Many consider that there are only a handful of vital elements to successful trading. Whilst psychology is the most often suggested item as being the most important, it covers a wide range of different things. Many would suggest that ‘your psychology’ is what will make or break you as a trader.
Essentially, your mental ability to manage losses and profits and the good and the bad times in trading, to manage risk, to not become too greedy and many others are all encapsulated under the heading of ‘trading psychology’. Interestingly, many studies suggest that humans are naturally inclined to fail at trading. We are naturally inclined to break all of the time tested trading rules.
One of the items also covered under ‘psychology’ must be decision making. Trading is effectively all about decision making. Before you even start trading, you need to decide on simple things like your goals as well as what taxation structure you will trade through, for example.
Then you decide upon your selection criteria for potential trades, how you will size your trades, whether or not you will include derivatives in your trading or whether you solely trade equities, and how you will exit your trades at either a loss or profit.
The vast majority of these decisions are important and can adversely affect your overall success if they are not sound decisions and supporting of each other. For example, if you trade medium term yet employ tight stops that are better suited to short term trading, you are likely to exit well over half your trades at a loss even though the security may eventually continue to head in your anticipated direction.
The method of stop loss positioning was not suitable for the selection process you were using.
Another example might be to use a medium term approach for your selection process however then use exchange traded options with only a few weeks until expiry to trade with. The expiry of the options is very likely to impact on your decision making before the medium term outlook for the underlying security eventuates. For those who are generally indecisive will most likely face extra challenges in becoming a successful trader.
Decisions are required often when trading and a fair percentage of the decisions that are required will be difficult. Humans are naturally inclined to break the time tested trading rules and this is why your psychology and decision making is such a vital part of your success. Successful traders have great internal control and discipline to overcome the natural tendencies.
They will likely cut their losses when deep down they don’t want to because they don’t want to lose money. They will likely stick with their position sizing model even though they feel super confident about a particular trade selection. Trading is all about decision making and successful trading is all about sound decision making based on the foundation of a solid written trading plan.