Psychology 101: Thinking for Success

Improve Your Trading Educational Series

By now you probably know that nothing’s obvious in the stock market. Few investors are consistently profitable because price movements are often counterintuitive. If you want to make money, the first step is getting your mind right for these realities of trading.

Successful Trading Is a State of Mind

Trading is different than most things in life because hard work and determination don’t always produce success. Pride and fairness mean nothing. It’s not like dealing with a co-worker or a family member. No one cares what you think, what you feel or how much money you’re losing. The market isn’t a person with empathy.

Fortunately there are some clear principles for adjusting your psychology to realities of the market.

Trading Is a Business

Few businesses survive from just one sale or just one client. Instead, they rely on a stream of transactions and customers. They seldom make all the money at once, but they can thrive by sticking with realistic business models.

This is a common obstacle for novice traders because their expectations are too optimistic. Swinging for the fences, they often strike out and get discouraged.

It’s better to hit lots of singles and doubles. A good trading strategy generates consistent strategies over time while minimizing risk.

That way, you go to work each day in the market. You follow your strategy just like any other job, and gradually the power of compounding will build your wealth.

Emotions Are the Enemy

Emotions are usually the biggest obstacle because they blind our judgment and make us believe things that aren’t true.

After all, feelings like pride and frustration are based on your own personal situation and not the reality of the market. They prevent us from seeing our own failures and changing course. The result can often be expensive losses.

Almost as bad, emotions can prevent us from seizing opportunities when they arise. We might be so upset about one losing trader that we refuse to enter other positions recommended by our strategy. I repeat: Emotions are the enemy.

You Need a System

Having a system is the best way to overcome emotions.

Trading needs a business model like any company. A grocery, for example buys food, advertises and runs its store. Each activity has to be done correctly.

The three parts of trading are:

  1. Analysis: “Stock picking.” This is everyone’s favorite.
  2. Entry: Knowing when to buy shares. Most people like this part too.
  3. Management: This includes taking losses. Few people are good at this, so we’ll discuss it in a future post.

Having a system makes it a lot easier to handle each of these steps. There are certain ways you select trades, certain ways to enter them and certain ways to exit. By making it strictly business there’s no room for emotions.

Probability Is Your Friend

Making money consistently in the market comes down to probabilities. Anything can happen at any time, and you don’t know what will happen next. However, we can identify certain variables that tilt the odds in our favor by making certain outcomes more likely. This is called an “edge.”

Good traders know when they have an edge and stick with it. They don’t obsess over individual positions or trying to be proven right. They trust having probabilities in their favor because that’s the business model.

Live to Fight Another Day

This brings us to the final point: Capital preservation should always be the primary focus for any trader.

While long-term appreciation is important, you must also remember that losing investments can not only erase previous profits. It can also wipe our your entire portfolio.

This is a big reason to let go of “being right.” Stubbornly remaining in bad trades is a common way to lose money. Future posts on risk management will explore key points like sizing positions correctly and navigating volatility.

For now the key message is that successful traders always live to fight another day.

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