1) Psychology

I have been a coach in the markets for almost 4 and a half years now, and in that time, I daresay I have likely encountered every type of trader and/or beginner out there. I’ve seen their psychological states, which in turn dictates EVERYTHING else that follows after.

There’s a reason Psychology is ranked #1 on my list of the 4 pillars, and that is because after 4 and a half years meeting all kinds of traders and clients, I have come to the conclusion that everything starts with your psychology.

Your psychology will influence your attitude. Your attitude will set your expectations. Your expectations will determine the emotions you will feel while trading. Your emotions and how you handle them while trading will determine your overall success as a trader.

Your psychology will also give rise to other very critical traits that a trader should have, such as:

  • Discipline
  • Patience
  • Decisiveness

How you feel when you’re trading and how you control it is the art of trading psychology. And that, as it often does, can singlehandedly determine your success.

Some common traits / habits I have encountered or get asked about are below:

  1. Do you feel the need to close out a position because it starts losing a little?
  2. Do you feel you want to close a trade because you’re finally making a small profit?
  3. Do you feel the urge to trade big position sizes just to feel the “thrill”, cause it’s “fun”?
  4. Do you want to suddenly jump into a trade because you feel you missed the entry?
  5. How come the return from Forex / Stock trading seems rather “low”?

All of these are traits and habits I have encountered before, and to be fair, they were mostly from beginners.

It is these initial bad habits, traits, and misconceptions that need correction early and properly for new traders to eventually become profitable.

You NEED to master your own psychology to control your emotions and to think clearly. As I said previously, your psychology will determine everything else that happens, from risk management to trade management, and how you handle winning and losing trades.

Some of the best quotes on trading are actually from Sun Tzu, and here is the one that best sums up trading psychology:

“Know thyself, know thy enemy. A thousand battles, a thousand victories” ~ Sun Tzu

2) Risk Management

No doubt, risk management is the next most important pillar for anyone to be a profitable trader, and it ranks #2 on my list. Even a simple basic trade strategy can be profitable when used with proper risk management. To quote George Soros, “It is not about being right or wrong, but how much money you make when you’re right, and how much money you lose when you’re wrong”.

That quote makes a lot of sense. It really doesn’t matter whether you got it right or wrong. What matters is how much profit you squeezed out of your winners, and how small your losses were with the losers.

There are only 5 possible outcomes when you choose to look at any chart:

  1. No Trade
  2. Small Win
  3. Big Win
  4. Small Loss
  5. Big Loss

I will only highlight 2 of the above that are most important.

The first, is “No Trade”. Many new traders and sometimes even veteran traders underestimate the power of just not doing anything. Sometimes, the best thing you can do for your account, is to sit on your hands. Staying out of the market when it is too choppy or volatile can do wonders and keep you out of trouble. Even if you trade and come out with an acceptable outcome, ask yourself if it was worth the emotional rollercoaster, because most often it is not, even if you win. Never underestimate the power of staying out.

The second, and most crucial is “Big Loss”. This you must avoid at all costs. A big loss is the only one that can really hurt your trading account (and your emotions).  All the other 4 outcomes do not significantly hurt your trading account. Taking a big loss is never acceptable as a trader. It usually means risk management was totally poor or there was no risk management to begin with. Also, do not blame the broker, the platform, or the market, as these are all factors you should have been aware of. Markets do gap up and down, and big news will always move the market strongly, and you need to anticipate these things.

For example:

  • Use a GSLO (Guaranteed Stop-Loss Order) if you have a sizeable position on an instrument that is known to gap up/down. It is worth the premium if market gaps against you.
  • Use an Options account instead of a SPOT trading account if choosing to trade “black swan events”, since you’ll only lose the premium of the option if market goes against you.

And of course never forget the cardinal rule for the stop-loss: Never move your stop loss wider. Every big loss was once a small loss.

When in doubt, practice the first point. Don’t trade. Stay out of the market.

What happens if you did lose though? Well let’s now take a look at the Drawdown table, and how much % return you will need on your remaining account balance to breakeven.

Drawdown Table

As you can see, the bigger the drawdown, the larger the % return you need on your remaining balance to breakeven and get your capital back. It gets worse exponentially. This is why, you must always protect capital, and why you absolutely always avoid big losses.

Remember, between Risk and Reward, the only thing YOU can control is the risk. You cannot control the reward, no matter how good you are at charting, analysis, or crafting trade strategies. There will always be losses in trading, and what matters is how much you lose when those losses come.

Gamblers focus on the reward. Traders focus on the risk…then manage it accordingly.

3) Adaptation & Skill

The third most important pillar as a trader, is your ability to adapt and hone your skills.

You need to understand the game of trading fully to know how best you should approach different instruments and markets. There are some pretty significant differences in trading across stocks, forex, oil and other commodities.

You will need to adapt yourself to each market and instrument, and also pay attention to how the market operates. Remember, markets can, and do, evolve. What worked before, may not work now. As traders, we adapt and continue to develop our skill.

Now the instrument you use to make those trades also matters. Are you going through the cash market? Or using CFDs, Options, or Futures? The dynamics of each type of instrument varies, and so does the risk, which is what you need to constantly manage.

After understanding the bigger picture, you will need to be highly skilled at the two main types of analysis. Fundamental Analysis (FA) and Technical Analysis (TA).

Contrary to what many retail traders say, you should not focus only on one. You need BOTH those analyses to be a truly complete trader and even investor.

Fundamental Analysis tells you WHAT to trade/invest in.
Technical Analysis tells you WHEN you should trade/invest.

FA will serve to keep you out of potentially dangerous trades. For example, something we always advocate at MatrixChart Systems is to stay out of penny stocks as they can be manipulated. FA will also serve to help you weed out what are truly good companies and those that are not. If you take the time to read financial reports and understand how financial ratios work, you can spot good companies to invest in and trade. More importantly, FA will also show you which companies you should stay away from because the numbers either do not make sense or are not healthy.

FA also helps craft your directional bias. For example, if you know a country’s economy is getting weaker, and their central bank is planning an interest rate cut, then you can anticipate a weakening of that country’s currency. For Stocks, if you anticipate more competition for a certain company and that competition will erode market share, then you know that company’s stock is set for a correction or decline. With a directional bias from FA in mind, your next question should be, “precisely WHEN and WHERE on the chart will the move take place?”

This is where Technical Analysis comes in. You need to be skilled at reading the charts. Specifically, you need to be skilled at reading candlesticks, market structure, patterns, key support / resistance levels, and other relevant indicators only if they add value. And of course you need to be skilled at doing all this, across multiple time frames.

Once you have your strategy, determine its accuracy to calculate the win rate, which is the probability of this method giving you winning trades. If the % is greater than 50%, you already have an edge.

The only question now is, can you manage the risk for the times this method loses? And can you manage your psychology to stay in the trade to maximize the profit when it is correct?

The trick here is to trade like a casino…. You have an edge, so just trade, and let your edge play out.

4) Growth Mind-set

The last pillar every trader should have, is a growth mind-set. This means, when things go wrong, or you are on a losing streak, do you feel sad, anxious, and annoyed? Or do you stop trading for a while, relax, review, and learn?

Every loss or mistake is an opportunity to learn. What went wrong? What did you miss out? Is there a way to enhance the trading strategy?

This kind of mentality can also help you at your day jobs in the office. When things happen that you cannot control and/or do not like, you can complain, whine, and sulk about it, or you can take a moment, let the annoyance fade away, then see how you can make the most out of your situation and learn from it.

As you can see, growth mind-set stems from psychology. However I put it here separately because even if you have good trading psychology, you might have overlooked the concept of having a growth mind-set.

Always learn, always read, and always keep growing.

Using fitness as an analogy, you don’t keep fit and stay in shape by going to the gym once a month now do you? It is an ever improving process where you grow with consistency and discipline.

It is the same with trading.