Consistent, successful trading careers are built on disciplined adherence to a well-developed and suitable trade plan, and these five psychological and strategic barriers are largely all that stand in the way, states Adrian Manz of TraderInsight.com.
Most of what has been published about the business of trading focuses on method. Everyone wants to read about chart patterns that can earn big returns, but few consider what is necessary to make those returns happen.
Examining what it will take to become a profitable trader using a particular strategy or approach to the markets can go a long way in shortening the learning curve, and can mitigate the effects of psychological discomfort on the results that can be achieved.
There are many different approaches to trading the markets, and usually just a handful of methods that will be a good fit for a particular person. Using the right criteria to select a methodology can go a long way in fostering success, but a trader needs to be as in sync with his or her own biases and psychology as with the parameters of any given system in order to achieve the dream of trading for a living.
I have seen the disconnect between what traders want to achieve and what they are prepared to do to get there first hand over the past decade. For many years, I have published my daily trading plan and my trading results in a very public forum on the Web. Aspiring traders are generally very impressed by the results, and rather frequently disheartened by the effort and concentration required to achieve them.
I have a rulebook that accompanies my plan, and I follow it to the letter. The rules span one-and-a-half pages and draw on my 20 years' experience in the markets to account for nearly every circumstance that I may encounter once a trade is live.
Multiple hurdles are included in the rulebook, and actions are taken in response to achieving or failing to achieve each hurdle. Procedures are in place for dealing with targets, stops, and for implementing trailing profit-protecting orders.
The rules take much of the discretion and emotion out of my intraday trading, and I find that this is the key factor in my ability to create consistent results month after month. Once the set of rules became ingrained in the way I think, they took on the role of discipline. And once an identifiable discipline is part of a trader's psychology, the key that opens the door to a successful trading career is in hand.
Wikipedia defines self discipline as "...the ability to motivate oneself in spite of a negative emotional state. Qualities associated with self-discipline include willpower, hard work, and persistence." That negative emotional state can, rather frequently, be part of a trader's day. The ability to push past the emotions and meticulously execute the parameters of a trading plan in a disciplined fashion can frequently draw the distinction between traders who will persevere and those who will seek other employment.
My wife and trading partner, Julie, who also happens to be a psychologist, agrees that discipline is one of the most significant precursors of success in the business of trading. She suggests that acquiring the discipline necessary to trade profitably runs emotionally parallel to Kubler Ross' stages of grief (denial, anger, bargaining, frustration, and acceptance).
That is to say, at the very least, that becoming disciplined is a very difficult and almost universal process for most of us. The analogy is a hard pill to swallow at first, but I think that it is generally correct.
Step 1: Denial
Many traders start their careers in denial that they have anything new to learn in order to be disciplined about their trading. People who choose trading as a profession usually are, or were, highly successful prior to making that choice and they feel that previous success and some hard work will naturally translate into profitability.
These are very smart people who have made very smart choices in the past, and it is natural for them to assume an easy transition. But previous successes do not necessarily translate to the world of trading, which involves more than intelligence and hard work to achieve good results.
The skill set is very different from what most of us have utilized in the past, and the need for focus and discipline is never ending. Some of the most highly educated and most successful people are naturally drawn to trading for a living. But misattribution of which skills and intelligence they can draw upon to succeed often leaves them unwilling to accept that they might need to do a significant amount of soul searching to build the discipline required to achieve success.
Step 2: Anger and Frustration
Denial about the need for discipline can give way to anger or frustration when the lack of discipline begins to affect profitability. Part of the problem here stems from the definition of success.
Most new traders equate success with a win, or making money, and failure with a loss, or losing money. They internalize these ideas and focus all their energy on scoring a gain.
Seasoned traders, on the other hand, equate winning with following a plan and its associated discipline. They know the track record of the set-ups over time and know what will happen if they stick to the discipline precisely. A day in which everything is done according to the rules is a win, and has nothing to do with money. Deviating even slightly results in much more stress than booking a loss. In terms of profitability, they see no good or bad days. They are all just days. This makes each trade a fresh, stress-free opportunity, and allows for an emotion-free implementation of their trading plan.
Step 3: Bargaining
New traders tend to see an opportunity to bargain when a lack of profitability accompanies a problem with discipline. The ability to bargain is a characteristic that sometimes serves well in business, but does little to foster success in trading.
Traders frequently believe they have found a compromise between rigid discipline and discretion. They follow their trading plan loosely, but want to use intuition to place some trades, as well as to eliminate planned trades based on what may be happening in the markets. They assume that those of us who have been trading successfully for many years must react in the same way and that rules were made to be broken.
Breaking a discipline, however, has more potentially negative psychological consequences than not following one at all, and these traders are setting themselves up to use profitable trades that occur intermittently as a way to undermine their entire trading business.
The trades that are placed off-plan and then lead to profitability can have a trader focused on finding a way to beat his or her own discipline for years, while the ones that lead to account drawdowns tend to be dismissed as simple mistakes: "If I would have handled the exit a little differently, or remembered to look at the index, that would have worked out differently."
Every trader has heard that logic inside his or her own head at one time or another. But the lack of concrete analysis that accompanies discretionary trading and an effort to bargain away the need for discipline dictate that shooting from the hip will lead to the same mistakes being repeated over and over again.
Step 4: Acceptance
Sooner or later, those who manage to stick it out make their way around to accepting the fact that a solid discipline is required to establish a consistent record of profitability. Trading successfully comes down to planning everything and then meticulously executing the plan. This is where it all comes back around to the Wikipedia definition that I mentioned earlier, as "...the ability to motivate oneself in spite of a negative emotional state. Qualities associated with self-discipline include willpower, hard work, and persistence."
Fortunately, most people going into trading are not strangers to these qualities. Discipline is important for success in trading, and increasingly important the longer a trader hopes to stay with it as a profession. But discipline alone is not enough.
Step 5: Strategic and Psychological Consonance
We seek consonance in most matters in life, struggling to find explanations for events or actions that are consistent with beliefs that we hold. By contrast, dissonance refers to the uncomfortable feeling we get when what we are doing does not sit well with the beliefs that we have. The concept of dissonance explains a lot of behavior that traders exhibit, and makes it easier to understand why one trader may be wildly successful with a strategy that another loses money with and dismisses as useless.
For the trader who can implement it consistently and generate good results, the strategy and personal psychology are consonant, that is, they are in agreement. For the trader who cannot stay the course and winds up losing money, the strategy and personal psychology are dissonant. It has nothing to do with right or wrong, talent or desire. The problem emanates from a bad fit.
An essential and often overlooked puzzle piece in staying disciplined is the consonance between the trading strategy chosen and one’s own psychology. People make decisions about which system or method to trade based on the returns they believe a strategy has made or how profitable a computer-generated model looks. They do not consider whether they will be able to stick to the rules without experiencing significant emotional discomfort.
The market to trade is picked based on how much money they have. They might choose to trade futures rather than equities based solely on the knowledge that the latter provides significantly more leverage. The effect of that leverage on the ability to stick to the plan, however, is not given adequate consideration.
Basically, the first three things any aspiring trader should consider when trying to learn or develop a new strategy are the following: risk tolerance, goals, and time requirements.
Knowing your tolerance for risk and understanding your relationship with money are critical in selecting how and what to trade. One of my partners, for example, very successfully trades financial futures. His systems work very well for him, because he is "in tune" with the leverage and equity swings that accompany his style of trading.
However, even though I know the systems inside and out, and have seen them consistently make money over time, the style of trading represents more risk and leverage than I am comfortable assuming on any given trade, and I know that I would have a very difficult time consistently replicating his success as a result.
Most new traders fail to consider how making trades will make them feel, and this leads to an inability to accurately execute a plan. An appropriate assessment of the risk one is comfortable with and the risk inherent in a strategy is an important first step in evaluating how to start trading.
Quantifiable and objective goals are a cornerstone for any successful business, yet most new traders can only say that they want to quit their day job and work for themselves. But trading to build wealth is very different from trading to generate income, and knowing why one wants to trade is as important as knowing that one wants to trade.
Swing trading may be more appropriate for someone whose goal is to slowly build an account, while intraday trading may be a better fit for someone whose goal is to build a new career. Knowing the reason for starting a trading business can define much of the discipline that needs to be internalized and the path that needs to be followed.
Finally, no one should lose sight of the time commitment required for various types of trading. I have friends trading professionally in every instrument in the industry and can say to a certainty that this is not a casual endeavor for any of them. Everyone has committed a significant portion of his or her life to developing a trading method that works, building and reinforcing discipline, and then refining everything almost continuously. Trading in any time frame requires a time commitment, and those who understand that success can be achieved only by putting in the hours are usually rewarded for it.
I started my career in this profession by personally going through what I have discussed here. I experienced all of the frustration and anxiety one could ever imagine, and like many traders, researched and read every approach and strategy I could find. I tried different time frames. I was a swing trader, then a scalper, and finally found my home trading positions intraday.
I learned important lessons about myself and what type of trading system would best fit my psychology. I was very good at scalping equities. I have a feel for the market’s small shifts and can see it unfolding on the OpenBook and on the ticker tape. But trading that way full time gave me significant angst.
In a different, but surprisingly similar way, overnight trades also caused me tension. I did not sleep well at night when holding positions. My forte is trading well-planned intraday positions that unfold over the course of hours and close out at the end of each session. The risk is definable within my comfort zone, and I can plan to deal with every contingency. This is the playing field that I have chosen, and it is where I can maintain discipline and flawlessly execute my plan.
The point here is that achieving success as a trader is very possible. But picking trading as a career requires that careful thought and consideration be given to variables other than the income that can be potentially earned following a specific methodology.
There must be a fit between personal psychology, discipline, and strategy that fosters an ability to stay the course in good times and in bad. In the absence of this fit, the business of trading will equate with a struggle. When the pieces of the puzzle come together, however, trading for a living can be one of the most financially and emotionally rewarding career choices a person can ever make.