Day Trading – A Psychological Challenge

 

Im sure you guys have all heard the saying that success in trading is primarily psychological. Some estimates of trading success attribute over 70% of it to psychology alone. While these phrases are commonly thrown around, I think its difficult to grasp the emphasis of them until you experience it yourself.

 

 

I think its hard to learn how to trade from reading books, watching videos, or attending webinars. Trading is something that is learned from doing, not watching. All of the lessons you read wont sink in until you experience the gut wrenching pain, the sleepless nights, the numerous times you almost throw your computer out the window, that all those traders before you went through. You simply cannot learn from the experiences of others until your brain has tangible, hard associations with those lessons, and the greatest lessons are the most painful ones. Then you go back re-read what they said and a light bulb goes off.

 

 

 
Emotional Cycles of Traders

 

After my 3rd blowup I’ve learned that I go through a predictable emotional cycle as a trader:

 

 

1) The Building Phase – I am disciplined in my entries and

 

conservative in my position sizing. My appetite for risk is low to

 

moderate, emotionally I am the most stable. This phase will last as long
as my equity curve is mostly flat or on a slight upwards trajectory.

 

 

2) The Ego Phase – As the wins pile up and my ego grows, my discipline

 

wanes. I start taking low quality setups just for the hell of it.
I become more aggressive and see a 1k winning trade not as a

 

winner, but as a loser. “Why didnt you use leverage and risk 4x as
much? You could have cleared 4k instead of a measly 1k!”.
Since I’ve had a string of winners, I am convinced that no harm can
come from risking way over my ideal Kelly fraction (which you know from my
other blogs results in a negative growth expectancy), the ego is in
full control.

 

 

3) The Greed Phase – I will get comfortable using leverage recklessly,

 

over-sizing into positions, and adding to losers. Ironically the worst

 

thing that can happen at this point for any trader is to WIN. Thats
right, winning like this re-enforces so many bad habits that will
inevitably lead to a blow up, but try telling that to yourself when
you just doubled your account balance in 3 days. The gains have
blinded you and now you are comfortable using this amount of size
relative to your bankroll. Gains like this are the norm and you expect
them to continue.

 

 

4) The Blowup Phase – Eventually your luck runs out and you come

 

across one of those rare parabolic multi-day pumps (AWX, IGC, NBEV,

 

YECO, VTVT, etc) At first it just looks like your everyday pump and
dump play, you short into strength and expect to bank on a dilution
dump later on, but this one doesn’t behave as expected. Warning signs
are all over the place but you are
blinded by your ego and greed to respect the price action.
So you add to your losing position, get stubborn and hold as it
continues to rip against you, second by second you see your account
balance dropping. At this point you are completely frozen, like a deer
in the headlights. Cutting the loss at this point would be too painful so you
decide to hold it until its too late.

 

 

5) The Recovery Phase – Once the emotions fade and reality sets in,

 

you review your mistakes and ask how you could have let that happen.

 

How you could have missed all the obvious warning signs and kept
adding to a losing position. Why you didn’t cut it sooner. You vow to
follow the rules religiously and protect your account balance next
time. Promise to yourself that this WILL NOT happen again, write post
it notes and put them on your desk as reminders. This phase of the
cycle is the most humbling experience every trader MUST go through.
Until you experience the full spectrum of emotions you will never be
able to succeed, because you will not know how you respond to all the
possible scenarios the market will throw at you. Every trader is different. We all have different
personalities and psychological makeups. Some traders will have cycles
similar to mine, others will have completely different ones, but the
solution is the same:

 

 

You must do everything possible to prevent these scenarios from happening. You have to identify the root of the problem and tackle it at that point. For me, all of my blowups have been a result of emotional trading. I was emotional because I had too much money on the line. I had too much on the line because my greed and ego were in full force. Even though my system produced an edge, I was never able to realize that because my position sizing was so far from optimal.

 

So what did I do? I took every possible measure to prevent these things from happening. I put in place max position size and max loss per day with my broker. I started using hard stops to make sure I wouldn’t get stubborn. I realized that in a state of stress it is much harder to take action (ie. stopping out for a huge loss) than to sit there and have a hard stop protect you from blowing up. Because I knew from history that in the moment I wouldn’t stop out, I would just hold it “a little bit longer”. The fear of stopping out right at the highs was greater than the fear of blowing up my account, despite the stock showing no signs of slowing down.



Emotional trading is losing trading, period.

 

Its amazing what I know now compared to 12 months ago, and Im sure I will say the same thing in another year, the growth never stops. Trading is a serious game. You are competing with professionals, predatory algos, big money manipulators, insiders, and market makers. All of whom have more money, information and experience than you do, add that to the psychological hurdles and its no wonder why most traders fail to profit or even make it past year one.

 

Ask yourself what kind of emotional cycles you go through and try to prevent them from happening in the first place, take every possible measure to protect yourself, because in this game it is YOU, not the market, that is the real enemy.

Best of Luck,
Kris Verma