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Why is Day Trading Futures Not Simple? Part III

Trading Psychology

Psychology. As an academic pursuit, futures trading can seem relatively easy, as discussed in Part I of this series, learning how to predict a move from A to B based on a pattern can be replicated and more consistently spotted. But, learning how to trade that A to B move is changed completely when money is put into the equation – your mind set changes from: “I think this will happen, I’ve seen it numerous times, let’s see” to “this needs to happen, I don’t want to lose, maybe this wont work, maybe I should take the profit now.” The difference is feedback: when money is on the line, the result, particularly if a loss, is more easily internalised and remembered. Whereas when it is academic feedback is less and so the result of the ‘trade’ is only remembered when it achieves its target. This is an example of availability heuristic – significant results, in terms of their impact on you, are more easily recalled and the average result is not, therefore the perceived value of a trade is skewed. Everyone remembers the one time a trade went suddenly wrong but find it hard to recall the numerous trades that wen to target.

Why do Trading Losses Matter More?

According to research that underpins Prospect Theory (Kahneman & Tversky) losses are felt twice as much as gains – this explains why they are more easily recalled and also why traders seek to mitigate loss before looking for profit. But why is this the case? Evolution. Humans have evolved to avoid dangerous situations – your natural instinct to prepare to fight, flea or freeze at the first sign of danger (a bush rustling) has been extremely helpful in not getting eaten by a tiger. But, when put into a trading situation, this instinct causes the same reaction to potential loss of money – a desire to get out of the situation. So, even when onside on a trade, the fear of losing can overwhelm the pre-planned assessment and likelihood of a trade working and cause snatching of profit (fleaing). More dangerously, when offside, the immediacy of a potential loss causes a fight instinct that can result in averaging and greater loss.

3 Ways to Manage Trading Psychology

  1. Consider Trades in terms of ticks rather than P+L by doing this the link between price movement and loss is broken. If a trade is expected move 20 ticks to target and after 10, it pulls back 5 ticks before going to target this is much easier to handle. Instead, attaching a monetary value and thinking “I was $1000 up and now I’m only $500” brings in fear that you could have ‘lost’ and could lose more so should get out of the situation. This is particularly important when increasing size – a trade in ticks is exactly the same in its movement whether trading a 1 lot, 10 lot or 100 lot.
  2. Categorise your trades. Being able to compared like-for-like trades not only creates a better understanding of the trade itself, but perhaps, more importantly, gives you the opportunity to objectively look at how the trade performs over time. Accept that trades will never have a 100% success rate so taking a loss is inevitable, not something to be feared. Whereas exiting a trade early can damage the overall performance by reducing average profit on winning trades
  3. Debrief your trade not just from a technical point of view but from a psychological perspective too. The aim here is to recognise common traits and situations that allow you to be influenced by subjectivity instead of your plan. If, for example, when onside, your desire to snatch profit often gets you out of a trade, then a trigger can be created: as soon as that felling is felt it should trigger a planned response to review the plan of the trade. This can be reinforced by writing down the trade plan and category before hand so the potential psychological pitfalls are recongised and accepting before entering.

Learning about what impacts your trading psychology, is just as important as learning to trade different strategies – every mistake or success has both a technical and psychological cause. Remember losing money is not the same as being eaten by a tiger.

Richard

Learn More About Trading Futures

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Written by Richard Bailey

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