Thursday, February 05, 2009

Cross-Talk: Building Confidence as a Trader

John Forman has an excellent post on his site that outlines practical steps for building trading confidence. He clearly links the psychology of trading--the confidence needed to take risk and weather adversity--to the learning process, emphasizing how the emotional appraisal of one's performance is linked to the development of mastery. Too often, confidence is treated as if it is a simple matter of visualizing positive outcomes and sending oneself ego-enhancing messages. When trading is systematically learned, confidence is earned. No psycho-babble can substitute for the lived reality of making mistakes, correcting them, discovering strengths, and building them.

All that having been said, the average developing trader suffers more from an absence of humility than a lack of confidence. Truly confident rock climbers, for example, trust in their skills, but also respect the mountain and the elements, never taking safety for granted. Similarly, a crack fighter pilot needs confidence to take to the skies, but also needs to never underestimate the enemy. Confidence becomes overconfidence when it is not tempered with humility. There is always uncertainty in markets; confidence allows the trader to put on a position in the face of uncertainty, and humility enables the trader to size the position to weather unexpected adverse outcomes.

Beginning traders are taught to establish, for each position, a profit target and a stop loss exit. The profit target is the expression of confidence; it is the anticipated reward for being correct in one's judgment. The stop loss expresses humility; it is the pre-preparation for being wrong. Humility without confidence breeds anxiety: we cut winning trades before they hit targets, exit trades before they hit stops, and undersize trades. Confidence without humility is what the Greeks called hubris: the pride before many a fall. It is expressed in the refusal to anticipate and take losses, as well as the oversizing of positions.

Much of the psychological challenge of trading is finding the proper integration of confidence and humility. When dollar signs dance across the screen and enter your head, it is easy to veer from overconfidence to underconfidence. To anticipate gain with boldness and purpose, but be prepared for loss with prudence and learning: that is a skill as useful in life as in markets.