A Confidence Builder That’s Not Money

06/22/2012 3:30 pm EST

Focus: TRADING

Gary Dayton

Founder, TradingPsychologyEdge.com

By judging success based on plan compliance instead of just bottom-line results, traders can build their confidence level without being hurt by outside factors, explains Dr. Gary Dayton.

Developing confidence as a trader is very important if you’re going to be successful long term. Our guest today is Dr. Gary Dayton to talk about how to develop that.

So, Dr. Dayton, traders need to have confidence in their strategies and their skills to make money, but how do you get there?

That’s a good question. In fact, it reminds me of a trader I work with who said to me, “Dr. Gary, if I only had more confidence, I’d be a really good trader.”

So, like a good psychologist, I said, “Well, what do you think would bring you that confidence?” His response was, “Well, that’s easy: more winning trades.” I thought, “Wrong answer!”

Confidence doesn’t come from results; it comes from the process of trading.

When we are results focused, we are thinking, “Well, is this trade going to be a winner or a loser? Am I going to make money today, or I am going to make money this week?” That’s placing confidence outside of ourselves. It’s what we psychologists call “external confidence.”

We never know whether any given trade is going to be a winner or a loser. We never know how the market is going to trade that day. It may be flat, or it may be rocketing off.

We never know how the week is going to turn out. So, when we pin our confidence on external factors like whether a trade is going to work or not, when it wins we feel good, but if it doesn’t win, we don’t feel good.

It’s the same with the market. If we’re pinning it on how the market is going to trade that day, it’s great if we’re in a good trend but not so great if it’s flat.

Now one of the things I know traders struggle with is after they have three or four losing trades in a row, developing that confidence to take that fifth trade.

If nothing else has changed and they’re still confident in their strategy to take that fifth trade, how do they go about doing that?

That’s right; it is an issue, and they are holding onto what happened in the past, but that has nothing to do with the next trade coming up.

Again, it’s looking at results, rather than on the process of developing good skills. The real confidence is going to come from mastering your ability to read the charts and read the market and your ability to execute and manage trades.

So, here’s three tips, if you will, or areas to focus on. One is to learn the technical side of the market, to really put a lot of effort into this and do this first, rather than starting to trade first, which is what most people do.

We want to reverse that process. We do this by studying charts. We do this by a lot of simulation trading. We do this by keeping a journal and keeping good notes and seeing where we need to make improvements on how the market trades in given situations.

We want to really push ourselves while we’re in this practice mode, if you will, to develop a competent level of skills and push ourselves to the point where we can excel in that. Once that occurs, then start trading, and trade small.

Go in one contract in the S&Ps, or if that’s too much, ten shares of stock. It doesn’t need to be 500 or 1000 or 2000 shares. Just start trading small and get the feel for trading, and then gradually increase your position size.

The third thing to do is to understand the nature of trading. It’s all about probabilities. If you’ve had three or four losses in a row and it’s hard to take the next trade, well, the next trade has nothing to do with what happened three or four trades ago.

There’s a paradox here in probabilities, and that paradox goes something like this: On any given trade, you never know whether it’s going to be a winner or a loser, but over a large number of trades, if we have a trading edge, then we have a certainty that we’ll be profitable.

So, for example, if we have a 70/30 win/loss percentage where seven out of ten times it wins, on any given trade, we never know if this going to be one of the seven times it wins, or if this is going to be one of the three times it loses, but over 100 trades, 70 should work out and we should be profitable.

Understanding probabilities is very important. So too is controlling what we can control, which is focusing on the process of developing good skills in chart reading and trade management, along with the understanding that this is a probabilistic game that we’re playing, and any probabilistic field is built on process, not on results. Do that and the results will start to take care of themselves.

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