Monday, June 03, 2019

Trading Psychology Techniques - 7: Facing Your Fears

A while back, I worked with a trader and reviewed his P/L statistics.  Keeping good statistics on your trading is a universal best practice.  The patterns of wins and losses--and the progress over time--reveals a great deal about your trading--and your trading psychology.

What made this trader unusual was a pattern of small wins and small losses.  He had a daily loss limit and never came near that number, either on the downside or the upside.  

When we examined his trading, it was clear that he had profit targets on his trades and he had stop loss levels.  These were appropriate, given his daily limits.  He gave himself room to be wrong with his stops and also gave room to trades to run if they worked out.

So what's the problem?

As we examined his trading, we quickly saw that he rarely let his trades stop out and he rarely hit his profit targets.  He stopped out of trades quickly when they went against him and he took profits quickly when trades went his way.

In short, his trading was an exercise in fear.  When he feared loss, he quickly exited.  When he feared losing gains, he quickly exited.  Over time, that had him playing small ball as a trader.  Psychologically, it meant that he was always acting on fear.

We reinforce what we act upon.  If we act on fear, we reinforce fear.  If we act out of frustration, we reinforce frustration.  Is it any wonder that, fearfully exiting one trade after another, this trader never developed confidence in what he was doing?

An important psychological rule is that we can only overcome our fears by directly facing them.  If I am afraid of going outdoors, I cannot develop confidence by staying indoors.  What I need is to experience the very thing that I'm afraid of and see--in my own experience--that nothing terrible happens if there is an adverse outcome.  In that sense, we don't gain confidence from success alone.  We gain confidence by failing--and seeing that we can bounce back.

This is where the use of imagery is tremendously helpful.  We can visualize, in great detail, having a winning trade reverse on us or having a trade hit its stop, and mentally rehearse how we would like to deal with that situation.  If we mentally rehearse these scenarios again and again, they become familiar to us and no longer so threatening.  That reinforces confidence, because we're telling ourselves that we can fail and bounce back.

Note that what we're doing with such imagery methods is sustaining a state of self-awareness while talking ourselves through the fearful episode.  With sufficient practice, we can become quite good at invoking the self-awareness in real time.  What we've rehearsed with imagery comes back to us during actual trading.

The trader I met with learned to redefine his fears.  Once he realized that playing small ball guaranteed he would never reach his goals, he became fearful of being fearful.  In other words, he changed his perspective.  The problem wasn't losing money; the problem became preventing himself from making money!  In the state of self-awareness, he now viewed his situation differently, and that enabled him to trade very differently.

Further Reading: