Is Psychology Important in Trading?

12/29/2012 7:00 am EST

Focus: TRADING

John Person

Founder and President, John Person, Inc.

Veteran trader and author John Person discusses how the failure to judge the risk of a trade can play a major role in a trader's psychological attitude.

I’m here with John Person, president of nationalfutures.com.  John, it’s often said that trading is a psychology game as much or more than it is a game about anything else.  You think that’s true?

I think what the aspect of the psychology is the discipline to wait for the right trade and then have the ability to put the trade on.  I mean part of the problem with trading is that people anticipate they don’t have a set of rules or defined idea of what their exit strategy is.  When I say exit strategy, I mean risk.

What’s the cut off that I’m wrong.  I think a lot of novice traders tend to take quick profits and let losers ride.

It seems to be eat like a bird and go to the bathroom like an elephant syndrome, I don’t know if we can say that on video.

The whole point is that from a risk reward perspective, if you can manage the risk and that goes without saying, that’s the first and foremost thing you say.  If I’m going to get into this trade, what’s my risk?  First thing because we never know if this is going to be the greatest trade ever, how long is the trend going to ride, is this a day trade, if my horizon, maybe I like the trade so well I can hold it overnight if I have the margin requirement?  Or is this a trade that I’m going to see a trend last and develop into the next three months.  I think for that aspect of it, people need to probably focus in on risk.

We talked about being well capitalized in the past.  Does being well capitalized when you start your trading career help you to undergo those psychological pressures that come when you’re holding these positions for long periods of time?

Trading with scared money is a whole factor of how people put themselves in harm’s way of trading.  They don’t have enough trading capital.  They’re afraid to lose, so then therefore that fear manifests itself into cutting their winners because they need to be quick to take a winner.  That’s kind of like how that psychology aspect all ties in.  If you can learn to overcome, and I think the best advice that I was given years ago is trade as if you don’t care if you lost that money.  Be prepared to lose that money; that’s what your risk factor is.  If you’re going to get into a trade and you know what your risk factor will be more or less, then that’s your decision that I can get into this trade and that’s what I’m going to risk.  If the trade is going to work, I’m going to be rewarded.  If it’s not going to work, I know what my risk is and it’s not the end of my world.

Is there a maximum risk that you recommend to traders at any stage in their careers?

I don’t think I would ever per se put a dollar figure because I think that’s where you’re position sizing comes in. If you start to say I’m only going to risk $100 per contract or I’m going to risk $200 per contract, I mean how many contracts do you have on?  Right?

I mean I think the risk is I’m going to set a stop based on a condition.  If the market closes above a high if I’m short.  If the market closes below a low if I’m long, I’m going to wait for the market to tell me when to get out.  The problem is that would be something in the old days we’d call a stop close only.  If the market stopped you out on the closing basis you would get out.  You wouldn’t know what the close would be. 

I think the condition of where the market closes in relationship to what the trade is, that’s one concept.  Another concept is if the market trades below a certain price level, breaks support, and you’re going to get out of that long position.  That’s where I think traders need to focus on what their risk factors are.  Another aspect is as an options trader as well, what’s your time horizon?  Sometimes option strategies can get you through.  Maybe you’re in the right trade, but you’re in the wrong strategy.  In other words, if you’re just an outright long, you may have gotten stopped out, and the very next day the market moves in your favor.  An option strategy might allow people to buy time to look for the trend to resume again.  Again, what’s that risk?  It all depends on (1) what your condition is for the loss; and (2) what’s your position size?

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