I use just one indicator, and weekly charts.

But my weakness found me out. I received an "F" grade in money management. I was putting 80% of my effort into stock selection, instead of about 10%, and not developing management skills.

There is always the opportunity to re-sit the test!

I believe the expenses have been a decent education.

Maybe a good discussion on risk management should be resurrected. I recall there being a bit on this previously.

Keep Smiling

Trading style :CFD's predominantly. Looking for ways to enter CFD trading over long term.

spider

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Saturday, February 25, 2006 - 11:25 pm:

There seems to be a lot of denial when it comes to psychology and trading.

Check out step 22 and 30 on smallword's list.

http://www.incrediblecharts.com/userscripts/forums/show.plx?tpc=11&post=59156#PO ST59156

If you ignore the importance of what is going on inside your head you will inevitably end up by helping me to feed my family, and you would not want to do that , now would you?

spider.

ingot54

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Sunday, February 26, 2006 - 01:10 am:

I have committed to memory Number 36 of Smallworld's post, Spider, as picked up by Chart Rider:

36. We stop thinking and allow our rules to trade for us (trading becomes boring, but successful) and our trading account continues to grow as we increase our contract size.

Ahhh ... yes! I have arrived.

Now to dash off a quick cheque to my mate Spider - his kids are hungry, and he has a wedding to pay for!

Keep Smiling

Trading style :CFD's predominantly. Looking for ways to enter CFD trading over long term.

vermante

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Sunday, February 26, 2006 - 10:52 am:

Some interesting comments -

In an effort to "split the atom" re -trading and enhance trading skills

entering into the mysterious world of trading psychology appears to be beneficial .

Do Motherhood statements like -:

I will win

never say die

etc etc

count .They appear to be more motivational quotes than trading psychology. It can apply to achievement in any discipline .

Is Trading Psychology a numerous set of rules /steps ?

Imagine reading through 30-40 set of rules before a trade can be confirmed !

The question then to be asked is -

What is Trading Psychology ?

Can it be easily identified and defined within a paragraph

More importantly- What's it influence/impact on the trading plan?

Cheers

Vermante

david_louisson

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Sunday, February 26, 2006 - 04:00 pm:

If I may quote Dean (source: http://forum.incrediblecharts.com/messages/35933/725695.html):

"To me there are just 2 things to consider
1. find a system that makes more money than it loses
2. religiously stick to that system"

I'm impressed by the clarity and simplicity of this approach.

If the system consists of a clearly defined set of rules, then (assuming that one is honest with oneself) it should be readily provable whether any shortcoming in one's trading is due to flaws in the system itself (point 1) or one's implementation (point 2). Psychology is related only to the second point. Provided that one follows the rules religiously (however easy or difficult that might be), then psychology is removed from the equation.

Rather than conduct an in-depth study of the human psyche, as many trading books seem to do, I've been trying to focus on developing a system that I have utter confidence in, through thick and thin, across all market conditions. If I truly believe that my system rules will consistently deliver optimum profit – or at least, the very best that the markets will REALISTICALLY allow at any point – and I'm aware that any deviation from the rules is more likely than not to undermine that outcome, then there is every incentive for me to religiously follow the rules.

My plan is to remove psychology from the trading equation as much as is reasonably possible – in other words, so that it doesn't have to be 60% of the total equation. Here are some ideas for doing so:

1. Shaping my expectation (especially toward losses): I need to somehow test (e.g. historically back-test) my rules across a vast and diverse sample of data, to get a feel for what is likely or unlikely to happen. The larger and more representative the sample, the more statistical confidence in the result. Specifically with regard to losses: what is the largest losing streak? How often does it occur? Under what types of trades, or market conditions, is it most probable? Use this testing to gain a feel for the market. When the losses occur, know what is realistically probable, and what is a "freak" outcome. Analyze the losses: what component aspect(s) of my system are no longer responding to the vagaries of the market? If I were to change this aspect (e.g. set a tighter stoploss), then what effect would this have had on all of the thousands of trades that I previously tested? In other words, I must have statistical validity in order to change any of the rules.

2. Understand WHY I developed each trading rule: For example, why must I always set my stop loss at N points below the last swing low? Because that has been shown statistically to be the optimum point. In the past, that has delivered, on average, X% greater profit than at N–1 points below, or N+1 points below. So when I open a position, I have statistical confidence in knowing that I'm doing exactly the right thing, regardless of the eventual outcome of the trade. Low (or preferably, no) ambiguity = less reason to deviate. In any given trade, the price movements may defy the precise nature of my calculation, but the point is that – whatever the outcome – I will continue to adhere to the rules because I AM CONVINCED in my own mind that they will, on average, deliver the best possible result. Beyond this, the markets are in control, but I have given myself the highest possible statistical advantage.

3. Detachment through low position size: Size positions to make losses utterly trivial, especially when one is starting out, then very gradually and gently increase the stake size as one's confidence grows. Put simply, if there is $20 at risk on a trade, I won't lose any sleep. But if there is $2,000 at risk, then I'm likely to panic the instant the position moves against me.

4. (following on from point 3) Diversify, to avoid emotional involvement in any single position. This also mitigates risk: if capital is spread across multiple (preferably uncorrelated) positions, then if one position spikes against me, the others will offer some degree of shelter.

However, let me repeat myself: the greatest incentive for me to religiously follow the rules is to have total belief in my system, and for me the dissipation of doubt and anxiety can only come from the proof of statistical confidence. That is why I will not start trading seriously until I have reached this point.

Am I making any sense?

David

ingot54

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Sunday, February 26, 2006 - 04:58 pm:

Psychology ... why don't we use a better expression ... "HUMAN NATURE".

Successful traders understand their own nature, and the nature of others. This allows them to "push the buttons" of other participants.

How?

The bigger traders, Institutions (we love to blame 'em) understand human nature. They understand that when they create a trend (yes, I believe they really do work this way), this will start a move resulting in higher volumes, in the direction of their choosing.

Consider this:

We have a tank in the back yard, and it springs a leak. Human nature makes us plug the leak.

In trading terms, we move to plug the leakage of money from our account ... that could be "sell" or simply allowing pre-set stops to be exercised.

But the market is not like a leaky tank, where plugging the leak solves the problem.

In trading, the leak will stop by itself (for this analogy only), and the "water" will begin to flow back the other way. If the "leak" is plugged (position closed) no money will flow back into our account.

Those who know this, succeed. We all have our "Trigger Point" where we decide that the "leak" will not stop, or that the size of the leak exceeds our tolerance, and we will be forced to succumb to our own nature, and move to stop the flow.

Again, the winner in the scenario, is the biggest fish. (Institutions).

Those with the best understanding of human nature and the deepest pockets do well in the markets.

Institutions can buy or sell into a sector over a period of a year, if necessary, in order to accumulate or liquidate a position. Those who recognise the trends, and the shakeouts that occur within trends, will survive.

I believe the analogy holds for all time frames.

Keep Smiling

Trading style :CFD's predominantly. Looking for ways to enter CFD trading over long term.

ingot54

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Sunday, February 26, 2006 - 05:20 pm:

The above is just my view, Vermante. In every time frame, there are varying degrees of volatility, but a trend always needs to be identified.

Some traders used to love Newscorp, and others loathed it, simply because of their preferred time frame of trading.

Why? The volatility played into the hands of some traders, but devastated others. This demonstrates the range of psychological responses possible.

It's like having a huge herd moving in an identified direction, but looking closer reveals smaller herds moving in the opposite direction, and still smaller herds again milling around, seemingly directionless.

In time, they are all swept along in the direction of the biggest herd.

David - with respect, I suspect what you seek does not exist, or is hiding in the same place the grail is.

I think if you put a toe in the water within the guidelines of your points (3) and (4) above, you will actually find your trading feet much sooner, and with much more success. (I know you already do conduct a few trades, but not at the level you will once you have your strategy established.)

I say this, because to my way of thinking, you already have a far deeper understanding of the technicals, and probably the Fundamentals required, than many traders on this forum who already trade successfully.

They do not need the depth of knowledge you have. They just trade - they have a street-smart understanding of how it works, and just do it.

Now, I believe we are trying to understand exactly what defines "Street-Smart ... Human Nature... Psychology"

Keep Smiling

Trading style :CFD's predominantly. Looking for ways to enter CFD trading over long term.

david_louisson

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Sunday, February 26, 2006 - 09:13 pm:

Hi Ingot

I think I understand where you're coming from, which suggests to me that I didn't explain myself very well in my previous post. So I'll try again with another example.

Let's say I'm back-testing a basket of stocks over a 5-year period, and that one of my setup criteria is ADX(14) > 25. This happens to produce 500 trades of which 260 are winners and 240 losers, with a PF (profit factor) of 1.17

Now I re-test using ADX(14) > 30, which will of course reduce the number of candidate trades. Let's suppose that it eliminates more losers than winners, so that the overall result gives a better PF = 1.26

So obviously I will trade with the value that delivers the statistically better result, i.e. ADX(14) > 30.

I realize that when I start real-life trading that the initial results might be frustrating. A number of profitable opportunities might pass by where ADX(14) is between 25 and 30, and the first trade(s) where ADX(14) > 30 might turn out to be losses. But my point is this – if the sample data for my back test was large, diverse and representative enough, it will give me the confidence to stick to the rules, i.e. continue to trade only when ADX(14) > 30.

For me the important point is not whether ADX(14) > 30 will deliver a better result than ADX(14) > 25 every time (which I realize is a grail-like impossibility), but the more positive the PF generated during the back-test, the more confidence I'll have in my system, and therefore it's easier to keep to the rules (whatever they might be), and the less stress caused by a losing streak simply because I (rightly or wrongly) believe that I have some kind of statistical backing.

Of course that example is an over-simplification – there would likely be many setup, entry and exit criteria operating together. But a statistical test would hopefully show which criteria, when varied, make the biggest difference to profit, and which have less effect. Thus one gains a "feel", as opposed to a take with absolute certainty (also an impossibility), for what is likely to happen.

Even though price movements defy precise statistical analysis, trends and patterns must exist, otherwise it would be impossible to systematically profit. Although the math might be imprecise, greed and fear are two of the most irresistible emotions, allowing TA to make the assumption that past patterns (e.g. trends, support, resistance) are more likely than not to recur in some shape or form, in the future. I agree that back-testing offers no guarantees, but it reassures me that I have given myself the greatest possible opportunity to profit. I can do no more than that.

For better or worse, that's the way my mind works!

David

ingot54

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Sunday, February 26, 2006 - 09:49 pm:

Thanks David.

The implication here is trust.

In childhood, we have learned to trust the parent-figures who provided our basic needs. Their consistency earns our trust.

But trust is fragile. As a child matures, gets older, more responsibility is placed on him for meeting some of his own needs.

Does that mean the trust is destroyed? No. The parent-figure is still there to back-up if required, and this actually strengthens trust, and builds confidence.

Participation in the market is similar ... and dissimilar at the same time.

You are striving for a method you can trust, by first making sure it can meet your needs, and standards, profit targets perhaps. Then, as you actually put this method to use, you expect to gain confidence in it.

The expectation (trust) is that is will do what it has shown it has done historically.

But while a child has someone to back-up in times of faltering, the market will not do that. It will dash your hopes just as easily as enrich you - it doesn't care about systems, methods, or whether you trust it or not.

Systems change over time - they may become totally ineffective, and require a re-think.

One of the key words a trader needs to understand, is "Random".

Once this is taken on board, the expectation of what will happen, even statistically, will dissolve.

The trader will sit back, hands clasped behind head, and with a cool smile, tell you : "I don't think. I trade what I see."

To me, if there is any psychology required at all, it is this: Do not attempt to pre-empt what will happen in 2 minutes, 2 days or 2 weeks. Just trade from the right-hand edge of the screen.

This might be in a weekly time frame, or from a five-minute chart. I am not discounting setup, or trader's edge, or any other of the essential strategic actions associated with trading.

I think I do understand where you come from with your approach, but the psychology of "What will you do when the tank leaks?" still needs to be addressed, for every trader.

That's where the rubber hits the road.

My point is that the Institutions have the ability to put a very big hole in our tanks, as well as the ability to overflow our tanks.

Hope that is not too abstract.

To me, trend is gold.

Keep Smiling

Trading style :CFD's predominantly. Looking for ways to enter CFD trading over long term.

ingot54

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Sunday, February 26, 2006 - 10:04 pm:

Another reason just occurred to me, David, why the ideal system can never exist:

The sentiment of human beings, and yes, even the Institutions are subject to sentiment, will affect the outcome over a period of time.

At the moment, we are still in a bull market, albeit with some increasing volatility. Parameters need to be adjusted for STRONG bull runs, such as a commodities sector can experience, and STRONG bear runs, such as a Telecommunications, or Information Technology sector may experience.

The effect on the overall market will depend on whether all of these sectors are currently bullish, or varying, or all bearish.

If the general market is ranging, (technically this is a bear market) then system parameters need finer adjustment to capture moves. But in a strong bull market, parameters could be very coarsely set, to capture only the strongest sector moves.

There is no way, other than hindsight, to determine exactly what phase the market will be in tomorrow morning.

The first of March 2006 may commence what will be the greatest bear market the world has ever seen ... or it could be business as usual.

We simply don't know. Sentiment is elusive, and fickle.

Earlier, moves were afoot in the Biotech and medical stocks. Where are they now - the runs seem to have subsided somewhat. Systems which got you into some of these, might now either have you in the doldrums, or out - whip-sawed by nothing other than sentiment.

Again, that's why I hate to second-guess stock moves - trade what I see, and just look for trends. Nothing else needed.

Finis.

Keep Smiling

Trading style :CFD's predominantly. Looking for ways to enter CFD trading over long term.

vermante

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Monday, February 27, 2006 - 07:21 am: