November 07, 2010

The Psychology of Trading

Extracted from the book: The Psychology of Trading, Dr Brett Steenbarger

Most of the time the problem with traders is that the frame of mind in which they analyze markets is different from the one in which they are actually making trading decisions. When the author encountered periods of uncertainty and stress, one of his techniques for handling the novel shifts is to temporarily get away from the screen. 

"Behavior patterns are anchored to one's states of mind and body." Once the traders learn the skill of shifting their emotional and physical states, they are free to create and to enact new patterns. The change of emotional and physical state is a powerful strategy for interrupting the impulsive and emotional problem patterns during the volatile periods of price action. 

However, many traders are so afraid of missing a possible market move that they dare not spend time refocusing on their trading plan. They fail to realize the far greater risk of losing sight of their plans and trading haphazardly. 

Your trading plan is your anchor; you most want to utilize it when seas are roiling. The psychological antidote to greed and fear is planfulness, not calm or confidence.

CONCLUSION Late in 2001, the author conducted a survey of the following traders personality traits and coping styles which known as NEO Five Factor Inventory: 

1. Neuroticism ---- the tendency toward negative emotions who reported the greatest problem with their trading 

2. Extraversion --- an outward orientation toward people and life.
3. Openness to experience - a desire for novelty, variety, and risk taking.
4. Agreeableness - the tendency to get along well with others.
5. Conscientiousness -  the capacity to be reliable, steady, and trustworthy.

The findings were eye opening. The traders who reported the greatest success (and who were willing to have me verify their success in case studies) tended to score high in conscientiousness. They were very steady and reliable.
The traders who reported the greatest problems with their trading tended to score high in neuroticism and openness. They were experiencing many negative emotions and tended to use trading for excitement.
The conscientious traders tended to be highly rule-governed in their trading. There was little excitement in their trading. Instead, they very consistently developed their plans and followed them.
The neurotic and risk-taking traders tended to make their decisions impulsively, without prior planning. They tended to revel in telling stories of their great wins and losses.
The survey above drove home one important lesson: Success in trading is related to the ability to stay consistent and plan-driven. Traders fail not because of their emotions, but because their emotions deflect them from their purpose. In developing their rules and systems, the successful traders had found a way to immunize themselves from the emotional effects of market volatility. Indeed, in many respects, the successful traders appeared to be every bit as fearful as the unsuccessful ones. It's just that the fears of the successful traders were not those of drawdown or missing a market move. Rather, they fears deviating from their plans. Dedication to purpose was the cornerstone of their success.

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