Trading Psychology: What It Takes to Succeed (>90% Fail)
My background:
I have been trading for over five years, full-time trading for almost two years, and have experienced significant gains (35,000%+) and losses (90–100%) throughout my time as a trader. Of course, these numbers may not mean much as I could have made a $1 trade for a 35,000% gain and a half total portfolio trade for a 100% loss. So, without getting into specific numbers, I will summarize my performance as significantly outperforming the broader markets over the past 3.5 years on a consistent basis. This contrasts with the overwhelming majority of traders who consistently lose money when trading.
This article aims to provide new and inspiring traders with insight into the psychological obstacles they will inevitably face. The main ideas I will detail include: the incredible level of mental stress, the importance of emotional management, and how to utilize position sizing to learn about each of the two in your trading journey.
Let’s first start with the mental stress involved.
Mental Stress
High stress, emotional turmoil, fatigue, and mood volatility.
While many people are exposed to these emotions within their respective careers, they are felt to a particularly high degree in the world of trading.
To say trading, especially with large capital, is highly stressful is an understatement. A better adjective is needed that will adequately portray what trading entails. Contrary to what many influencers who sell you their crash courses on successful trading lead you to believe, the truth is that not everybody has the personality to be a trader. The many are called, but few are chosen adage applies here. Many wish to be traders but cannot cope with the high-stakes nature of trading. Finance and trading gurus have the incentive to add misdirection and mislead newcomers from this fact because the people who often make the most money are not the gold miners but those who sell the pickaxes. Anyway, when it comes to personalities fit for trading, nobody says it better than Tom Costello in his hedge fund entry guide “The Front Office”:
“I’m convinced that unless you have a natural predilection for managing a high stress occupation, like a test pilot or someone working in ordinance disposal, even if you have all the other relevant pieces, you’re not going to succeed at trading” (pg 138).
One bad trade can wipe out a year’s worth of full-time salary or even a decade’s worth if you work for a firm or have the capital to do so. Trading, therefore, requires caution and precision in decision-making to avert a financial miscarriage. Removing intrinsic emotional influence as a trader is essential. To do so takes practice, exposure to a wide variety of experiences, and unrelenting perseverance. A good trader can manage their portfolio with an understanding of their emotions, formulate an array of potential entries and exits based on thorough analysis of varying scenarios, and finally execute their projected plan accordingly, all while under immense pressure.
This is not to deter you from trading but to implore you to ask yourself: “Is this path a good fit for me?” If it isn’t, perhaps investing for the long term, in a less active and risky way, would be a better approach for you. Just as traders have different strategies based on their risk tolerances, people do as well when it comes to making money with money. So it is wise to look before you leap.
So, where and how would I begin if the risk and responsibilities of trading have not deterred me?
Emotional Management
There is no shortcut for this part, so read carefully.
Trading requires considerable mental fortitude. Only through dedicated experience does a trader learn of the perseverance needed to survive and outperform others. It begins with self-awareness. Traders must be able to be honest with themselves no matter the situation. They must find the answers to difficult emotional questions from an honest and analytical point of view:
- What information did I overlook to suffer this loss?
- Where else did the trade go wrong? Why did I exit my position when I did? Did I exit based on my emotions or my analysis?
- Why did I continue to push my target exit price higher? Why did I make such a greedy decision? This ultimately led me to hold the position for too long, so it became a considerable loss instead of making a sizeable gain.
- How can I improve for next time? How will I implement these improvements?
- How much of this trade was even in my control? How could I have positioned better to hedge for this scenario?
Only after practicing this exercise can the skills later be utilized in managing one’s emotions. Finding the answers to those questions is step one. Observing and understanding these emotions while these events are unfolding is equally challenging. Keep in mind that this is not a one-time effort, but a constant exercise of self-discovery after new scenarios and experiences present themselves. This can come in the form of a new asset class with different risks or a change in our strategies based on the available trading capital over time. Ultimately, this evolves into the ability to take emotions out of money and trading, irrespective of the size. There are no consistently successful traders who lack these fundamentals. They are prerequisites to successful trading.
To gain real experience and learn, you will have to lose some money first. This is an inevitable prerequisite as well. You will need to observe and understand how you react under pressure and then learn from that. Paper trading does not work. Paper trading is offered by many exchanges and in business classes as a simulation where you trade with fake money for fake returns. No matter how great or terrible you are as a paper trader, those experiences will not reflect the decisions you would make when trading your or your company’s actual money. The harsh reality is that you will lose money for a while. This may take a few months or a few years. For my first one-and-a-half years in trading, I constantly incurred losses and made poor decisions. The learning curve is steep. In my eyes, it is better to think of it as the cost of learning.
Emotional management and exceptional self-awareness are the backbones of every successful trader. Our trading strategies are unique because they derive from our own risk tolerances. Some people can trade with all of their money as they bear no other responsibilities, while others may have a debt to pay or other dependents and opt for a smaller trading portfolio. Observing how you function, how much money you are willing to risk, and how that affects your potential return is essential to eventually form a strategy that works for you.
Size
The easiest way to reach this understanding is by observing how you react based on the size of your trades. For example, if you risk 50% of your portfolio for a trade, how much risk are you willing to take on to get to your target return? For example, let’s say that 50% of your portfolio trading the S&P500 would have netted you maybe a +/- 5% every week in 2022. If you wanted more risk, perhaps you would trade Bitcoin moving at a net +/- 10% every week in 2022. For each trade you take, how much are you willing to risk and therefore seek as a return? Unfortunately, there is no reality where you can take on the risk of the S&P500 in a trade and expect the rewards of the same capital in Bitcoin.
The size of your position is everything, and knowing how to position based on your reaction to that size is a skill that takes time to understand and build upon. To reiterate, this can take a long time and a reasonable sum of money before you find a strategy that allows you to think analytically, manage your emotions under many scenarios, and trade successfully. Trial and error and feeling burned or disappointed are experiences all traders face and learn from. The difference between bad and good traders is how they learn from their mistakes and handle pressure. Learning from one’s mistakes is integral to successful trading. It speaks volumes about the rationality and integrity of a trader.
Personal Goals
One method of learning about how you should size your trades is understanding your personal goal when it comes to trading. Let’s pretend that you think your trading hobby or side hustle is reduced to an equation.
(The risk you are willing to take) x (the money you are willing to trade) = your unique financial goal
For example, perhaps you aim to reach a point where you can trade full-time and travel the world. I would say this is a fairly common goal for young traders, so let’s use that as an example with this equation.
You always start with your goal: traveling the world and trading full-time.
The first step is to analyze and break down your goal into bite-sized pieces. Although this will take some time and research, it is highly recommended as it helps you ascertain that the goal is achievable. Let’s say traveling the world means working remotely whenever and wherever. You would need to find rough estimates for what living costs look like to rent an Airbnb or hotel year-round in the places that are attractive to you. This would be in addition to the expected yearly salary from trade full-time.
The point of a salary would primarily be to build your trading capital but also save towards a big purchase or to allocate money towards other revenue streams. First, we would need to figure out what your five-year plan is. Let’s say you want to buy a house in five years and save a portion of your income toward that. What would the estimate be for that house? How flexible is that estimate? The list can go on and on, but narrowing it down to big purchases and lifestyle choices can help form an idea of what a yearly target might be to be a full-time trader.
The main reason why finding this goal is so crucial is that without a vision in mind, it is easy for your trading strategy and risk profile to be adversely affected as a result. Most commonly, you may be greedy and take too many high-risk trades because you don’t know what you are working towards. This could result in losses because a defined profit-taking strategy may be ignored. After all, all traders can agree that they want to make as much money as possible. This is a mindset to stay away from because chasing gains will lead to poor entries and exits and a fundamental lack of structure and strategy.
Only after you find your unique financial goal can you work backward to determine your risk appetite. Also, the higher the trading capital you have, the lower the risk you need to take. For example, if you have a million dollars, you would only need to make 10% a year to make $100,000 a year, which has a much more flexible range of assets to trade from. Conversely, if you have 10,000 dollars, you would need to take a significant risk to make $100,000 a year.
To summarize the sizing of your positioning: find and assess your goals and available trading capital to clarify the appropriate risk and sizing of your trades. Remember to remain reasonable, as taking on too much risk (like options traders on Wallstreet bets) will often lead to significant losses. A common proven strategy is slowly building through profitable trades instead of one all-in on a moonshot meme coin. The latter is a quick way to get burned. Remember: In trading, it pays to be cautious and rational.
Thank you for reading!
