Innerworth featured articles

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James is considering whether to implement one of two trading strategies. Both strategies offer good odds of success, but James doesn't want to make a rash decision. He wants to carefully consider both the upside and downside before he commits. James is in a deliberative state of mind; he's trying to consider all alternatives in a logical, impartial, and comprehensive manner. Great thinkers, such as Benjamin Franklin advocated prudent decision-making in which the pros and cons are carefully compared. Similarly, contemporary decision researchers suggest that people can avoid making common decision-making biases through evenhanded consideration of all possible alternatives.


Research has shown, for example, that cultivating such a deliberative mindset helps one be receptive to incoming information and decrease the influence of self-serving decision-making biases. However, a recent study by psychologists Dr. David Armor and Dr. Shelly Taylor suggests that deliberating between two alternatives may not always be beneficial. In some cases, it may be wise to just quickly choose an alternative and focus all one's energy on achieving an objective; in other words, just do it.

In a well-controlled experiment, participants were randomly assigned to one of two conditions. In the deliberative condition, participants were asked to decide between two equally effective strategies to obtain a reward, before using one of the strategies to reach an objective. In a second condition, participants were not given a choice, so they would immediately focus all their energy on using a single strategy to achieve the desired goal. There were clear advantages to focusing on a specific strategy, rather than deciding between two options. Participants who did not deliberate showed greater determination, commitment, curiosity, and confidence than those who did. They also viewed the task as less difficult and performed better.

Trading often requires making a quick decision, but no one wants to make an uninformed or impulsive decision. Prudent decision-making is the hallmark of success. Drs. Armor and Taylor suggest, however, that there are some situations where a great deal of deliberation is actually an impediment. Some trading decisions may be such situations. Your psychological energy is limited and spending too much time and energy may exhaust your limited psychological resources and hamper performance. So sometimes it's useful to stop deliberating, and just do it. Just implement the trading strategy and focus on the outcome. You may find that you'll achieve greater profitability in the end.

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Stan and John have been following a stock and trying to anticipate the pivot point. Stan declares, "After looking at the troughs and moving averages over the past 30 periods, the facts indicate that the pivot will be exactly at 50. I'm positive; it must be right at 50." John replies, "Exactly 50? Maybe around 50, but I wouldn't be that precise." These two traders have very different personality styles when looking at information and drawing conclusions. Stan wants to just focus on objective facts. He is a "tough minded" decision maker. John, in contrast, is more intuitive. He sees so-called "facts" as merely subjective interpretations. Like many seasoned traders, John relies on an abstract feeling he has for the markets and trusts his intuition. He's an intuitive trader.

How do you observe the world and gather information about it? Do you just want the facts and the specific details and none of that "touchy-feely" stuff? Or are you more intuitive? You don't believe in facts. You think reality is subjective, merely an artificial construction that differs from person to person. You prefer to think in theoretical and abstract terms. Perhaps you are a little of both. Philosophers, such as William James and Carl Jung, have relished demarcating various "types" of people. "Types" are ideals that don't really exist in a pure form. They are merely loose categories we use to make sense of the world. They reduce information overload, but often distort. Despite the inaccuracy of placing people in categories, it does often seem that some people fit more into one "type" than another. Take, for example, what James called the "Rational" versus the "Empiricist," or what Jung called the "Intuitive" versus the "Sensor." Sensor types prefer cold hard facts and see the world as rational, predictable, and orderly. Intuitive types are more fanciful, and see the world as random, theoretical, and conceptual. This typology may also apply to the way people approach trading. Which type of trader are you?

A trader who is a sensor, for example, may want to know the specific price level where resistance begins. He or she would prefer to follow a specific set of rules to identify precisely where resistance begins. An intuitive trader, in contrast, merely views the "rules" to identify resistance as just guidelines, which may work sometimes but not always. For example, perhaps resistance will be a round number or a previous peak or trough, perhaps it will not. No one knows for sure; such guidelines are just possibilities, not hard and fast rules. Sensors look at market concepts literally, believing they are true-life entities, rather than just abstract concepts. An intuitive trader looks at the markets in a figurative sense. All signals and indicators are subjective in the end, may be a little inaccurate, and are a mere approximation of reality. There's a good chance they will be wrong and that's all right.

When it comes to the markets, it's generally advantageous to be an intuitive trader. Reading the charts and getting a feel for the markets is subjective. Trading decisions are merely based on educated guesses. It isn't exact, but mushy, random, unpredictable, and conceptual. It's not linear, matter of fact, and predictable. Expert traders and trading coaches have long noted that sensors have difficulty learning to trade. They want to find all the specific facts and unfailing rules that can be used to forecast the markets. They tend to think that if the "right" set of signals can be discovered, they can make big profits. It would be nice if it were that simple, and if it were, there would be a bunch of smart people with Ph.D.s in economics and other fields who would be billionaires, but there aren't. Why? Because the markets are so complex and chaotic that it takes intuition, hunches, and a kind of creative and artful mastery to win consistently. The logical analysis of facts and figures can only go so far when you are trying to trade the markets, which have inaccurate figures and are largely inexact. So if you are a "natural" intuitive type, you've got a head start. And if you are a sensor, try to nurture your more intuitive side. Become an intuitive trader, and you'll see your profits grow.

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How much capital does one need to start trading? Every person who is new to trading asks this question. It's often the first question that pops up at trade shows and in trading-school classes. But is it the right question to ask? The answer may not be as obvious at it seems. Viewed from a conventional standpoint, one might think that all you need is the minimum amount required to open an account by your brokerage firm.

The regulators set minimums that vary according to whether one will be trading stocks, options, futures contracts or perhaps a combination of these vehicles, but in practice the various brokerage firms can, and frequently do, require customers to open accounts with a greater amount than the statutory minimum. It is important to realize, however, that merely meeting the account-size minimum does not necessarily put one in good stead to begin a trading career. A more important question should be asked up front: How much money do I need, not in my trading account, but in my bank account?

Of course, this is very different from asking how much one needs to merely start trading, and answering the question may require a degree of personal reflection that goes much deeper than calculating how much to put in a trading account. In fact, if trading the S&P E-mini contract, it is theoretically possible to make $300 to $500 or more in profits per day with just $7,500 in an account (currently the minimum to open an account for trading E-minis through Terra Nova Trading, for example). But does this mean that someone who can meet the minimum requirement is in excellent shape to trade? Not necessarily. Suppose a novice trader has $7,500 to open an account, but not a dime more to put into it if he or she should lose it all by trading poorly? Under such circumstances, the loss of such a sum – hardly impossible, even for someone employing conservative trading strategies -- could end that person’s trading career. Could one expect to trade well under such a threat? Probably not, since confidence is crucial to anyone who would seek success at trading, and few things undermine a trader’s confidence so thoroughly as a nagging fear of losing one’s stake. It's like trading with a gun to one’s head, and it metaphorically describes the trader who is barely able to cover monthly household and business expenses while honing his or her skills. It is a problem that has tripped up many a beginner, and it makes success far more difficult to achieve when steady profits are needed just to pay one’s bills. It's far better for the new trader to be financially secure from the start – secure enough so that an entire year spent without profit on the learning curve would not impact one’s lifestyle or threaten one’s financial security.

So we should not fool ourselves into believing that merely meeting minimum account-size requirements will suffice. In fact, if it costs you $80,000 per year on average to meet all household expenses, then you should have at least $80,000 in liquid savings to see you through your first year of trading. This, of course, is in addition to the sum you will use to fund your trading account. Having a sufficient sum in the bank to meet a year's worth of living expenses will provide a cushion against adversity, as well as a psychological bulwark against the ups and downs that are a normal part of every trader's learning experience.

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Alan Greenspan, in his opening remarks at the August 29, 2003 symposium sponsored by the Federal Reserve of Kansas City, said, “Uncertainty is not just an important feature of the monetary policy landscape; it is the defining characteristic.” He went on to say that macroeconomic models are vastly over simplified. Indeed, the economy is complex. There are so many forces and variables, known and unknown, that influence the economy, it's impossible to account for all of them.

The economy isn't the only complex system. Complex systems proliferate in nature. Ancient philosophers, such as Heraclites of Ephesus, made this observation long ago. All the elements of the world, such as time, fire, water, earth, and air are constantly in flux and figuratively, it is impossible to "step into the same river twice." Nature is constantly dividing and reuniting itself. And the market is no different. You will never enter a trade in the exact same river (market) you previously traded. It may look the same, but it will be different. The current will be faster or slower (volatility); it will be deeper or shallower (volume); the water will be clearer or muddier (visibility). There are thousands of variables, and almost none of them are comprehensible.

And what would you guess is the biggest variable of all—which you probably assume—is constant? As Pogo so aptly put it, “We have met the enemy and he is us!” Your personal psychology is also constantly in flux. You are happy one day and melancholy the next; you are continuously learning new things about the market and forgetting others; your confidence level twists and turns like the river’s path. When you left the house for your trading floor, did anything go wrong or especially right? What about the trip? How was the mood of your fellow traders when you arrived? How did your first trade go off? Did you have clarity the minute you began trading or did you struggle for it?

Everything is moving, whether we see it or can measure it. This insight is particularly important to system’s developers or traders using black box software. It helps explain why certain trading software programs work well for only a short time before they crash and burn. There are many other reasons for this phenomena but the ever-changing interplay among market forces is certainly a big part of it.

How can you deal with constant change? First, always be aware of it. Expect it. Accept it as normal. Second, protect your profits from the ravages of the unexpected. Risk management, such as protective stops, is vital. Constant vigilance can make a big difference; healthy skepticism can be a lifesaver. Third, become a full-time student of the particular market you trade. Develop a passion for trading and your primary trading entity. Work at becoming a Zen-trader, where you become one with the market and feel its moves as you would if you were swimming in the river. None of these approaches are easy, but neither is becoming a successful trader.

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Many members of the "established" investment community are quick to point out that investing is not gambling. To the general public, gambling has many negative connotations. When professional gambling is mentioned, most people immediately think of compulsive gamblers who seek out high levels of unpredictable risk and impulsively lose their paychecks, and money that is crucial to their basic survival. But gambling is not necessarily "bad" or "evil."

Indeed, professional traders are essentially professional gamblers. It's all a matter of cultivating the right mindset, the cold and focused mindset of a professional gambler.

Although trading is a form of gambling, it's vital to make a clear distinction among compulsive, amateur, and professional gamblers. Compulsive gamblers are addicted to gambling. They gamble to get a rush and a feeling of euphoria. They have absolutely no discipline. Obviously, trading is no place for the compulsive gambler, or compulsive trader. But many confuse compulsive gambling with professional gambling, yet these two types of gamblers are polar opposites. Professional gamblers, as well as professional traders, may take risks, but they manage them carefully. They look for high probability trade setups and only then do they place a bet.

Amateur gamblers, or social gamblers, are interested solely in enjoyment and entertainment. They budget a fixed amount of money for gambling entertainment, and then, spend it as they would for a movie, concert, sporting event or some other fun activity. Fun is fun, so it doesn't make sense for a social gambler to develop a detailed strategy for beating the casino, or carefully limiting risk at the blackjack tables, for example. Part of the fun of social gambling is getting a thrill, and the hope of finding Lady Luck on one's side and winning a big jackpot.

Many novice traders, however, make the mistake of applying the amateur, social gambling mindset to trading. They view trading as entertainment. If you've got money to burn, there's no harm in taking this attitude toward trading, but most of us want to make profits. And a social gambling mindset can quickly wipe out your trading account. If you are serious about trading professionally, changing this mindset is vital. You may find trading enjoyable, but the main objective of professional trading is making profits. Not only does that mean building winning trading skills, but careful risk management, discipline, emotion control, and executing trading strategies in a peak performance mental state.

Don't put on trades just to get a rush of excitement. Seek out high probability trade setups, and stand aside until you find a setup where you can win. In gambler's parlance, "you've got to know when to fold 'em." You must also act like a professional gambler when it comes to risk management. Just like a professional gambler, trading is a matter of patiently waiting for the odds to move in your favor. On each roll of the dice, a professional gambler risks very little, so as to anticipate and recover from a losing streak. Professional traders also face losing streaks, and it's vital to minimize risk to survive those times when your game is a little off, and you need to wait for the odds to return to your favor.

It's useful to view trading as professional gambling. It puts it in proper perspective. However, rather than an amateur player, you are the casino who carefully discerns the odds, makes sure they are in your favor, and takes advantage of the "law of averages" to ensure that over a large number of trades, you make a big profit. By abandoning an amateur mindset and cultivating a professional mindset, you will trade profitably and consistently.

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Once a trade is entered, there are two possible outcomes: on the light side it can make money; on the dark side it can lose. Between the light side and the dark side is the breakeven point, and because it is in-between, it has psychological significance. It separates fear and hope on the dark side and greed on the light side. The side you are on determines how you see this fulcrum.

When on the dark side of a trade, the breakeven point is a spot of light that inspires hope. Humans have a natural tendency to avoid risk and loss. When in the midst of a losing trade, many tend to hold on and hope that the loser will turn around and return to the breakeven point, where there may be no profits, but at least there are no losses. But hoping often leads to losses in the end. Hope has no place in making trading decisions. When putting on a trade, the entry point and the protective stop should be calculated up front. If this is done properly, there is no reason to let hope, or any other emotion, influence your trading decisions. You should trade almost mechanically. If the trade goes against you, simply exit once the stop price is hit. Don't let hope play a role in your trading plan.

There are many good reasons to cut your losses, rather than hope for the loser to turn around. When you are in a losing trade, you are rarely alone. Many other traders are also long, for example, trying to exit without a loss. And there are shorts defending this area to protect profits. It's unlikely that you can be the victor of this contest, so the best choice is to just cut your losses, and move on to the next trade.

The vantage point from the light side is quite different. In the midst of a winning trade, traders tend to take profits too early, again because they are averse to risk and potential loss. By exiting early, however, they don't let their profits run. This limits the size of the winning trades, so that across a series of trades, the overall profit is diminished. But there's a way to lock in profits, let the trade run a little longer, and pile on a little more profit. Once the profit exceeds the initial stake, a stop can be placed at the breakeven point. This strategy lets you lock in some initial profits while virtually eliminating risk. The most you can lose is commission costs. Besides reducing financial risk, the emotional stress is also eliminated. And reduced stress means you can evaluate the bigger picture more objectively.

Unfortunately, many novice traders are so consumed with capturing a profit and showing a green profit/loss statement that they cannot follow through with moving the stop to the breakeven point. They feel the strategy inhibits them and may limit their potential profits. They wrestle with moving the stop back to its original point, where they entered, or simply canceling it altogether. This can be disastrous to a trading account. Stops should never be changed to a more harmful position or cancelled altogether. Such practices will stir up emotions that adversely sway trading decisions, and eventually lead to one's demise. Discipline is always the best strategy.

Whether on the dark side or the light side of the breakeven point, it's useful to realize its psychological significance. When on the light side, you'll be motivated by fear and hope. While on the light side, you'll be motivated by greed. It's vital to recognize these emotional tendencies and do everything possible to counteract them.

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Vince Lombardi once said, "Winning isn’t everything; it’s the only thing." This quotation emphasizes the virtue of setting a clearly defined goal, and working tirelessly to achieve it. But an over-emphasis on winning at all costs can be detrimental, especially when it comes to the hectic and challenging world of trading.

Winning is surely important. If you lose too often, you’ll eventually wipe out your trading account. But it's vital that you look at winning from the proper perspective. Many new traders face early success, only to give it back to the market soon after. This often occurs when traders are overconfident. As a result of minimal skill and a bout of good luck, they thrive, but in the end, their wins are not justified. And eventually, they "blow out." When it comes to short-term early wins, it's possible to win with little skill. This early success, however, tends to put novices into the wrong mindset. They erroneously think they have the requisite skills to trade consistently and can just focus on maintaining a winning track record and the prestige and bragging rights that go with it.

But in the long run, an unbridled need to win can lead to failure. For one thing, the more a trader focuses on winning, the more he or she is likely to "choke" under the pressure. Extreme stress and pressure can enhance performance if a task is well practiced and relatively easy. But trading isn't easy, and for the novice trader, it's outright impossible, whether one knows it or not. For example, traders must filter trade setups through their own personal psychology, and when engaging in a challenging psychological task of this sort, stress and pressure will bias and distort perceptions. It's essential to cultivate a calm, relaxed, and focused mindset. But when one feels that winning is all-important, it makes one feel uptight, nervous, and scattered.

There’s another sports saying more fitting to trading: "It's not whether you win or lose; it's how you play the game." In terms of trading, successful trading is a matter of building rock solid trading skills and using a well-defined plan consistently. Trading is a matter of capitalizing on odds by implementing a strategy over and over so that the law of averages works in your favor. Across a set of flawlessly executed trades, you will come out with a profit. If you follow your plan haphazardly, you can't take advantage of the odds. Your track record will fluctuate sporadically with your wavering discipline. Winning isn't nearly as important as consistency and sticking with a game plan. So when you're trading, remember you're "winning" even when you are losing as long as you are following your trading plan. By following your trading plan consistently, you may not win on any given trade, but across a run of trades, you'll be a winner.

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Throughout our lives, we are told to foster a competitive spirit. We compare ourselves to others, inspire ourselves to do better, and try to beat out our peers. As children playing sports, we are advised to hone our skills and become a star player. In school, we are warned that higher grades are the key to long-term success. And when we enter the working world, we learn that survival depends on beating out our competition. But when it comes to trading, you aren't actually competing with anyone but yourself. When it comes to trading, cultivating a competitive spirit can actually do more harm than good.

Comparing our performance with others does seem to have some advantages. Knowing that a goal is attainable is often a powerful motivator, for example. Several scientific discoveries were slow to materialize because they were thought impossible at first. But once the goals were deemed feasible through comparisons to others in the scientific community, progress was accelerated. But comparisons can also have adverse influences. Ironically, people who achieve great things usually work independently and could care less how others are doing. They follow their own timeline, follow their own passion, and look inward for where to go next. Trading is a similar creative process. You are the one who needs to hone your trading skills. You are the one who must find a method that matches your aptitudes and personality. Comparisons to other traders can often prove problematic. How you perform has nothing to do with how others perform. It's likely to cause negative emotions, such as jealously or envy. Upon seeing that you are doing relatively poorly compared to a fellow trader, you are likely to think distracting thoughts such as, "Why can't I do as well?" or "I must not be as good of a trader as I had thought," Such thinking does nothing to keep you focused on honing your trading skills.

Don't look at anyone else's record but your own. You'll often be tempted to compare your current performance to that of others. That's how it's been throughout your life, and it's not easy to change a lifelong pattern overnight. But with trading, you must restrain this urge. Everyone has a different learning curve. To keep your spirits up, you'll do best as a trader to focus on improving your past performance record, rather than looking at those of other traders. You don't know what factors created their performance records, so comparisons can only mislead and hinder you. Other people's records do not have a direct bearing on your own record. By searching for factors that are going wrong with your method, however, you can identify the personal factors that have been specifically holding you back, those that are unique to you.

What factors distinguish your winning trades from your losing trades? Where can you improve? Once you identify these factors, the next step is making a plan for the future to maximize your strengths. For example, if you find your strength lies in trading at the open of an upward trending market, focus on honing skills to trade consistently under such conditions. Who cares if you make 50% less than other traders? Your energy should be focused on making yourself consistently profitable, not on beating others. Such comparisons will only disappoint and distract you. (And in the end, in all likelihood, you'll eventually end up making huge profits anyway, if you just focus on you.)

Although you may have achieved success in the past through comparison with others, it can be detrimental for trading. You'll be more successful by scrupulously examining your own past record, identifying factors that predict your own personal low performance, and modifying your approach. So curb your competitive spirit. Focus on you, the markets, and nothing else.

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In one of our Innerworth Master Interviews, a young trader mused about the seemingly low regard that common folk hold of traders. In contrast to those who pursue traditional professions, such as lawyers, doctors, or accountants, traders are often seen as merely a bunch of hobbyists trying to make a few extra bucks in the markets. Most people think anyone can do it, as long as they have the time, money, and stomach for it. It is common to hear an acquaintance say, "Trading. I've always wanted to try it," but you rarely hear an acquaintance say, "Brain surgery. I'm going to try that someday."

The traditional investment community doesn't give traders any more respect. Many brokers are happy to take their money from commissions, but behind their backs, many see traders as nonchalant gamblers or as misguided amateurs. And mutual fund managers are frustrated that the masses can't tell the difference between the traders, who they think are taking unwarranted risks by trying to profit from short-term volatility, and them. In the general public most see traders as reckless unrestrained pursuers of greed. Several trading coaches are quick to counter with, "Traders serve an important function: they provide liquidity." All these statements are true to some extent. Traders are not pursuing a traditional profession; you can't major in short-term "trading" in business school, for example. Traders are gamblers who take risks that most would consider intolerable. Many enter the trading profession because they are a little more motivated by money than say a minister, social worker, or others who have taken a vow of relative poverty to help the greater good. And in their defense, traders do help regulate consumer prices by providing liquidity. But in the end, none of this really matters. You'll find that seasoned traders don't concern themselves with such philosophical issues. They don't care what anyone thinks or how the greater society values their role or function. They love trading. It's a passion and a strong calling, as strong as any calling that draws anyone to pursue any profession. They really don't care what anyone thinks. All that matters is what they think. They know what they want to do with their time and energy, and that's all that matters.

Why are we so overly concerned with what other people think? In the corporate world, or while working in any large institutional setting, getting along with others is paramount. You've got to maintain your reputation. If people call you a "hot head," a "schemer," or "two-faced," it will impact your ability to get along with others, and successfully climb the corporate ladder. So keeping your reputation in check is part of survival. But traders work for themselves, and are only accountable to themselves. Observing what others think and maintaining a reputation is irrelevant. As a trader you must learn to abandon such social comparisons and attempts to protect your reputation. Top-notch traders are true individualists. They look inward toward their own values to decide what they want to do. They don't care what other people think of them. They would be traders no matter what, even if the whole world unanimously agreed that trading was the noblest of all professions or everyone viewed trading as the prime example of vice.

The fact is that in the big scheme of things, most people are going to view working as a trader as hardly as noble as other professions. Let them think what they like. You are not going to change public opinion. So instead of worrying about what other people think, look inward. You're going to waste precious psychological energy by worrying about the legitimacy of trading or what they think of you for pursuing such a career. Save your energy for trading. Save your energy for pursuing what you really want to do. Enjoy trading and celebrate the fact that you've found your true calling.

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A widely popular belief in the field of behavioral finance is that investors are "overconfident." They put on risky trades that don't pay off, and in the long run, end up with a lower account balance than those who put on fewer trades.

The evidence for this supposition comes from a seminal study by finance professors Brad Barber and Terrance Odean. They analyzed account records from a large sample of online investors. A subgroup was identified as "overconfident" in that they had a substantial initial success at the start of the observation period, but ended up with lower account balances at the end of the observation period compared to less confident investors. The overconfident investors put on substantially more trades than other investors, yet achieved few rewards for their efforts. By putting on significantly more trades, they paid more in commissions, which in turn resulted in overall lower account balances. The overconfident investors were single men in their early thirties, and thus, it seems as if it is young single men who are the most overconfident and prone to overtrading. Although this influential study suggests that some investors are "overconfident" compared to others, a psychological measure of overconfidence, or optimism, was not used to assess this trait. A kind of circular reasoning was used to identify those who were overconfident: those who put on more trades were thought to do so because they were "overconfident." But overconfidence is a personality trait. To show that the tendency to be optimistic and overconfident impacts trading performance, it is necessary to measure it. Science moves forward and sets limits and restrictions on general conclusions. Additional studies are needed to address this issue further.

A study by Dr. James Felton and colleagues, in the current issue of the "Journal of Behavioral Finance," sheds light on this initial finding between overconfidence and trading performance. University students taking a finance class participated in a 13-week simulation. Each participant was given an imaginary $500,000 to invest. There were some real incentives for doing well in the simulation, however. Students could win $500 if ranked in the upper quartile of the simulation, and a portion of their grade was based on their performance. Optimism was measured with a reliable and valid psychological measure. "Risky" investments were defined as investing in futures and options and as the number of transactions made across the 13 weeks. Men and women did not differ in their levels of optimism, but optimistic men made more risky trades (futures, options, number of transactions) than pessimistic men, pessimistic women, or optimistic women. In contrast to Barber and Odean's preliminary study, being more optimistic and making more risky trades didn't seem to have any negative consequences.The final values of the accounts did not differ between men and women, or between optimists and pessimists. Optimistic men, although making riskier trades, performed the same as everyone else.

So is being an optimistic trader such as bad thing? The verdict is still out. Additional studies are needed. All the same, it's probably not a good idea to be optimistic to the point of putting on trades without carefully managing risk, such as limiting the size of a position or using protective stops. But perhaps a moderate amount of optimism and confidence is useful. Dr. Felton and colleagues point out that pessimists often panic, become fearful, and tenaciously deny they are in a losing trade. A moderate amount of optimism, in contrast, ensures that even in the midst of a losing trade, an optimist may be more likely to seek out information and make an informed decision. So, in the final analysis, it is a little like walking a tightrope between extreme unrealistic optimism and extreme debilitating pessimism. Finding the right balance is the key to trading consistently and profitably

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Humans have a tenacious need to protect their assets and avoid risk. This is especially true for novice traders. It took a long time to build up sufficient capital to trade seriously, and it's understandable to fear losing some of it. Novices tend to seek absolute certainty before taking a risk, and gaining such certainty can take time. But when it comes to short term trading, there isn't very much time for long deliberations. Market conditions are in continuous flux. Decisions need to be made relatively quickly, and if one waits too long to execute a trade, he or she may miss a significant opportunity. The reasons for hesitation are many, and it's useful to be aware of them, and make a plan to thwart them.

The complex charting software available these days can often increase the tendency toward hesitation more than reduce it. It's tempting to look at as many indicators and signals as possible. Doing so, however, can be very time consuming. That's why seasoned traders advise looking at only a few key indicators.

Hesitation is usually related to a lack of confidence in one's trading strategy or trading ability. There may be several reasons for this lack of confidence, with some more deep-seated than others. One may not believe that his or her trading plan is adequately developed. Some traders may question their trading plan because they know that they did not spend enough time preparing it. Sometimes hesitation can be an intuitive warning sign, a way of telling oneself not to be too overconfident. In this case, hesitation can act as a motivator. If you feel you are hesitating because you have not prepared adequately, then spend more time preparing for your trades. Learn about new higher probability setups, reduce your doubt and indecision, and in turn your hesitation through more adequate preparation.

Hesitation can also reflect a deep desire to be right and a fear of being wrong. We are often afraid to face our inadequacies. By putting off a decision, we don't have to face our limitations, and can pretend that we are better traders than we really are. Extreme perfectionists are especially prone to this type of indecision. They continuously second guess and doubt themselves. They believe that if they are wrong, they cannot handle it. This occurs in trading decisions as well as other life decisions. Extreme perfectionists may fatalistically think that once they make a bad trade, it will be the start of a downward spiral and a complete blowout of one's trading account.

Finally, hesitation may relate to low self-esteem or other deep-rooted psychological issues. Individuals with low self-esteem tend to lack confidence in many different life domains. Doubting one's ability to trade, and thus, hesitating to make a trade may reflect a more pervasive, deep-seated self-doubt. People who hesitate may have a conflict regarding their success. They may have a "fear of success" where at one level they strive for success, but at another level, they secretly believe they cannot attain it, or do not deserve it.

Identifying and eliminating a problem with hesitation is useful. Chronic hesitation can erode one's trading confidence. One may put on trades, continue to hesitate, miss important market moves, and see his or her equity begin to dwindle. As one's confidence is further eroded, hesitation may worsen. So, if you're prone to hesitation, it's vital that you address this problem early. Identify the reasons for it, and make changes as soon as possible. By eliminating this common and pervasive ailment, you can trade profitably and consistently.

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Many people begin a trading career with the high hopes of becoming the next Warren Buffet or George Soros and buying multi-million dollar homes and fast cars. They have imaginative ideas about how much money they'd make if they were to buy a stock that would go up 12 dollars in a week. They set these types of expectations in their minds and qualify them with other ideas like, "At least if I make 50,000, I'll be happy," or "If I make a million dollars then I'll quit - I don't need more."

Then they start to trade . . . and lose. The sorts of thoughts and expectations that bring these types of traders to the markets are guaranteed to perpetually produce losses. This is because the presence of this type of mentality often indicates that the trader is not trading for the sake of the activity, but for the money. Although almost all traders are interested in making profits, trading for the purpose of wealth is quite different.

Whether the trader has loans he wants to pay off, or just wants that fancy sports car, the mental pressure that comes with these types of financial expectations tends to set a certain "standard" or quota in the trader's mind. Naturally, this then shifts the trader's perspective and risk control parameters. Often, this causes the trader to be unnecessarily risk averse, causing him to realize profits without regard to proper risk reward ratios, and to maintain unrealized losses beyond his stop loss points.

Successful traders almost always trade for the sake of the activity (or at least with the mental approach that comes with it). You'll often read about them saying that they don't really care about losing money. This doesn't mean that they have a disregard for loss, but that potential monetary losses are not a driving force behind their trading or investing decisions.

Traders who get into trading for the profits tend to learn fairly quickly that the more they want the money, the easier they lose it. It's very important to find out what your purpose in trading is. If you find that you're trading with any kind of financial pressure, you need to think about why that pressure exists and then work to remove it, so that you can enjoy trading for the great activity it is. The profits will follow.

[qxr1011]

It's common to hear comments like, "INTC's a good stock. I know someone who made a lot of money on it. I'm going to save up capital and go into INTC," or "Dell is terrible. I'm never getting into Dell again." If you're shaking your head and sighing, chances are you're more experienced than most traders, but not necessarily protected from making the same type of error yourself.

Many people commonly stereotype stocks, futures, and other investment instruments based on one specific event or experience, or sometimes based on recent activity.

Basing decisions on a specific historical event or experience often causes traders to develop mental "blocks," which can be detrimental to their state of mind while trading. Blocks will narrow the trader's perspective, potentially shutting out considerations that might be critical to his or her decisions. This type of activity generally demonstrates that the trader doesn't have a good understanding of his own trading personality and isn't confident about his trading plan.

Basing decisions on recent activity can also cause problems for the trader. Suppose a specific stock has been steadily rising and you've made quite a bit of profit by trading it. Because of this recent activity, you mentally label the stock as a "good" one. The likelihood is that the stock is not going to maintain such a steady rise. In fact, it's likely that it will "correct." By virtue of mentally labeling the stock, you've formed a personal attachment to it, which will cause you to overlook potential reversals or corrections, have great difficulty in sticking to your stop losses, and therefore to give back most, if not all, of your prior gains. Such losses can lead to further issues about self-esteem and confidence.

Stereotyping tends to be indicative of misplaced confidence. Any successful trader can tell you that if your confidence is coming from a stock's price patterns (over which you have no control), instead of from your trading plan and personality (over which you have the most control), you're headed for losses.

The key to avoid stereotyping is to understand that trading instruments can't be "good" or "bad" - traders can be successful or unsuccessful. Avoid judging stocks, futures, or whatever you're trading, and focus on objectively evaluating the effectiveness of your trading plans and personality. Strive to hone your trading psychology and to develop a set of solid tested plans. The rest of it can't, and doesn't need to be determined.

[qxr1011]

Traders often banter about letting preconceptions and so-called "conventional wisdom" unduly influence their ability to anticipate the markets. Market conditions are in constant flux, and forming an overly strong opinion, especially when it's oversimplified, can produce preconceptions that are hard to shake. That's why some traders steadfastly advise against forming a strong opinion. It's also wise to frequently question so-called "conventional wisdom," which is true only when a particular set of conditions is met. Flexible traders try to approach each day with a blank slate, so they can “read and react” to the markets rather than erroneously allow their preconceived ideas of the market to bias their current perceptions. It's vital to remain open-minded, flexible, and ready to adapt to whatever the market is doing on a given day.

Here's an example of how preconceptions and a blind adherence to conventional wisdom may allow one to miss what's happening in the current moment. It's conventional wisdom that the strength of the U.S. dollar influences stock prices. But this correlation is hardly a trading universal. It's crucial to consider that although a strong correlation is possible, it is not always strong. It depends. Over the last six months or so the US dollar has been relatively weak, but the weak dollar has not influenced stock prices for the most part. Even on more pronounced days of intraday dollar weakness, stocks have had little intraday swings in response to dollar swings.

So for the past six months, the so-called conventional wisdom did not hold. A flexible trader, while aware of the conventional wisdom, maintains an open mind and is ready to see that in the current climate, the supposition does not hold.

Flexible traders are adaptive. They simultaneously consider what "should happen" according to conventional wisdom, along with what is currently happening. Rigid traders, in contrast, are confined by their unfailing adherence to their preconceptions. They are not open-minded, but are on the lookout for when a rule is confirmed. Rather than proficiently acting on current market conditions, they wait for the rule to gain confirmation. In this case, they wait for when there is actually a strong correlation between the strength of the dollar and stock prices (which seems to have occurred recently). When that time finally comes, they are likely to say, "I told you so." Well…conventional wisdom is somewhat true, otherwise it wouldn't be conventional wisdom. So if one waits long enough, one's preconceptions are bound to receive confirmation. But what are the costs? By waiting, one has likely missed many good trading opportunities. Rather than let preconceptions guide you, it's better to just look at the current market conditions and take decisive action.

In short term trading, “it only matters when it matters,” so assuming a rule-of-thumb holds consistently can mislead. Being adaptive is critical. Every day it's useful to ask, “What is working TODAY in the markets?” It may be initiating trades from the long side only. It may be selling downticks in the minis when bonds up tick. It may be buying strength in mid cap stocks with big short interests when they are up good, even though the major indices are lower. By being adaptive one can simply look at what seems to be working each day on its own and stand a much better chance of being successful. So enter each day with an open mind. And if you do form an opinion, know how to tuck it away temporarily, and don't let it interfere with your ability to be objective, and adaptive to whatever the markets tells you today.

[qxr1011]

An ongoing controversy among psychologists concerns the benefits of optimism. Some psychologists argue that optimism is always beneficial, while other psychologists point out that extreme levels of optimism may be associated with biased and inaccurate estimates of negative outcomes. As highlighted in our Innerworth feature articles and the Insights and Attitudes sections, there are clear advantages to holding an optimistic attitude. Rather than limit your success, it is useful to have a positive attitude, and believe that life offers one endless opportunities for success. Why limit yourself by thinking that you will experience unfavorable events? Well...it depends on the accuracy of your perceptions.

A crucial distinction can be made between realistically estimating the probability of favorable events and unrealistically believing that favorable events will occur, when they are unlikely to occur. Realistic optimism is more useful than unrealistic optimism. For example, if you have a very poor trading strategy, it isn't realistic to believe that it will produce profits over a long series of trades. Unless one carefully and objectively monitors the success of a trading strategy, and determines its actual success, the equity in one's account can be rapidly depleted. A realistic estimate must be calculated and a new strategy must be developed should the estimate reveal the trading strategy is unprofitable. One may hold optimistic beliefs, but they must be accurate. Unrealistic optimism may lead to not only inaccurate estimates of failure, but inaction regarding necessary precautions to prevent such failure.

A recent study by Radcliffe and Klein illustrates the disadvantages of unrealistic optimism. Participants were asked to estimate the probability that they would experience an unfavorable outcome, in which an "objective" estimate of the actual probability was known. Unrealistic optimists underestimated the probability of the unfavorable event compared to realistic optimists. They also allowed their unrealistic optimism to influence their behavior. When presented with information regarding how they could reduce the probability of the unfavorable event, they did not review it closely, compared to realistic optimists. In addition, unrealistic optimists did not show proper concern and did not take necessary steps to move the probabilities in their favor.

These findings illustrate how optimism sometimes reflects a "defensive" motive to protect one's self-esteem. Rather than developing realistic expectations of an unfavorable event, and taking proper precautions to decrease the occurrence of the event, unrealistic optimists ignore important information that may signal a downfall.

Too much optimism is unrealistic, yet too little optimism can be very self-limiting. It's critical that you find the right balance between realistic self-motivating optimism, and unrealistic biased optimism. Make sure that you are using optimistic beliefs to your advantage.