You can’t master the markets as no one knows the future or can predict what millions of traders and investors will do today or tomorrow. The best we can do is master our own behavior in disciplined execution of our own system.
The majority of new traders look to find consistency making money from one strategy, this is impossible as the market is always changing. What should not change is the principles of your trading system that gives you an edge over the long term. Consistency can only be found in your actions and behaviors not in the markets.
Mindset of a trader
The mindset of a trader must be one that accepts uncertainty, trades within their own framework of profitable principles, but can accept losing money. Traders are entrepreneurs accepting risk for the potential of rewards. Traders can accept they don’t know what will happen next but can manage the risk while they seek rewards.
Emotional trading mistakes
The biggest mistakes most traders make are ones due to overwhelming emotions. They hold a losing trade because they don’t want to take the loss as it proves they are wrong and it hurts their ego.
New traders let losing trades run hoping for a reversal, but cut winners short in fear of giving back small gains. This is the opposite of what they should be doing, this creates a negative risk/reward ratio.
Fear, hope, and greed are expensive emotions to act on in the markets. They can be managed and worked around.
Trading psychology rules
1. Know your edge
If you know what your edge is in the markets then you will stay within your circle of competence in executing it. An edge is simply an advantage you have over other traders for creating bigger wins than losses on average. Knowing your edge can keep you away from random trades and gambling, creating more consistency in execution of your system.
2. Know your expectancy
If you know your profit factor and win rate for your trading system you are more likely to stick with it during losing streaks as you know the losses are temporary. Not knowing their system expectancy causes new traders to abandon a new system too quickly and go back to taking random trades as they feel their strategy doesn’t work.
3. Make execution your focus not results
Focusing on what you can control can lead to more disciplined and consistent actions in trading. You can control entries, exits, and position sizing. You can’t control price action and volatility. Focus on the playing field not the scoreboard. If you have a system with an edge the results will take of itself over time.
4. Follow a trading plan
A trading plan documents your trade management from entry to exit before any money is risked. A trading plan can bring consistency to actions as it’s written when no emotions or ego are activated. It’s a map for a trading journey that sets the guidelines and can keep you safe from bad behavior and random actions through quantification of steps.
5. Use consistent position sizing parameters
The size of your trades should be consistent based on the parameters of your system. Most trades should be the same size with some changes made based on volatility of a chart or market. The variance in risk taken should be consistent and not vary much from trade to trade. Emotions and the ego should never influence your trade size, only math is a good risk manager.
6. Use signals not opinions or predictions
Signals triggered by the market create more consistent results than beliefs about what will happen next. Signals are objective while beliefs are subjective. External guides are more reliable than internal guides when it comes to trading.
7. Focus on what is happening not what you think should be happening
Stay open-minded to what is currently happening in the markets so you keep the consistency of disciplined action. Stay ready to exit from a loss or enter on a new signal. Stay flexible in your actions and disciplined with your execution of signals.
8. Know your minimum risk/reward ratio
Stay consistent with your risk to reward ratio from entry to exit. If you enter with a 1:3 risk to reward ratio when that profit target is reached consider locking in profits. Risk/reward ratios are always changing as a trade moves against you are in your favor, manage accordingly. Don’t let a risk/reward profile move against you, keep risks that are still worth the rewards.
9. Know when you are wrong
Have a stop loss level for every trade so you know where the trade is wrong. Keep losing trades consistent in the magnitude of losses. Don’t allow trades to move too far against you and create huge losses. The number one reason most traders are unprofitable is due to allowing huge losses.
Keep losses consistently small through a combination of proper position sizing and stop losses. A trader should never lose more than 1% to 2% of their total trading capital on any one trade if they are serious about achieving long term success.
If a trader has a $100,000 account, they should position size and set stop losses to limit losses to no more than $1,000 for a single trade. A stop loss level should be at the price level that would signal a trade is wrong, and work back to position sizing.
If a trader with the above account size ($100,000) enters a stock long at $105 and the logical technical support on the chart at $100 then their risk is $5 a share. A $1,000 risk is 200 times $5. So the trader could buy 200 shares of the stock for a total position size of $21,000. This is a 21% position size and the 1% risk on the total trading capital with a stop loss at $100 a share. This is how to manage losses to keep them consistently small.
10. Understand your discipline determines your trading destiny
Your ability to stay disciplined and consistent in your actions determines your trading success as much as any other factor. Combining the right trading psychology with a trading system with an edge and then using proper risk management can make you a consistently profitable trader.