I recently read an article written by Peter Noel Murray on psychologytoday.com. Â Peter’s article was about how memories of experience influence behavior. Â I think there are some important analogies to be made by traders in the concepts Dr. Murray is presenting. Â Let me present an excerpt of what he says and then I’ll make some comments. Â Here is a snippet of what he mentions:
At a recent TED conference, psychologist Daniel Kahneman, Nobel Prize winner and one of the founders of behavioral economics, gave a talk on why our experiences and our memoriesÂ can be so different.Â Â His concept provides important insights about all consumers, but especially for those who purchase luxury brands.
For example, a consumerÂ could have a great experience with a product or service, but only have bad memories when thinking about it later. Hereâ€™s how. Letâ€™s say you are on vacation and have dinner at the best restaurant recommended to you. Perfect table. Food is exquisitely prepared. Wonderful wine. The experience is fantastic. However, when clearing the table the waiter spills coffee into your lap. Odds are that the coffee spill will degrade your memory of the food and wine, no matter how exceptional you otherwise would have remembered them. And if the hot coffee burned a leg or damaged an expensive dress or suit, the wonderful dining experience may not be remembered at all.
The point that Dr. Murray makes is that you can have a series of good experiences that can be overwritten by a single bad experience. Â If the experience is threatening enough, there is a hidden part of you that will do everything it can to keep you from that bad experience. Â Think about what happens when you trade. Â You can have a series of great trading days and then comes the dreaded losing day. Â If you are a haphazard trader that does not have a plan and your next breath hinges on the chance that you are able to make good decisions under the pressures that the market can throw your way, you are casting yourself into the perfect storm. Â You might as well throw a hot cup of coffee on the hand that you use to trigger your orders. Â That one bad trading experience will be what you remember. Â More importantly, that experience will the one on which you base your next market decision. Â That is not good. Â How can you execute a trading plan if you are scared of burning yourself? Â Dr. Murray goes on to say:
Kahneman points out that the decisions we make are based on our memories, not our experiences. So for that restaurant, your memory will have negative consequences. Not only will it prevent you from returning, it will be shared with all of your friends who ask about your dinner.
How do you get around spilling hot coffee all over your trading psyche?
The bottom line is that in trading you will either need to eliminate losing or accept it as a part of the business. Â My guess is that the second is more realistic. Â But that is not the only thing you must do. Â You must also guard your psychological capital by making sure you enter the market with a plan. Â This can mean many things to different traders. Â To some it means that you simply have an entry and an exit strategy for every trade. Â To others it is a bit more complex and involves portfolio risk analysis and distribution. Â Whatever you do, don’t be a gunslinger. Â You’ll eventually run out of bullets. Â When you run out of bullets, you can bet you will be on your way to the land of the 47% or the 99% depending on what political party you profess. Â In the end you want to be a one percenter. Â To get there as a trader, you have to guard your psychological capital as much or more than your financial capital. Â This doesn’t have to be complicated. Â It can be as simple as staying away from your computer if you know you are not in the mental condition to trade. Â If you just had major fight with your wife/husband/partner, put the keyboard down and move away slowly. Â Do not put yourself into a situation where you are guaranteed to spill coffee on your great trading plan.
For traders, psychological capital is more important than financial capital. Â Remember that. Â If your subconscious is fighting you, trying to keep you from an anxiety attack because of the memory of that day you busted your trading account, profitable trading will be a much more difficult thing for you to attain. Â The approach I would suggest is to simply accept that losing is part of trading and do all you can to put yourself in the place where your losses are because of the market and not because of you. Â What does that mean? Â It means that if you lose while trading your plan, that is just the market. Â You can be proud. Â But if you lose because you decided to trade when your mind was focused on some major issue in your life that hinders your judgement, then you can’t be proud. Â You can only be to blame. Â Not the broker. Â Not the market makers. Â Just you. Â Particularly if you read this article.
Be careful out there. Â Many happy ticks and pips to all.