The Neuroscience Behind Trade Size

The Neuroscience Behind Trade Size

This is a guest post by ‘Daytrade with ZEN’ @Zen_n_Sys. He has a passion for patterns and Neuroscience and has been day trading since 2003.

“It is not just about keeping you in business for a long time, it is about doing it with clear thinking”

The hallmark of any successful strategy is its underlying framework that is minimally dependent on extrinsic factors, and can produce similar results over a period of time. If you have started trading with a mentor who held your finger on a well defined path to the point where you were successful, you have been more fortunate than you can realize. However, my judgement is that most of us start from the ground floor of being clueless, and learn about technical indicators, trading platforms and go through our first series of trades swinging between hope and fear.

Most traders are focused on profits and losses, at least in their starting phase, and very few take trading as a challenging profession where you have to define your objective, determine the needed skill set, and work hard to improve it. In more than 15 years of my trading career (by my own experience with myself, and watching some succeeding and others giving up), I can see the difference between success and failure in one basic principle, i.e. traders that focus on profits based on their lifestyle aspirations, versus effort to make great trades based on technical patterns and risk analysis do not do well. In other words it is about “trying to chase the money” versus “having and following a technical plan, and let the money take care of itself”.

Interestingly, when I conducted a casual poll on my twitter feed, more than 50% of voters find it challenging to follow their plan with discipline. This is the group in my opinion that has a potential to be successful in comparison to those who are either not comfortable with their knowledge of technical analysis yet, and even worst who find it challenging to have a plan, and trading it. At this point I would skip to think about those who are trading without enough technical knowledge, and without a plan and share my insight with those who have worked hard to learn technical patterns and have a plan but fail to follow it through.

The hard part in trading is that you can chalk out a plan in words and write it down on paper but there is nothing that can be specified about clicking the mouse when time comes to execute, because being a human who has emotions our belief system can go awry. A great plan is not a plan if it is not executed with rationality.

The Neuroscience Behind Trade Size

If I may have the privilege of getting a little technical here, and talk more from my training as a neuroscientist than a trader, then I will have a few words on our neural processes that are actively engaged during trading. I will present here only part of a complex circuitry for the sake of relevance and simplicity.

In this figure above you can see that larger trade size will trigger the fear of a bigger loss, and higher probability of suppression of cortical circuitry that is responsible for rational thinking and analysis. Suppression of cortical circuitry can implement many ways in the context of trading, such as not respecting your stop price and/or adding more to your losing position without reasoning. On the other hand if you anticipate a big reward because of larger trade size, your anticipation of large profits will lead to overly excited mesolimbic circuitry that will feed into your risk seeking behavior, and will ultimately lead to impairment of rational thinking again, interfering with your execution abilities to take profits, and/or will make you trade with bigger risk in following trades. This can also interfere with executing your plan to take profits at the level you have planned, and start thinking about much bigger profits as your circuitry underlying risk taking behavior starts firing up.

So in a nutshell if you keep your trade size to a minimum where your neural circuitry is neither suppressed or excited, you will be able to think clearly and will not bother about $$ value of your trade. You will keep executing your plans and money will start following you in no time. Above all you will discover the true pleasure of patterns in price action.

On a different note: Think about other jobs where people make 100s of thousands of dollars, be it a surgeon or a lawyer or an entrepreneur. They spend years working hard and practicing, before they are rewarded with big money. So ask yourself one question – Why would the stock market give you lots of money just after you have spent a few months in parallel to your regular job? It does take years of hard work to gain knowledge, understanding yourself and making yourself disciplined. Out of many ingredients for success in the market, you will find nothing else more of a game changer than the trade size because it will keep your emotions in control and let your intelligence trade.

Happy Trading – Zen.

You can follow  ‘Daytrade with ZEN’ on Twitter @Zen_n_Sys.



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