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Trading Psychology: How to Build a Solid Foundation

December 2, 2010 | By

The story of two home owners…

Joe and Bob have just purchased two beautiful beach front properties on the Gulf coast.  Both are very excited about this opportunity and begin building their homes right away.  As a few weeks pass, Joe’s home is almost finished, while Bob is still laying the foundation.  Joe has built his dream home in the matter of weeks, and Bob is still building and reinforcing his foundation.  Finally, after months of patience and hard work, Bob’s home is finished.

Later that year, a devastating storm comes crashing through their town.  The storm completely wipes out Joe’s home, while Bob’s home hasn’t budged.  Bob’s home is standing strong with minimal damage.

Joe built his home very quickly.  His only focus was to finish building his home, and he never considered the risk of building in this manner.  Yes, he was able to live in and enjoy his home for several months, while Bob had just began laying his foundation; however, as soon as the first storm came passing through, all of Joe’s work was washed away.  He was only concerned with the end result, and in the end, had nothing to show for it.

Bob had a much different approach.  His number one objective was to build a home with a strong foundation, knowing his home would have to weather a storm from time to time.  In the end, he experienced minimal damage.

A trader’s psychology is his foundation.

The same is true with commodity futures trading.  Markets are constantly changing.  As a trader, you need a strong foundation to weather the storm.  Over the last few years, as traders, we have had to weather a devastating storm.  We have endured crisis in our banking system, a housing bubble collapse, government bailouts, the flash crash, and overall weakness in economies around the globe.  There is no question markets have been challenging, but it is the foundation of your trading plan that will always keep you on your feet.

In my opinion, the foundation of every trader’s plan lies between their ears.  No matter if you are a day trader, an options trader, or long term position trader, your foundation revolves around your disciplined trading psychology.  How else can two traders following the exact same trading system receive completely different results? A trader’s psychology is his foundation.

A healthy trading psychology can look like:

  1. Being comfortable with the capital at risk
  2. Being confident in the strategy in place
  3. Remaining optimistic about future opportunities.

This is the foundation for your trading.

Be comfortable with the capital you’re putting at risk.

Nobody wants to lose money.  We wouldn’t invest if we thought we were going to lose our money, but we have to accept the fact that it’s possible.  You will never be a successful trader if you are not willing to accept this fact.  If you aren’t comfortable with the capital you have at risk, your emotions are going to takeover and make it impossible to stay disciplined with your trading approach. Like the story of the two home owners, Bob wasn’t in a rush to reach his end goal. He understood there was risk building a home on the gulf coast, but he felt the end result would be worth the risk.  The same is true for traders.  We need to accept the risk/reward parallel.

Be confident in your trading strategy.

It doesn’t matter if you are a technical trader or a fundamental trader; you need to have confidence in your plan.  You need to know why you are taking the trade, what you are willing to risk on this trade, and what your profit target is.  Without these parameters, fear and greed can easily take over.

This is why your trading strategy has to draw a distinct line in the sand beginning with the reason behind the trade.  If you don’t know why you are entering a trade, DON’T.  You must have a reason or idea behind every trade.  Once this reason is established, you need to set profit and risk parameters prior to entering the trade.  If the market moves to X, I will take my loss and move on to the next trade.  If the market moves in my direction to Y, I will take profit.  Without these distinct parameters, you are at the mercy of your emotions.

You need to “plan your trade, and trade your plan.”  Stay disciplined and do not deviate from this plan.  You are going to have winners, you are going to have losers, but this discipline is the concrete that holds your foundation together.

Remain optimistic.

There is a lot to be said about a positive attitude.  Do you feel trading becomes easier when you string together a few big trades? And does it become more difficult when you’re in a rut? A major factor of this is remaining optimistic.  When you’ve taken a few losing trades, you begin second guessing yourself.  You see an opportunity, but hesitate and miss the trade because you doubt yourself.  The next thing you know, that trade is a winner and you begin forcing trades to make up for the one that got away.

You need to stay positive.  You need to remain optimistic.

When you string together a few big winners, you have confidence in your strategy.  You see a set up and you take it.  You trust your plan.  You have to keep the same mind set when you are in a rut. You understand not every trade will be winner. It might take you longer than you think to reach you goal, but you need to focus on your foundation. Just like Bob did not get frustrated and lose his patience as he saw Joe enjoying his home, you shouldn’t get frustrated with delayed results.  Focus on your foundation and the rest will fall into place.  You will be able to weather the storm so you can enjoy brighter days.

Accept your risk/reward parameters, understand that you are only risking this capital because you have confidence in your trading plan, and stay optimistic.  Every trade provides a new opportunity.  Be disciplined and trust that this foundation will allow you to accomplish your commodity futures trading goals.

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