Great Expectations – Part 3 of 4

Great Expectations . . . Part 3 – Mind Over Money

“You are your own worst enemy. If you can learn to stop expecting impossible perfection, in yourself and others, you may find the happiness that has always eluded you.” Lisa Kleypas

The biggest challenge trader’s face, aside from inexperience, is their own psychology when entering the market. Having a trading plan with a clear set of rules is a necessity – on that we can all agree. But why is it we have such difficulty following the simple directions outlined in our rule set? We need certainty. It is how we approach the world every day. We have routines, habits and idiosyncrasies that dictate our behavior based on anticipated outcomes. We have difficulty accepting that something may be out of our control or fall outside our expectations. This is fear. We spend our lives avoiding fear, so we gravitate to those behaviors that alleviate fear. By nature we are risk averse. Trading flies in the face of all we have been conditioned to accept. There is no certainty in the market, so applying your expectations to the market creates fear in that you cannot control the outcome. You see the potential gain by virtue of profits, but fear overwhelms. Why? We have limited our abilities by our own beliefs.

The trading mindset accepts the risk and uncertainty of the market. If we show statistically that our trading system overtime will produce a profit or has a positive expectancy, we can use this data to suppress the fear of a loss. This is no different than any other business. Any prudent business person studies his market to determine potential profit opportunities. He realizes that there is risk in that not every opportunity may reach its full potential – some will, some will break even and some will lose. He still accepts the risk because his training, expertise and tools will provide an advantage or “edge.” Trading is no different. Some trades will reach their intended targets, some partial, some breakeven and some will lose. The trading mindset applies the trader’s edge based on experience and a sound trading plan just like the business man. Without experience and a sound plan, there is no edge. In the uncertainty of the market, an edge is the best we can achieve; there is no perfection, so having the expectation of certainty is unrealistic. This is the greatest psychological challenge we must learn to accept; that even if we do everything “right,” we still have the potential for a losing trade.

I mentioned in Part 2 that even though I had done back testing and applied the rules of a system, I was still struggling emotionally. What I came to realize was that the system did not fit my psychological profile. It was a scalping system based on an 8 pair portfolio on the 5 minute time frame. The system was introduced to me by a friend who did not reveal that he was losing money as well. I finally confessed to him that my back testing showed it was profitable, but I was overwhelmed by the amount of indicators and the speed at which I was receiving signals. I decide to test the system on a higher time frame. I removed the indicators that were providing redundant information, and reduce the portfolio to 4 pair. In my training class, I was shown the importance of trade plan development – how all of the elements of a trade plan should be customized to fit my individual trading profile. This was a game changer. After some practice, I could comfortably look at any trading system, back test it based on the time frames and markets I trade, and apply the indicators I could use effectively. I had to honestly analyze why I did anything and build an objective case whether to keep it or change it as it related to my plan and my psychology. I began to trust myself. I began to believe and use logic and rationality instead of supposition and opinion.

Before placing live money at risk, I would demo trade the system for 30 days to make sure I was prepared to act when I received a signal and manipulate my trading platform efficiently. Most importantly, I would react calmly, without hesitating, because I believed the system (based on stats) would apply my proven edge. My trading time frame allowed me to check my rules when I received a signal without being rushed, so I was no longer anxious or nervous. This trade plan development training became the foundation for me to decide independently how I would trade, what I would trade, and which rules I would apply for back testing and entering the market. I was actually learning the skill of trading. I was no longer dependent on other traders or marketers for input. It was finally happening. I began to trade live with mini lots and gradually increased my lot size as my trade execution became confident and consistent.

The next challenge going full time was to determine my individual tolerance for risk. Based on my back testing at that time, I determined that a stop of around 50 pips would give me the best win/loss ratio for my trading time frame. The question I had to ask and honestly answer was when eventually trading full lots, was I willing to lose $500 to gain $1,000 (At that time, my plan called for a minimum 1:2 risk/reward). I had to put this in perspective. As a business person, I had invested tens of thousands of dollars in new business ventures, some of which were very successful; others did not perform as well. None of these opportunities had the long term upside potential of the currency markets nor did they have the seemingly infinite amount of opportunities. The amount seemed reasonable from that perspective. Based on the size of my account and back testing stats, I determined the risk per trade against the winning performance of my trade plan and became comfortable with the risk. This risk acceptance became one of the most critical elements in removing the emotional investment in each trade. I became consistently profitable once my trading mindset became one of total belief and acceptance; belief in my trade plan and rules of engagement, and acceptance of the responsibility for my actions and the risk of each trade.

After first becoming aware of my trading psychology, I initially underestimated its importance. I finally stopped being my own worst enemy and began to trust. The transformation came to fruition when only I realized I had to work on me and that no system or plan could hide the fact that I was afraid. The fear of being wrong and the fear of losing were crippling my progress. It soon became evident to me that conquering this fear is the single most critical part of any successful trading plan execution. Without it, I had a shallow definition of success as a trader. Now having mastered it, I developed a positive, winning attitude. I began to thoroughly enjoy trading. I became obsessed with the markets and looked forward everyday to looking at my charts and getting a new trade signal. I am believer, not because of “faith,” but because of empirical data I had to work to gather from back testing. In this data is the proof that if I see this, then I do that. I am not guessing, hoping, wishing or really even doing much thinking. I am not lethargic, I’m prepared. I am not reacting, but attacking.

I now expect to win, but I completely accept losses and do not waste a minute dwelling, whining or thinking about them. I am sure I will never know it all, but I know enough and have the ability to look at any market with total confidence and resolve. That is solely the result of doing the back testing work and acquiring the belief in my trade plan and system.

Had I known all of this at the outset, I could have honestly taken years off of my learning curve. I still would have had challenges, but having the tools and methodology sooner would have made all the difference.
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In Great Expectations Part 4, I will discuss how goal setting creates performance expectations from which you can measure your progress.

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