Trader Psychology (ZT)

Discipline

One of the key factors mentioned by almost every good trader is discipline. Discipline, as you might imagine, takes a variety of forms. For beginning traders, one of the toughest challenges is to keep trades small. Believe it or not, more than a few top traders don't allow any one position to account for more than 1% of their total portfolio. Linda Bradford Raschke, one of the traders featured in The New Market Wizards, attributes much of her success to managing risk in this way. As a result, her average trade, at the time the interview, had a profit of only $450. At the same time, her average loss was only $200. Keeping her position small didn't impede her profit though. By remaining disciplined, she earned over $500,000 trading that year.

Limiting Your Losses

Another aspect of trading that involves discipline is limiting your losses. Here, there isn't a magic formula that works for everyone. Instead, you have to determine your own threshold for pain. Whatever you decide, stick to it. One of the biggest mistakes people make is to take a position with the intention that it be a short-term trade. Then, when the position goes against them, they make a seamless and unprofitable transition from trader to long-term investor. More than a few people have gone broke waiting for the trend to reverse so they could get out at break-even. If you are going to trade, you have to be willing to accept losses--and keep them limited!

Another mistake novice traders make is getting out of profitable positions too quickly. if the position is going well, it isn't healthy to worry about giving it all back. If that's a concern, you might want to liquidate part of the position or use options to lock in your profit. Then, let the rest of it ride. Mark Ritchie, one of the founders of CRT, an extraordinarily profitable Chicago-based trading company, once kept a trade on for 4 years because it kept working for him. Not every trader has that kind of patience. And not every trader makes as much money as Mark Ritchie.

Fear

Of all the emotions that can negatively impact your trading, fear may be the worst. According to many of the traders interviewed in The New Market Wizards, trading with scared money is an absolute recipe for disaster. If you live with the constant fear that the position will go against you, you are committing a cardinal sin of trading. Before long, fear will paralyze your every move. Trading opportunities will be lost and losses will mount. To help deal with your fear, keep in mind what fear is:

Confidence

The flip side of fear is confidence. This is a quality that all great traders have in abundance. Great traders don't worry about their positions or dwell on short-term losses because they know they will win over the long term. They don't just think they'll win. And they don't just believe they'll win. They KNOW they'll win. As Linda Bradford Raschke put it, "It never bothered me to lose, because I always knew that I would make it right back." That's what it takes.

Greed

Greed is a particularly ugly word in trading because it is the root cause of more than a few problems. It's greed that often leads traders to take on positions that are too large or too risky. It's greed that causes people to watch once profitable positions get wiped out because they never locked in profits and instead watched the market take it all back.

Part of the remedy for greed is to have, and stick to, a trading plan. If you faithfully set and adjust stop points, you can automate your trading to take the emotion out of the game. For example, let's say you are long the 50 calls in a stock that rises more rapidly than you ever expected. With the stock at $77, the dilemma is fairly obvious. If you sell the calls, you lock in the profit but you eliminate any additional upside potential. Rather than sell the calls, you might buy an equal number of 75 puts. The $25 profit per call that you just locked in will more than offset the cost of the puts. At the same time, you've left yourself open to additional upside profit.