May 8, 2015

The Laws of Trading


Trading is one of the hardest endeavors/professions on the planet. Navy SEAL BUDS selection graduates a higher percentage of trainees than the percentage of successful traders. So if you aspire to become a successful trader and want to smoothen your learning curve now, review these Laws of Trading. Let me know your thoughts in the comments below.

A successful trader needs a growth mindset (my skills can always be improved) instead of a fixed mindset (my skills cannot be improved because of excuse X, Y, and/or Z). Watch this video by Stanford University professor Carol Dweck, Ph.D., on the power of a growth mindset. Or check out this shorter and just as great video by Bite Size Psych about the growth mindset and how it's absolutely vital to success in any endeavor.

Discover your vision of the future. What do you want your ideal future to look, feel and sound like? A clear vision helps identify the right goals to navigate you to your personal idea of success. But first, make sure to do a quick check of your biases of success, in other words, make sure your vision of success is just that, genuinely personal. You don't want to create a vision that society (friends, family, the media, etc.) has pressured you to adopt. This video by Bite Size Psych will help you check your biases and ensure that you select a vision that truly fits you, and not someone else.

Will power is very limited and almost entirely ineffective at helping us achieve long term goals or behavior change. So when you hear people say, "I just need more discipline/motivation/etc.," what they're really saying is that they need more will power. But will power will always fail them. What is effective at helping us become a better trader and getting to super successful land? Setting small and achievable goals (or new habits) to execute each day. That is the answer and holy grail to that question, and research proves it.

Focus on one goal or one new habit to execute each day and then celebrate every time you do so. This celebration releases dopamine, which is very addictive. Imagine what happens when you become physically addicted (mind and body) to achieving the very goals and habits that lead you directly to the one place you desperately want to go? See what I mean now? Good! Now, if you'd like more helpful resources on goals and behavior change, Brett Steenbarger, Ph.D. (world renowned trading psychologist and author of several great books on improving trader performance) has written several great posts on the subjects here and here.

Will power is still important to pay attention to because it depletes quickly (like after spending some time on even modestly difficult tasks). When will power gets low, the human brain switches to a risk-seeking, instant gratification mindset in order to feel better now! This mental switch is catastrophic to our visions and goals because our minds want to feel better now, regardless of any bad consequences that may happen. What are some typical examples? People typically turn to sugary foods, fattening foods (I'm definitely guilty with this one), booze, smoking, illegal drugs, and sex to help feel better now. So they may feel better now but what happens next? Typically dark emotions follow like shame or regret. Not to mention some people get into trouble with the law or with their friends and family. This sounds like something we all struggle with at times because society can be stressful, so how can we protect and replenish what little will power we have so that we can avoid these unhelpful situations?

First, use it very wisely! Read this great book, The ONE Thing, by Gary Keller (founder and chairman of the board for Keller Williams Realty, the world's largest real estate franchise) and Jay Papasan (co-authored the bestselling Millionaire Real Estate series with Gary Keller) about why focusing your will power and energy on the single most important goal at the moment is the most effective strategy at achieving your wildest dreams. If you notice yourself losing will power and discipline, consider trying this powerful 2 minute distraction technique from Guy Winch, Ph.D. (explanation starts around 13:35). And if you'd like more information about strengthening emotional health, check out this video by Guy Winch, Ph.D.

Second, learn to accept failures (e.g. losing trades) and don't beat yourself up over them. I linked the Bite Size Psych video on will power again because it also explains how beating yourself up over any failures in life is absolutely disastrous. Learn to accept failures because at least 30% of your trades will fail, IF you follow your rules! It's just part of the stock market game. Learn to truly accept failures in life because they're normal in trading, not abnormal. Turn any frustration that builds up into some constructive action, such as analyzing why a trade went bad. First of all, did you follow the rules of your system and edge? If so, no worries, a failed trade is accounted for in your system (30% or more will be losers typically). If you didn't follow your rules, set a simple goal for tomorrow to follow the rule you broke this time. Try to remember the consequences of not following your rules as vividly as you can because you want to associate the pain and the frustration and the misery to not following your rules. This will make it less likely you break your rules in the future.

Only 20% percent of your trades are responsible for 80% of your profits (a.k.a. the Pareto principle). Learn to identify and prioritize your best trades. Read the book I mentioned above, The ONE Thing, by Gary Keller and Jay Papasan, and The Playbook by Mike Bellafiore (co-founder of SMB Capital and author of the trading classic One Good Trade).

Want to significantly and quickly improve your trading performance and reduce stress? Then journal thoughts and emotions about chart patterns and trade ideas BEFORE taking a trade (see "Journaling emotions" video on my Resources page).

Diversify your sources of self-efficacy/esteem. Why? Because 90%+ of traders fail, so it's vital you have multiple sources strengthening your self-efficacy/esteem outside of trading to help weather the inevitable losing streaks, trade management mistakes, and volatile markets relentlessly testing your dedication, discipline, tenacity, and motivation (see also Brett Steenbarger, Ph.D.'s article about emotional diversification).

A calm and focused state of mind is required of every successful trader during all parts of the trading day, and the week for that matter (trading execution, trading preparation, etc.). Certain triggers (environment, mental, etc.) force you away from a calm and focused state of mind, and lead you down the path of poor trade ideas, poor trade executions, and poor trade management. Check out Brett Steenbarger, Ph.D.'s video about identifying and defeating these triggers and maintaining that critical calm and focused state of mind, day in and day out.

A structured daily routine (a.k.a. process) is the single greatest predictor of a successful trader. Don't focus only on trading successes & failures or swings in P&L. Focus your energy on setting a clear routine for each portion of the day, as well as weekends, and adapt that routine as you evolve as a trader.

Document and test everything (routines, chart patterns, trading execution, emotions, etc.) to help identify trading strengths and weaknesses, and to track your progress. Use these observations to set goals like what was discussed above. Knowing precisely how you're progressing on your trading journey reduces stress and increases performance.

Risk management is more important than any other aspect of actual trading. Always identify where you are risking to and how much money you are risking BEFORE ever taking a trade.

Think probabilistically. Always be calculating the odds of whether the buyers or sellers are in control/about to control/or equally in control of the price of a stock. I'm not saying this is easy by any means. But this should be done by identifying clues in the price action according to your trading system. Identifying these price action clues helps focus your attention on the best stocks to trade and when to trade them.

  Sorry guys I know this is a ton of info. But I'm interested to hear your opinion about the laws of trading.

Take care,

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