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Bad trading psychology is one of the main reasons why people fail in trading the financial markets. No trading system will work, no matter how good, if a trader cannot follow it with discipline and focus over a long period of time. It is emotions and ego that usually drive a trader to abandon good risk management settings and trade too big, with too much risk, and destroy their accounts regardless of past success.

Although emotions can never be completely removed from trading because we are humans and not machines, emotions can be managed to allow us to feel them, understand them and make the right decisions about the actions we take. We can act more like entrepreneurs and not players in our trading once we learn the right mental management techniques.

Here are the top three trading psychology lessons I’ve learned in the markets in my 30 years of experience.

How to Reduce Business Stress

Treat each trade as one of your next hundred trades.

If you properly manage your position size based on the volatility of a chart, no single trade should mean much on its own and blend into the results of your next hundred trades. If your risk of loss is only 1% of your total trading capital, if your stop loss is triggered based on the mathematical size of your position, it is only one of your next hundred trades.

The main causes of trading stress are uncertainty, lack of confidence in your strategy, trading too big and taking too many risks at once. If you know your trading strategy has an edge based on your backtesting, chart studies, or risk/reward ratio, then smaller trading is the solution to all the problems traders face with stress.

Stop trading so big, this simple principle immediately changed my trading psychology. Trade big enough to be meaningful but not so big that it puts you on tilt.

Here are my position sizing guidelines for total trading capital.

20% position size for regular index ETFs.

10% position size for large cap stocks.

5% position size for leveraged ETFs and small cap growth stocks.

1% position size for option contracts.

Focus on your strategy, not your opinions or predictions.

Ego is a person’s sense of self worth or self importance. The ego is a mental construct that can be both conscious and subconscious. An ego is the self-concept that a person tries to protect and keep free from pain, destruction, and embarrassment. A trader has to trade his trading strategy and abandon signals and his trading plan in favor of his own ego because he does not want to admit he was wrong comes from stubbornness, self-delusion and big losses.

The trader is the weakest part of any trading system because ego can take over and lead to terrible decisions, all in the name of saving face.

Most market predictions are based on ego. A trader wants to be able to tell that he called a high or a low or made a great stock pick. Signal and system based trading is a way that eliminates the need to predict, you just need to quantify and react. You cannot control what happens on a chart after taking a position. All you can control is what you do. A good trade is one where you followed your entry and exit parameters to create a good risk/reward ratio, not whether you made money with lost money, the market decides that .

Stubbornness is an emotion that stems from the ego because it doesn’t want to be proven wrong. Many times this leads to letting a losing trade continue to play out against a trader. Egos find it hard to take stop losses because they hate to be wrong. Good and bad must be changed into good and bad trades and determined by long-term discipline, not short-term results.

Egos lock themselves into a bullish or bearish attitude and let their opinions do their business. Following the actual price trend creates a better chance of success than having an opinion on what should happen next.

You shouldn’t let trading consume your whole life. Markets should be just one of the many things you do in life. A diverse life outside of the markets with friends, families, hobbies, learning new things, and staying healthy will help you keep your perspective during times of losses and downturns in trading capital.

A profit and loss statement cannot define your personal value. Your profits are more a reflection of whether the price action is conducive to the success of your method currently, not whether you are a good trader or not. Your self-esteem should be determined by whether or not you have followed your trading system with discipline, consistency, and risk management.

Opinions and predictions outside the context of an edge are an illusion of the ego. Trading a quantified strategy with an advantage based on systematic parameters is the mark of a profitable trader. Trading should be a way to make money, find your validation elsewhere, or connect it to your ability to execute.

How to manage a transaction

Execute a predetermined trading plan instead of trying to decide what to do once in a trade.

Instead of trying to figure out what to do after entering a trade, your pre-determined trading plan should already be written before you even enter a position. A trading plan explains how you will manage a trade within the context of your trading system. Where you enter and where you exit based on signals.

A trading plan is used to express the actions you will take to express your trading system to the market through entries, exits, and position sizing. A trading plan defines the parameters for executing your signals with real capital in the markets based on predetermined signals. A trading plan is created when the market is closed for use when the market is open.

A trading plan should be structured to minimize losses when wrong and maximize gains when right on a trade. It must express your signals specifically so that they can be executed quickly without hesitation.

Stop losses and proper position sizing minimize losses. Profit targets and trailing stops can maximize gains. Never trade so big that your emotions or ego become too strong to execute your trading plan.

Your trading plan should be based in the context of your system using your watchlist, time frame, risk tolerance and return goals to express your strategy in action.

A trading plan redirects your decision-making process away from your ego and prevents mistakes from becoming emotional when a trade moves against you or for you in a big way. A trading plan is where you turn to make the right decision when fear, greed or ego wants to take over. Independent traders always have a boss, their trading plan.

If you want to learn more about my experiences and become a profitable trader yourself, you can check out my bestselling trading books at Amazon here.

I have also created online trading courses on my website here. My educational resources can save you time and money on your trading journey.

Image created by Holly Burns