Wednesday, September 19, 2007

Trading Psychology

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Have you ever wondered, as I have, what makes this kind of difference in people`s trading? It is not always a native intelligence, talent or dedication. It is not that one person wants success and the other does not.

The difference lies within your psychology. Your psychological mindset is likely to play a larger role in your trading career than your chosen technique or any other details associated with your day-to-day practice.

Now, I am not the only one to discover this... In his book, Trade Your Way to Financial Freedom,

the renowned American psychologist Dr. Van Tharp discusses the role psychology plays in your trading success. He divides trading into three "Ingredients of Trading." In his pie chart, System is 10%, Money Management is 30%, and psychology is 60%. He discovered that the trader`s psychology has more to do with his success than anything else does.

What exactly is your psychology?

In short, your psychology refers to your emotional responses to a given situation... In trading, fear, greed, vanity, pride, hope, jealousy, and denial can all affect investment decisions. Although your aim in the market is to maximize your profit and minimize your risk, emotions often make this easier said than done.

For example, traders who react emotionally make the wrong decisions, such as the common mistake of holding a losing position in the belief that someday it will become a winner.

This classic mistake is called loss aversion. Loss aversion refers to the tendency for people strongly to prefer avoiding losses than acquiring gains. Some studies suggest that losses are as much as twice as psychologically powerful as than gains. Loss aversion compels most traders to hold a losing stock while it plummets downward. This clouded judgment clearly contradicts the trading adage "cut your losses."

These investors also engage in other forms of irrational behavior, like attributing success to skill and losses to bad luck. Worst of all, this is just the tip of the iceberg when talking about the other devastating effects of trading using your emotions.

The truth of the matter is, without controlling your emotions, most new traders lose all their money very quickly in the markets. In fact, most are completely wiped out within the first year of trading. So, as you can see, your emotions do play a big part in determining whether you fail or succeed...

Wednesday, September 12, 2007

Creating and Managing a Trading Journal

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I saw this article from Toni Hansen's Online Trading Blog.

It is about Creating and Managing a Trading Journal, below are a few points that I think I can use it for my journal here and be able to improve on.

  • It is a great deal more constructive to use charts in your trading journal.On the top of the chart in the corner I write what the pattern I traded was. I also write the symbol, sector, entry time, price, exit time, price and gain or loss there.
  • Then on one side of the chart I write my pros and on the other I write my cons. On the chart itself I mark all relevant info: support and resistance, trend lines, volume, etc. so that when I look back at my chart, I automatically focus in on the main points that helped me decide to take the trade. Then, under my chart on one side I write the things that I did correctly and on the other I write down things I could have improved upon. I then organize my journal according to patterns.

  • At the front of each section I then have a list of pros for that pattern and cons for that pattern which builds on itself as I learn. I also have a sheet that lists things I constantly do correctly on that pattern and my most common mistakes. Organization is essential. Your journal must be something you can actually learn from. If you want, you can add equity curves. These can help you narrow down times of the day or week where you trade better and even times of the year. On an equity curve I'd suggest marking significant life events as well.

  • One review method that works really well following a trade is to cover up the outcome and walk through it bar by bar as it develops to help cement that progression into my mind. It allows me to focus more clearly on the key points as a pattern develops that I might not have seen initially. That way I can recognize it more quickly the next time you see the same action forming.

After reading Toni's article, I'm happy that I do practice keeping this journal and it is easier to discover a trading pattern. By just a click I can see what I've done right or wrong for the same strategy in the past. I really love blogging, it is very organize and systematic.

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