What Is Trading Psychology And How To Master It

As with any form of speculative activity, the importance of psychology in trading simply cannot be overestimated. Humans are emotional beings, and they have well-defined psychological traits that often accumulate into a number of unique personality types. Furthermore, when trader’s group together in mass, their overall psychological behaviour moves markets and creates the very chart patterns that excite technical analysts.


Keep reading to discover my top tips, and to learn more about:

  • What are traders personality types

  • What is trading psychology

  • How to get in the mindset of a successful trader

  • The basics of trading psychology

  • Trading psychology tools and techniques

  • Important Trading Psychology Books



The fundamental psychological factors of a trader’s personality often come to the foreground when trading activities start to generate significant profits and losses, since many people experience strong feelings when making and losing money.


Trading psychology has been studied extensively by many researchers, typically to determine what type of trading mindset and personality type are most successful in terms of generating consistent trading profits. Several of these researchers have written important books on the subject that traders can read to gain insights into their own activities and whether or not they are psychologically suitable to become a successful trader.


This discussion of the psychology of trading will start with an overview of the basic trader personality types as distinguished by Dr. Van K. Tharp.


Trading Psychology or Personality Types

In Dr. Van K. Tharp’s research on trading psychology, he separates traders into a set of fifteen personality types that can be assessed using his online Tharp Trader Test. These trader personality types each have a psychological profile that contains various weaknesses and strengths.


His website contains greater detail on this subject for the interested reader. The defining characteristics of these fifteen personality types are:


  • The Accurate Trader

These traders are noted for their tendency to use detailed analytical processes and keep meticulous and accurate records. Traders with this psychological profile often keep detailed notes of their decision making process in their trading journals, which tends to help them on future trades. Due to their fastidious attention to analysis and recordkeeping, these traders can sometimes fall into the trap of paying more attention to these activities than to making profitable trades.


  • The Administrative Trader

This trader profile is characterized by the trader’s tendency to be practical, decisive and realistic in their approach to trading. The Administrative Trader has a tendency to be responsive to changing market environments that can result in profitable trades. In addition to adapting to different market conditions, this type of trader has strong decision making capabilities and can delegate authority when working with others.


  • The Artistic Trader

Artistic traders are characterized by their tendency to use their intuition and creative thinking in their trading more so than other traders. Due to their creative streak, Artistic traders tend to be more flexible and can adjust to changing market conditions. Nevertheless, this feature can be a double edged sword and cause problems for the trader if they become emotionally attached to losing trading positions.


  • The Adventurous Trader

This trader profile is noted for their open minded and flexible approach to trading and includes some of the most successful traders. Adventurous traders use their ability to respond effectively to market information and are generally accomplished analysts, prioritizing data and using it to make sound trading decisions. Adventurous traders often take significant risk and focus on factual information when making trading decisions.


  • The Detailed Trader

The Detailed Trader profile is characterized by a preliminary analytical process before taking a position in the market. Detailed Traders use logical assessment and careful analysis and often keep intricate notes on their trades and reasons for taking them. Nevertheless, many traders with this psychological profile can fall into waiting too long to establish or liquidate trading positions, resulting in significantly lower returns.


  • The Facilitative Trader

This type of trader generally has a serious and sober approach to trading, preferring to trade in a social environment or interacting with other traders. Because of their focus on the social aspect of trading, these traders typically excel as part of a trading team or acting as someone’s trading partner. Facilitative Traders often observe the big picture of the market and trade in

a decisive and well organized manner.


  • The Fun Loving Trader

This trader profile is characterized by a playful approach that includes a degree of social interaction when trading. Fun Loving Traders tend to have a positive outlook that reflects their optimistic viewpoint. However, due to their optimism and social interaction with other traders, their emotions could affect their objectivity when trading.


  • The Independent Trader

These traders tend to use their own interpretation of data and act independently of the crowd when trading. While their abilities to think outside the box can result in profitable trades, their lack of social skills makes them poor team players.


  • The Innovative Trader

This type of trader is noted for their creative and intuitive approach when analysing information and establishing trades. Innovative traders tend to be able to process large amounts of information and react quickly in the market. In addition to their abilities in analysing and reacting to market conditions, these traders tend to be good leaders and can excel in reading people.


  • The Planning Trader

This trader type tends to be a competent leader and communicates well regarding trading matters. They tend to be well-organized and realistic, and they make trading decisions effectively. They tend to focus on facts to make reasonable decisions, and they can respond quickly and flexibly to new trading conditions by developing new systems.


  • The Socially Responsible Trader

Such traders tend to be loyal to social values they deem important and enjoy

a social life. They seem most successful as traders when a trading opportunity presents itself that is consistent with their values.


  • The Spontaneous Trader

These traders typically think and react quickly when trading, although they tend to do so without having performed much analysis beforehand. They can find planning and following through difficult when it comes to their trading strategies.


  • The Strategic Trader

This trader group tends to make intelligent trading decisions based on factual information, and they aim to develop a suitable level of competence in their trading related activities. They are typically seen as practical, realistic, well-organized and decisive when trading. These traders also tend to have the ability to see the big picture when engaged in trading and they can think quickly when needing to respond to shifts in the market. They easily understand difficult concepts and learn actively.


  • The Supportive Trader

Such traders tend to be insightful, solemn and can be depended on for trading activities, although they lack some of the important characteristics of the best traders, so they typically either take on a support role within a trading team or offer financing to more successful traders.


  • The Values Driven Trader

This trader type tends to be independent and to focus on trading’s material rewards, ideas and relationships. They can also make decisions well and can see the bigger picture. If they can get beyond their emotions and value system, they can become successful as traders.


A Successful Trader Psychology

In addition to having identified the above fifteen trader personality types,

Dr. Tharp has also determined several key psychological characteristics of successful traders. His research on trading psychology led him to identify three key psychological traits shared by just about all of the best traders.


These include the following overall personality characteristics:


  • Good traders have the ability to see and grasp the “big picture”. They can also make connections between events and recognize good trading opportunities as they arise.

  • Such traders can ideally analyse markets logically in order to make sound trading decisions.

  • They also tend to be decisive and well-organized, in addition to being able to perform operations sequentially.


Each trader’s individual success potential can be determined by assessing how many of these favourable characteristics they already have or are willing to work on developing. In particular, Dr. Tharp identified that Planning and Strategic Traders tend to show greater potential for initial trading success due to them having all of the aforementioned personality characteristics.


On the other end of the spectrum, Dr. Tharp indicates that the Supportive, Artistic and Fun Loving Traders tend not to have any of these characteristics. Rather than trading themselves, they can often do better by allowing other people to trade their accounts for them, unless they plan on performing considerable work on themselves to correct their sub-optimal trading mind set and develop the personality traits necessary for success.


In between the above two groups are those trader personality types that have only two of the above characteristics. These include the Detailed, Facilitative, Innovative, Spontaneous, Independent, Administrative, Values Driven, Socially Responsible, Accurate and Adventurous Traders.


How To Master Trading Psychology And Discipline

Pick up a book or magazine article about trading psychology and you're likely to find prescriptions for success based on controlling emotions and increasing discipline.

Yes, emotional arousal can interfere with performance, but does that mean that elite performance is a function of dampened emotions?

When you look at some of the greatest performers in sports -- and in trading --you'll find highly competitive individuals. They are quite emotional and don't take well to losing. Lance Armstrong? Michael Jordan? Tiger Woods? Muhammad Ali? All were quite intense, emotional individuals who managed to channel their emotional drive into victory.


Conversely, I've encountered many well-balanced individuals who have sought success in trading. They don't blow up, they follow rules faithfully, and they have no intense, competitive emotional flame burning within. I've never yet seen one go on to become successful. Can anyone watch the really successful college basketball coaches--Coach K., Jim Boeheim, Bob Knight, Tom Izzo--and attribute their success to emotional restraint? Yes, there have been emotionally reserved winners--think John Wooden and Dean Smith--but one suspects their emotionality was that of

a warm mentor, not that of a cold fish.


The important ingredient in success is not emotional dampening per se, but the enhancement of concentration and focus. That is what enables people to act with sustained purpose and stay rooted in their goals. When we review the lives of great individuals across a variety of fields--the research of Dean Keith Simonton and K. Anders Ericsson stands out in this respect--what we find is that the greats have prodigious capacities for work. They are hugely productive.


They sustain effort hours at a time, day after day, week after week, year after year. Only the ability to regularly access "the zone"--that flow state of consciousness that comes from being wholly absorbed in an activity that captures our interests, skills, and talents--can account for the amazing dedication of the Olympic athlete, the great career scientist, or the chess grandmaster.

Indeed, such exemplary performers can use emotion to access the zone. Michael Jordan used to provoke players on opposing teams so that they would argue and fight back. That would arouse Jordan's competitive instincts and elevate his game.

When we operate outside that "zone" and lose our focus, we are no longer activating that executive centre of our brains--the frontal lobes--that control planning, judgment, and reasoning. Left with a weak executive centre, we become like the person with Attention Deficit Disorder: prone to wandering attention, reduced self-control, and impulsive behaviour.

That makes it look as though "emotion" and "lack of discipline" cause our trading problems. In reality, however, these are the results of the problem; not the causes.

The goal of trading psychology is to build consciousness, not reduce emotion.. The goal is to create regular access to the flow state of heightened learning and focus. Talking to a trading coach, in itself, won't accomplish that; nor will well-intentioned efforts to calm oneself or take breaks from trading.

We can only build consciousness by working on consciousness. That is why I find meditation, self-hypnosis to be valuable tools for traders and emphasized their use in the psychology of trading.


These methods don't eliminate emotion; they build minds. If we can exercise for 30 min./day and build our cardiac fitness and our physiques, maybe -- just maybe -- a similar commitment could strengthen our abilities to operate within life's "zone".


So, how to build traders psychology.

The moment that real capital is put at risk in trading, everything changes. Trading goes from an intellectual exercise where loss is abstract and not personal to a visceral experience where potential loss unhinges the rational mind and primitive emotional responses take charge of the trading mind. After experiencing real losses, the emotional survival brain even starts anticipating potential losses (rather than gains) and hijacks the trading mind BEFORE action decisions are made. If you have dealt with fear of entering a trade or fear of pulling the trigger on a perfectly good set-up, you have experienced the baffling power survival emotions have over rational thought.

Or if you have perceived that a trade could be getting away from you if you just sit there and wait for it to shape up properly, then muscled your way into the trade, only for it to collapse – you, too, have experienced survival instincts overriding rational thought to create a mind incapable of trading effectively. Others are primed for over trading when their desire to experience the feeling of winning big (and feel that squirt of dopamine creating euphoria in the brain) mesmerizing the rational trading mind into the gambler's mind – where restrain is forgotten in the pursuit of a dopamine rush (winning money).

It seems like these emotions take over your trading mind out of nowhere. But that’s not the case. The case is more about a lack of understanding your emotional nature and knowing what to do about it. And particularly about not understanding how the survival instincts of the emotional brain overwhelm the rational thinking from the neocortex. Let’s step back a few steps so that you can begin to understand what is actually happening when you experience fear of loss or experience the greed associated with over trading or impulse trading (what I call gambling).



Emotions and the Act of Trading

Traders try to control emotions without understanding them. And this oversight gets traders in trouble all the time. Because of that most strategies for emotional control work only in the very short term and collapse when put under pressure. The most misdirected common emotional control methods involve denying the emotion, resisting the emotion, or using positive affirmations (I am a disciplined trader!, I am disciplined trader!) to control the unwanted emotion.


This is an attempt to push the emotion aside as if it were not connected to your capacity to think. As we develop more understanding of emotions, you will come to understand why these methods (though popular) are both misguided and add to the problem of dealing with emotion and mind. In essence, you will discover that you have been attempting to push a 600-pound silverback gorilla around. Full of testosterone, but misguided.

First, what is an emotion? For years Cognitive Behavioural Theory held that emotions happened after thoughts. This theory holds that the way a person thinks about an event creates the emotion that arises out of the experience. Actually the reverse is true. What Neural Biology has established is that emotion is first – thought comes forward out of emotion. And that all thinking is emotional state dependent. But this idea that thought comes before emotion and thought is the king came much before CBT.


It started with Renee Descartes, who opined, “I think therefore I am”. So, people have for centuries held the belief that thought was king and that emotion was of secondary value. And that is the very same bias that most bring into trading. They want to push off the relatively unimportant element of emotion so that they can get to the rational mind – and trade without emotion..


Unfortunately, we have put the cart before the horse. In reality, the horse is emotion and the thinking is the cart. Emotions are not even psychological in nature – they are biological. But they take over psychology. All thinking is emotional state dependent. It is the emotional state that governs what kind of thinking you bring to the performance of trading. There is no freedom from them as Descartes envisioned. No matter how appealing this notion is, the facts demonstrate that logical thinking (Spock thinking) without emotional support is an illusion. The problem is that unwanted emotions keep popping up and hijacking the trader’s mind. And they don’t see the hijacking coming because they are denying the power of emotion and trying to control the emotion by will power. (Remember that 600 pound gorilla?)

But, why can’t you control an emotion by will power? To begin with emotions are biological action potentials that coordinate the interface between the organism (that’s you, the trader) and the environment (the markets). Literally, changes in the environment of the market you are interacting with will trigger emotions in the organism (that’s you, the trader) that control thinking output and action back toward the environment. This is the dance of trading.


When you are looking at a potential set-up with evidence for entry, this dynamic emotional relationship exists between you and the markets. As you are evaluating a potential trade, you are looking for certain confirmations (positive developments in the market). As the confirmations are checked off, you are preparing for taking action in the market. That action is predicated by your emotional appraisal (more about that later). The emotion as biological action potential is preparing you to take action by entering a trading or letting it pass by. Either way emotion has created thinking that allowed you to act upon the environment of the markets. Logic becomes possible only after both fear and greed are regulated so that they do not take over the thinking of the mind.


The Glitch – What the Brain is Designed to Do

Your brain’s prime directive is self-preservation – to keep you alive. It will do anything to accomplish this mission, including lying to and deceiving itself. It was built to control both environment and outcome. And there was a time not so long ago that this was a major problem. The world in which our human ancestors lived was dangerous, so self-preservation was a serious task. By seeking control over outcome IN THE SHORT TERM, the brain of our ancestors adapted to the lethal dangers that lurked in their environment.


By concretely surviving in the short term, the individuals of our ancestors developed lightening quick emotional responses to dangers in their environment THAT PRECEDED THINKING because thinking responses to threats is too slow for survival concerns. As a trader you experience this problem every day when emotion runs over logical thinking in the heat of a trade.

During the development of our emotions (remember those biological action potentials that coordinated action between the organism and the environment – here’s where it developed), short-term survival was more highly valued than long term benefits. This development because wired into the emotional brain as pattern, so as soon as cues from the environment demonstrated threat to life – the brain fired up the emotion as precursor to taking action instinctually.


Everything went along great until the thinking brain began to emerge from the emotional brain. All these survival instincts were already wired for self-preservation before our ancestors started thinking. So it was natural for the survival instincts that had been so successful in our more primitive past, came along for the ride into modern man.

The glitch is that your brain cannot tell the difference between a biological threat to survival from long ago and the psychological discomfort you experience when you encounter uncertainty in your trading. No one told the emotional brain about it. And it continues to act as if any threat to your power (your money) is a threat to your very existence. Self-image around your sense of power to survive and the symbol of money became linked. And this is where the brain and trading became poor bedfellows.


The way it works in the brain is that information comes in through sensorial data FIRST to the emotional brain. Here it is quickly evaluated by the hippocampus first. If the information is remembered as a danger to life (remember it sees psychological vulnerability the same as biological threat), it is immediately sent to the amygdala (fear centre of the brain) for immediate action (that’s what an emotion does) without sending to the thinking centres of the brain. This is called an emotional hijacking. And do you remember that linkage between your self-image of power and money as a symbol of power becoming linked? Here is where it comes into play. The sensorial information never gets the thinking brain. And you act from the instinctual survival emotions of fear, anger, and/greed. And your capacity to trade effectively is lost.



Correcting the Problem of Survival Instinct

Unless you won the genetics lottery, the brain/mind you brought to trading is simply not equipped to produce success in trading. It was not built to deal with uncertainty. Instead, it was built to deal with the certainty of survival in the short term. For the vast majority of traders with a typical emotional architecture, this new adaptation has to be learned. Traditionally in trading continuous exposure to uncertainty and risk has been the method used to force the brain to re-adapt its established patterning (this is known as exposure therapy in psychology).


As appealing to logic as this method is, it has not proven to be an effective way of forcing the brain to change survival strategies that have long been translated into traits passed along through history. Mostly, exposure based solutions re-traumatize the trader so that he or she becomes even more emotionally reactive to uncertainty and the lack of control over outcome that is a given in risk management.

In trading, to be effective, you have to cool the reactive primal emotional circuitry so that you can think in the long term – probabilities. This is not what the brain evolved to do. But if you need your brain to shift from the survival instinct of self-preservation (survival success) in the short term to probability management for success in the long term, you will need to harness the

neuro-plasticity inherent to the brain and consciously adapt it to the new standard.


Much like there are therapies for stroke rehabilitation based on the neuroplasticity of the brain, where they re-train and re-route functions of the brain to accommodate injured areas, so too can the brain be retrained to experience uncertainty and fear of the unknown very differently than the primitive circuitry of the fight/flight response of the emotional brain.

To do this, you will need to train your brain’s response to uncertainty. To the emotional brain, uncertainty is a bad thing when it comes to threats

(and as long as you risk capital, your brain will be view uncertainty

as a dangerous occurrence in your environment). Currently your brain

is organized to view uncertainty this way:

UNCERTAINTY > VULNERABILITY > THREAT > FEAR/ANGER

This is the survival instinct response that traders experience every day.

Notice that psychology does not kick in until the emotion is already coursing

in your body and brain as chemistry. Logical thinking is hijacked before it even gets started. The moment that uncertainty rears its head when capital is put at risk, it is wired to interpret that experience as a threat to self-preservation (vulnerability). The felt experience of vulnerability triggers your sense of powerlessness so it is interpreted as a threat to biological life, rather than just psychological discomfort. From here, the rational brain/mind is automatically hijacked and the brain pushes you into fight/flight with its goal of short-term survival.

This is where you experience fear of loss, fear of entry, fear of pulling the trigger, self-sabotage, revenge trading, over trading, and the like. Psychology showed up late for the game and was overwhelmed by primitive emotional response to perceived threats from uncertainty.


Harnessing Neuroplasticity for Probability Management

It is a specific circuit that has to be re-programmed to start the change process. When sensorial data comes to the emotional brain, it is first evaluated by the hippocampus. Based on memory stored there, a decision is made to route the information to the thinking brain so that logic and reason can be applied to managing uncertainty and risk (desired outcome). This is called the high road.


It takes more time for this circuit route to come to conclusions that can be acted on, but this is where probability management (and not life and death decisions) occurs.

But, if the hippocampus decides that the matter is too threatening to sit around waiting for a reasoned response, a decision is made and the sensorial information is routed to the amygdala, where fight/flight responses govern emotional and behavioural responses toward the environment (the way you react to the anticipation of trades going against you or the reality of a trade going against you). Here the amygdala hijacks the thinking brain and the trading mind is toast.

The needed key skill here is to regulate the emotional sensitivity so that the hippocampus doesn’t over react and hijack the rational mind from being part

of decision making. Using diaphragmatic breathing and muscle relaxation

to interrupt the genesis pattern of an emotion is a highly effective method for emotional state management. Because emotions are biological, they also have a signature that includes breathing style and muscular tension. These aspects of the emotion are necessary for the emotion to grow to the point of overwhelming the rational mind. When the emotion is confronted by a change in breathing style and muscle tension, the emotions of fear and anger cannot maintain themselves. You are literally cutting off their fuel.

Once you have competence in managing the physiology of the emotion, the belief system behind the emotion can be examined through applied mindfulness. Ultimately this is about a learned belief that leads you to fear uncertainty or to embrace uncertainty. This is the work of trader psychology.


Talking about trader psychology may stir intellectual debate, but the real work of trader psychology is about re-working the beliefs are you projecting onto the markets about your capacity to manage uncertainty (with your trading account as the arbiter). Simply being knowledgeable is never enough. It is the hard, but satisfying, work of examining the beliefs that drive your performances in trading that matter. Biologically, you inherited beliefs that you must be in control (either by sheer will – a winning attitude, or not losing by being perfect) that are impossible to maintain with the feedback loop of your trading account.


Psychologically, you learned about being a winner as part of your self-image, where performance and being became fused together.

Again, holding up the self-image of needing to prove yourself a winner in the face of taking losses as part of the business of trading – is an impossible task. Your notion of winning and being a winner are the fundamental beliefs that have to be adapted for success in trading. When this happens, you are freed from the instinctual survival drive in the short term and the need to prove yourself as a winner. You have no control over whether you will win or lose – but you have enormous influence over the beliefs that drive the performance of your trading process. This is the new “Winning Nature” that bridges the gap between controlling outcome (which is impossible) and controlling your process (which you can do repeatedly).



Five Important Trading Psychology Books

In order to learn about the optimal trading psychology and mindset, many novice traders choose to read some of the seminal literature on the subject. The following books comprise a short list of five such books that many experienced traders would recommend to a beginner interested in the subject of trading psychology.


  • Reminiscences of a Stock Operator by Edwin Lefèvre

This very popular book tells the fascinating story of Jesse Livermore’s equity trading career that spanned the early part of the 20th century. Still very relevant to traders in the modern era, this book perfectly illustrates the fact that the mass psychology that drives markets — and the individual psychology that traders face each day — really do not change much. Many traders were given a copy of this book to read when they first started out in training programs at professional trading firms and I highly recommend it to others interested in the topic.


  • Trading In The Zone by Mark Douglas

In this book, Mark Douglas encourages traders to take on a probabilistic approach to trading and to form a powerful “winner’s mind set” as the keys to obtaining the best results while trading. He provides his readers with concrete steps and ideas for changing a trader’s fear of losing money into achieving ultimate success as a trader. Although Mark had no formal psychological training, he wrote this book on trading psychology from his own personal experience operating in the markets. This is arguably the best book ever written on Trading Psychology, certainly one that has had a profound effect on me.


  • Super Trader: Make Consistent Profits in Good and Bad Markets by Dr. Van K. Tharp

Dr. Tharp has an extensive theoretical and practical understanding of what sort of personality traits make traders successful. This book expands on his insightful personality testing results to offer an overall approach for how people drawn to trading as a full-time profession can become successful financial markets traders.


  • Market Wizards: Interviews with Top Traders by Jack Schwager

This well-known and classic book provides the reader with a fascinating series of interviews by some of the world’s top traders. Each of these experts provide valuable insights, trading tips and information that most traders will find illuminating. The book also contains some excellent quotes from great traders throughout history, many of whom managed to move beyond their losses and ultimately generate great wealth from trading the markets.


  • Trading in the Zone: Maximizing Performance with Focus and Discipline by Ari Kiev

In this book, Dr. Kiev describes a set of proven ways to get into and then remain in the “Zone”, which describes an optimal trading state for success. Dr. Kiev offers various beneficial psychological tools that traders can use to benefit and enhance their trading skills no matter what sort of trading style they prefer to employ. This book seems especially useful for those who feel they need help reviewing, managing and optimizing their emotional responses when trading.


It also contains an interesting set of trader case studies that explain how they deal with their emotions while trading and which provide useful insights into how to go about developing an optimal trading psychology and mind set.


Speculation Psychology and The Optimal Trading Mindset

The psychology and emotional discipline of the successful market speculator has been the subject of many interesting books, such as those listed above. Although not all experts agree, the research that has been done on this topic tends to point to a number of beneficial psychological factors and behaviours that people need to engage in to stand the best chance of success as a trader.


These can be summarized as follows:


  • Avoid trying to beat the market. Instead try to be sensitive to its direction and align yourself with it.

  • Learn to put fear and greed in the right place. Feel fear when you are losing money so that you cut losses short and greed when you are making money so that you let profits run.

  • Avoid getting over confident and taking excessive trading risks.

  • Avoid letting losses destroy your confidence and ruin your day, and start to see taking losses as a simple cost of doing business as a Forex trader.

  • Keep a positive mind set.

  • Focus on maintaining trading discipline and good money management practices.

  • Stick to your trading plan no matter what the market does. Refine your plan if necessary, but only do so once your trading positions are closed to avoid having them influence your plan.


The basic idea here is to look at your market speculation activities as a business. Certainly, you will win on some trades, and you will lose on some trades, so see that as part of the process of trading. Overall, you should always seek to manage your business and your trading funds so that you will be able to remain in the game long term.


Why Traders Lose Their Discipline

When traders lose money, they often attribute the problem to a lapse of discipline. Such a lack of consistency, however, is actually the result of many different problems--not the cause. Traders lose discipline with trading for the same reasons that dieters lose discipline with dieting or people getting in shape lose discipline with exercise. Quite simply, our moods, needs, and mind states of the moment tend to overwhelm our longer-range intentions. We pursue short-term pleasures (and avoid short-term discomfort) at the expense of longer-term rewards.


Here are some common reasons why traders (and most other human beings!) fall short of being fully intentional:


  • Environmental distractions and boredom cause a lack of focus - All of us have limits to our attention span and these are easily taxed during quiet times in the market;

  • Fatigue and mental overload create a loss of concentration - The demands of watching the screen hour after hour make it difficult to be sharp, creating fatigue effects that are well-known to pilots, car drivers, and soldiers;

  • Overconfidence follows a string of successes - It is common for traders to attribute success to skill and failure to situational, external factors. As a result, a string of even random wins can lead traders to become overconfident and veer from trading plans--especially by trading too frequently and/or trading excessive size;

  • Unwillingness to accept losses - This leads traders to alter their trade plans after trades have gone into the red, turning what were meant to be short-term trades into longer-term holds and transforming trades with small size into large trades by adding to losers;

  • Loss of confidence in one's trading plan/strategy because it has not been adequately tested and battle-tested - It is difficult to tolerate even normal drawdowns unless you have confidence in your methods. This confidence does not come from mere positive self-talk. Rather, it is a function of testing your methods (historically and in real-time) and seeing in your own experience that they truly work;

  • Personality traits that lead to impulsivity and low frustration tolerance in stressful situations - Psychological research suggests that some individuals are more impulsive than others and less conscientious about adhering to plans and intentions. These personality traits often are accompanied by stimulation-seeking and a high degree of risk tolerance: a deadly combination.

  • Situational performance pressures - These include trading slumps and increased personal expenses that change how traders trade and lead them to place P/L ahead of making good trades. By worrying too much about how much money they make, traders can no longer follow markets with a clear head;

  • Trading positions that are excessive for the account size - This is much more common than is usually acknowledged. It creates exaggerated P/L swings and emotional reactions that interfere with cool, calm planful behavior;

  • Not having a clearly defined trading plan/strategy in the first place - Interestingly, many traders do not consider themselves to be discretionary traders, but in fact do not have a firm, explicit set of trading rules that they follow. It is difficult to be consistent with a plan (and to evaluate your consistency), if you don't have the plan clearly laid out;

  • Trading a time frame, style, or market that does not match your talents, skills, risk tolerance, and personality - All too often, traders veer from their plans because those plans are ones that they feel they *should* follow, but that don't truly come naturally to them. These departures from discipline are actually unconscious attempts to trade in a style that is more in tune with the trader's skills and talents.


As you can see, not all discipline problems have their origins in the trader's psychology. Many times, the loss of discipline reflects problems with trading itself. Discipline in trading is not so different from "discipline" in a romantic relationship: if you're doing the right things, there's little need or desire to stray. But if your trading is not meeting your needs, it's all too easy to break your trading vows!


Mass Psychology and Its Measures

Many traders use measures of mass market psychology to influence their trading decisions as part of their trade plan. Most chart patterns used by technical analysts are considered reflections of some aspect of mass psychology that tends to repeat itself.


Some technical traders also use Elliott Wave Theory, which takes into account the psychology of the market as its trending movements typically unfold in five successive waves, followed by a counter-trend correction that usually unfolds in three waves.


Another popular measure of mass psychology in the financial market is the Commitment of Traders or COT report that is published each Friday for the preceding Tuesday’s contracts by the U.S. Commodities Futures Trading Commission or CFTC. The results of this weekly report inform traders regarding the net amount of outstanding positions in each contract where twenty or more traders hold positions near the CFTC’s reporting limits, and which are broken down by several category of trader, including Commercial and Non-Commercial traders.


Commercial traders are those who are generally hedging their exposures that arise in the course of doing business. In contrast, Non-Commercial traders are typically speculating in the futures market. They consist of financial institutions, individual traders and hedge funds.


This leads to the calm, patient mind need for successful trading.


Trading psychology is much easier when we have a genuine "why" underlying our actions. Too many people are pursuing trading because they can't figure out another way to work independently and make enough money to support themselves. This is understandable, but invariably ends badly. People setting themselves up as gurus are all too willing to exploit the desire to make a living from trading. A great question to ask about any idea advanced by a guru is, "Why?" If you--and they--can't really explain why an idea works, how do you know you actually have an edge and not just another pattern fit to market data?

Trading success is the end result of developing the proper trading habits, and habits are the end result of having the proper trading psychology.


Trade well,

Dom