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Trading Psychology -vs- Trading Method
By: Barry Lutz
It is said that trading is 90% psychological and 10% methodological. Does this
then imply that regardless of trading method, a trader that has control over
their emotional issues will thus be a profitable trader, or will it be
impossible to ever control emotions without the proficient implementation of
method? The trading method viewpoint will suggest that not only are these
statistics not the case - trading psychology does not exist. Trading method will
be the determinant of profitability, and this will be done through: (1) the
ability to understand the method's inherent strengths and weaknesses (2) the
ability to maximize these strengths and minimize the weaknesses.
The Trading Method Viewpoint
Trading psychology has become so widely discussed and promoted through books and
consultants that it has become a very convenient rationalization and excuse for
losing. Why take the responsibility for a lack of work ethic and trading without
any concept of plan, an honest assessment which would be a ‘hit’ on the trader’s
self-esteem – when you can just blame it on trading psychology instead?
Trading psychology is ‘something’ that a trader creates from existing
personality traits that are not initially related to trading, but surface from
trading without method understanding. The outcome of course is fear, but
wouldn’t this be the case when doing anything that was perceived as ‘dangerous’,
and which was being done without the necessary understanding and skills?
Trading, with its inherent characteristic of accepting financial risk while
participating in unknown outcomes, is certainly ‘dangerous’, and thus the more
preparation and understanding that is needed.
Trading Scenario
Consider the a trading plan which has the following three setup types: (1)
initial which your intended trade entry (2) first continuation which is used to
enter a trade in case you have either missed your initial entry, or you decided
that you wanted more confirmation because it was a counter direction trade (3)
second continuation which is intended as a trade addon setup, but is also one
‘last’ chance to enter a trade.
You get an initial sell setup that triggers, but you do not take the trade =
trade1. The trade breaks cleanly and goes to what would have resulted in a
partial profit, and then before price goes down further, it retraces back to the
area where the sell was done. This price holds so the swing remains short, and
from this hold of what is now resistance, you get the trigger of your first
continuation setup BUT you don’t take this trade either = trade2. Why wasn’t the
trade taken? You decide that after missing the initial entry that you have
missed the trade; your emotions and biases tell you that the ‘move’ has gone too
far. Again, this trade breaks cleanly, not only adding to the gains of trade1,
but also giving a partial profit on trade2.
Price now consolidates between the lows and the price resistance that you would
typically be using to stay short if you had taken either the initial trade, or
the first continuation trade. Instead of the swing reversing after
consolidating, it continues down again, and with this continuation your second
continuation setup triggers = trade3. AND AGAIN - you don’t take the trade.
After all, if you didn’t take either of the first two trades, how can you
possibly take this trade; maybe you were wrong when you thought that the move
had gone too far to take trade2, but certainly that’s the case for trader3.
Like trade1 and trade2, trade3 is a profitable trade. This swing has really
turned into a great directional move, with each break holding on weak retests –
a textbook example of the strengths of your trading method, but YOU have never
entered a trade. You are going nuts! You are getting into this damn swing - you
just can't take it any more. Another retrace holds as a lower high. You don’t
have an entry setup, but that doesn’t matter, the other three trades were
profitable after a lower high. Isn’t it interesting, the same emotions which
wouldn’t let you enter your plan trades, are now ‘forcing’ you to take a
non-plan trade.
Instead of YOUR trade going to a lower low and to a profit, it instead goes to a
higher low and then reverses into an initial buy. Bad just got worse, you also
don’t exit when the swing goes into buy. After what you went through to finally
get into the trade, you have to try and make it work, and after all the trend is
down – right? TraderA uses this initial buy to exit their profitable sell and
sell addon; they decide that they want more confirmation of swing reverse before
trading the counter direction. A first continuation setup triggers and they go
long, the swing has reversed, and this trade reaches its first profit target.
TraderB finally ‘gives up’ and exits THEIR short, although with a two point loss
instead of the intended one point, and without any consideration of taking their
next plan trade, the first continuation buy. This trader is done for the day,
but at least they were ‘right’ all along; the swing had gone too far to enter,
and their fears had been warranted – this was a losing trade that they should
not enter.
Is this a trading method or trading psychology issue? What ‘message’ is TraderB
going to take from what has just happened. Will they take the attitude that they
should not be blamed, they just can’t trade because of trading psychology? Or,
will they acknowledge that the method did win, that the resulting loss was not a
method trade, and even if it was, the loss would have been offset by the prior
winners. Will they acknowledge that THEY made their worst fears come true and
not only turned this into a losing trade, they also increased he size of that
loss, and then avoiding another method winning trade.
Granted, psychology was involved with what has happened in the described trading
scenario, but that is a function of the individual’s ‘core’ personality, and
would most probably be an issue regardless of what was being done; if there is
‘risk’ involved, there will be an ‘emotional’ response. Thus, it is first
necessary to separate personal psychology from trading psychology, and the use
of this concept as an excuse for trading actions. Then, if trading psychology is
going to be controlled, this will be done through the development and
implementation of a tested plan that the trader is willing to follow. Do not
trade with ‘built-in’ excuses for failing, you will have lost before you begin,
and will continue to do so with a continued ‘snowballing’ of emotion to the
extent where trading will no longer be possible.
About the Author:
Barry Lutz has been trading, and teaching others to trade since 1997, through
his firm Tactical Trading, LLC., www.tactrade.com. He also writes a daily
trading teaching lesson called the Trade Journal, which can be found, along with
other resources on trading psychology and trading method at The Tactical Trader, www.tactrading.com |
