The Importance of Your Mindset
There are three main elements to trading that must be understood and worked on if you want to be successful. Some people, including my first trading mentor Stuart Mcphee, refer to them as the 3M’s – Money, Method, Mind. ‘Money’ really means money management, i.e. how to calculate risk, how to size your positions, understanding your expectancy, etc. A very important topic which a number of members have already emailed me about (firstname.lastname@example.org) and which I will cover in detail. ‘Method’ is the methodology/strategy you use to pick your buy and sell points and manage your trades when they are open. This is where most new traders start. They are desperate to know what to buy… and surprisingly pay little attention to when to sell and how they will manage the position while it’s open. I would humbly submit that this is the least important element of the 3M’s, despite it being the most fun. And then there is ‘Mind’. This is the ‘you’ part of the equation. The most important part of all but often the element given the least attention. I’d like to change that, starting today. I’ll be posting a series of articles over the next few sessions dedicated to this topic. If you’re a new trader, make sure to read them.
Trading psychology is, by far and away, the MOST important aspect of trading. Yet surprisingly it is an area of trading that most people dedicate the least amount of time and energy to.
For example, most new traders are concerned with how they are going to select their trades or the latest trading method ‘guaranteed’ to be successful, rather than how their own thought processes and biases might affect how they trade.
The most common example of this I have seen is when a new trader does not appropriately consider how much risk they are willing to take on board. In their planning stage (if in fact they even consider it) they contend that they are prepared to accept a certain amount of risk and the subsequent consequences of that risk. When they come face to face with that outcome in the real-world however, they react in a manner different to how they thought they would.
For example, many trading strategies have an expected drawdown, i.e. an amount that a trading account may fall below the original balance. Given that not every trade taken will provide a positive result, it stands to reason that a trading account can and will fall below the original amount if a series of losing trades are experienced. Many new traders might say that they are prepared to experience a 30% drawdown (i.e. their starting balance of $10,000 is reduced to $7,000), only to find that when their account is down 10%, they bail out because they are scared of losing any more money. This can have broader implications. If their trading methodology is sound, they may just have experienced a tough period and the next 10 trades they take could be winners, sending their account soaring back into the black. However, because they were not able to cope with the drawdown they have taken themselves out of the game and removed any possibility that they will recover the money and become profitable.
If the new trader had been able to better assess their own risk tolerance, they would have been able to reduce the risk profile of their trading strategy accordingly.
When it comes down to it, your psychology is what ultimately will determine your success or failure in any pursuit in life. Those who have a positive attitude towards life and their goals will undoubtedly achieve better outcomes than those who have a negative and defeatist attitude.
This principle is perhaps even more pronounced when it comes to trading because of the subject matter. Just about everyone is concerned with their financial security and independence, placing a high level of importance on the achievement of this end. As such, it naturally becomes a highly emotive topic, stirring feelings that other, more trivial matters, simply do not.
Having acknowledged this, one can begin to understand just how important a person’s psychology is when it comes to trading. Over the next few days, I will highlight some of the traits that many successful traders have learned in order to give themselves an edge. Furthermore, the discussion will help you to recognise what type of attributes you already possess and how you can use those attributes to your advantage.
Before placing your first trade (or your next trade if you have already started trading), it is a wise idea to take stock of your character attributes.
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