Wednesday, January 3, 2007

The Three Pillars of a Trader's Mindset

Most traders come to the market with expectations of high returns, in the belief that their chosen method or approach, combined with their general abilities gives them the foundation to perform and succeed in the seemingly easy playground known as “The Market”.

However, only a few number of traders are able to generate consistent returns on their equity, and most are on a roller-coaster experiment!! Why is this? The (good) trading literature explains why this game has more to do with a self-discovery process than other professional endeavours. Are the top traders superior because of some special tool/methodology/trading system? The answer is no. The reason why they are able to consistently take money out of the markets is because they follow a common path of being focused, being disciplined, and being confident.

Let’s detail these 3 pillars of a trader’s mindset:

Being Focused:

Most people begin their trading journey attracted to trading because of its potential of making easy money. The trading industry often supports this view by selling the idea of “Trading out of your home”, “Living the dream”, “Trading from the beach” etc... The idea that trading is an enjoyable and easy way of making money is probably one of the main culprits of why people don’t succeed in the markets!!! The reality is completely different. Trading is one of the most demanding endeavours that someone can undertake. As K. Van Tharp, Mark Douglas, Brett Steenbarger and other brilliant market experts demonstrate in their (excellent) books, trading faces everyone with beliefs that are strong obstacles to trading mastery. What you can learn from these great authors is that a persons beliefs must be re-programmed into more adapted views of what trading is about. For this to happen, a person must go through a very deep introspection and a permanent assessment of how they react to the “heat of the battle”. What the authors show us, through different means, is that first you have to be extremely focused on the task.

A trader that does not have a strongly developed plan to trade the markets will be assailed by never-ending waves of conflicting inputs that will make him lose his focus and his mind in fighting the markets. As Mark Douglas and K. Van Tharp explain very well in their books, the markets have no beginning and no end. Any moment is unique and the only way to find order in the markets is to develop a methodology adapted to your personality that will allow you to gain an edge, and to be able to implement it consistently in order to exploit this (usually) slight statistical advantage. In order to develop such a trading plan, a trader needs to intensively work out his methodology, back-test it in order to validate his concepts and last, but not least, “practice it “. This latest part is probably the most overlooked aspect in the trading literature. Brett Steenbarger’s books and blog highlight this fundamental part of a trader’s development. As for a Fighter Jet Pilot, or a Professional Golfer, a trader needs to practice, and practice, and practice until he considers himself fit enough to enter into this challenging playground called The Market. Once those steps have been completed, a trader’s success will depend on how focused he is in any given moment. The danger, as for other routine-based endeavours, is to get bored or unduly relaxed and this will inevitably lead to disasters. Here again the confirmed trader faces the challenge of being consistently focused on his skills, and on the markets, in order to avoid falling prey to his own weaknesses. This leads us directly to the next pillar of a Trader’s mindset: being disciplined.

Being disciplined:

This is probably the most recurrent concept mentioned in trading literature, but what does it mean exactly? “Discipline is any training intended to produce a specific character or pattern of behaviour, especially training that produces moral, physical, or mental development in a particular direction”*, i.e.: to be disciplined you need a specific set of rules to follow. Without rules, discipline is an empty concept!! In order to be disciplined, a trader first needs to set the rules that he will need to follow. Here we come back to the necessity of first working out a methodology, and then applying the rules to make the most out of it. This is usually called the “Trading Plan” and it is the foundation of any successful trader. Many would-be traders find it hard to write down a specific trading plan since it is very far from the typical “easy money” illusion that many people have about trading. Being able to articulate a precise, step-by-step plan is the result of intensive study and research of the markets behaviour. Once this intensive observation period has produced some trading ideas, it is time to test the concept through back-testing, and even more importantly in real-time. Any trading approach can and must be tested, be it a fundamental, supply/demand model, a quantitative system or a technical analysis methodology. Once the tests have confirmed that the strategy has a demonstrable edge, the real difficult part begins, and this is the systematic application of this edge to the markets. One of the major issues facing the trader once he has formulated a strategy is to make sure that his personality and organisational availability will be in accordance with the execution of this plan. It will only be through the continuous practice of the trading plan that the trader will gain confidence in his ability to execute it flawlessly. Markets have a way to spot any of our psychological weaknesses and only the focused and intense practice of the trading plan will produce the consistent pattern of behaviour that characterizes successful trading. This is the necessary discipline that can lead to confidence!!

Being confident:

Being confident is the ultimate prize for any trader; some call it being in the “zone”, some others talk about finding the “Holy Grail”. What it really means is that, as for any performance based endeavours, trading will satisfy you only once you reached the state where “you know what you do”. Trading is not different from any other demanding undertaking, it requires mastering the different stages of the learning curve and the quality of this learning process depends on how focused and disciplined the trader is in honing his acquired skills. Once the trader has identified, through practice, what markets, methodology and timeframe he is comfortable with, he will slowly gain confidence in himself by systematically repeating all of the steps that constitute his trading plan until it becomes part of his personality. Just as for a tennis or a golf player, being confident makes the difference between winning and losing, so it is for the trader. And, just like the tennis or golf player, the trader can only gain this confidence through a well worked out set of skills, a battle plan and the continuous practice at a performance level. Losing focus or relaxing the discipline will very rapidly threaten the trader’s confidence. Hence, it is of the utmost importance to understand that this virtuous circle has to be maintained during every trade. And here we touch the challenge for any trader: only the repetitive and focused practice of his plan will ensure that he will stay confident in his trading. This can only be achieved through a balanced and healthy way of living and a sound detachment of the day to day results.

Only the traders that live and work and hone their skills in accordance with the principles that we detailed in this article will be able to stay consistently focused, disciplined and confident....

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