How to Develop the Successful Trader's Mindset

Posted 06/05/2009, 9:00 am EST by Sean Lydiard from tradingmarkets.com

To be a successful trader, you must build positive feedback loops into your mindset.

In my previous article, "What Traders Can Learn From the World’s Most Successful Companies," I suggested that there were ten factors that a trader should integrate in order to enhance his or her trading success. The process is inspired by the Six Sigma method of management – the search for excellence and consistency, day after day, trade after trade.

Strategies That Lead Traders Nowhere...

The objective is to produce excellence in trading execution, rather than spend time in a constant search for a Holy Grail system that does not exist. Most new traders want to believe that, if they could just find the right trading strategy, then their trades would be profitable and they would be able to sit back and rake in the “moola”.

Such a trading fantasy is just that – a fantasy. Even if one could find a very high probability trading system, there is always the problem that the system cannot and will not be right 100% of the time. So what happens when the system has a losing streak? Is the trader prepared for the inevitable drawdown of his or her trading capital?

To overcome the emotional anguish, some software companies suggest that the solution is to build a trading strategy, back test it to be sure it is profitable over the long term, and then let the software generate the entry and exit signals, so that the trader will not suffer emotionally. The computer becomes your proxy trader. Some systems not only generate signals when to buy and when to sell, but they even automate the order entry and exit process.

Unfortunately, all that this automation does is transfer the emotional anxiety from watching the trade to watching the computer. Playing with technology causes the trader to forever try to fine tune his program, so that the results will be improved. Whenever I see this, it always reminds me of an audiophile who believes he can differentiate the sound of his audio system according to what cables are connected between the amplifier and the speakers. “Ah,” he says, “Listen how clear those gold cables sound!” But in the end, the audiophile ends up listening to his equipment and forgets to listen to the music.

The Real Solution is The Trader's Mindset

This brings into focus the concept of a Trader's Mindset. Mindset is the first component of any trading model when one prepares to become a successful trader. It all starts with one’s mindset. Mindset can be defined as “thought patterns.” How we respond to events and stimuli that we encounter each day is directly in accordance with our individual mindset. Therefore, if we can set up the appropriate mindset or thought patterns suitable for the activity at which we wish to excel, then we have a chance of producing excellence.

Everyone is different but certain emotions are hard wired into us as part of the human condition. Two of these emotions are Fear and Hope. We all take actions in the hope that they will produce a desired result. If they do, we feel elated, but if they don’t we suffer. In trading we hope to increase our equity, by entering and exiting the market in accordance with our strategy, but if we are wrong, we lose confidence and begin to feel the inevitable fear. If fear is not managed, it turns into to panic and panic leads to large losses. The only thing left for a trader to do is to pray.

By consciously building a model that will alter your mindset in such a way as to create positive feedback loops, a trader can gain in confidence and learn to manage both winning and losing trades. So what is a positive feedback loop? It is the set up, in one’s mind of a path of actions that lead to positive results. The positive results in turn lead to new positive actions and therefore, we discover that success breeds success.

To go about the process of building positive feedback loops, one needs to encompass a holistic procedure that will integrate all the components of trading, such as having the right amount of capital, a proper trading system, a suitable market and a management strategy that contains the inevitable risks. Risk is a feature of life, not only of trading. Therefore, if a trader can learn to measure risk, he can learn to manage it. Once risk is manageable, so that the trader feels as if he is in control, a positive feedback loop is in the making.

TradeStation Chart Analysis

In the above chart, we see a market that turns quite abruptly. If a trader is long, without a plan of what he will do should the market turns unexpectedly, he is likely first to feel anxiety as the first bearish candle is printed, then as the price continues down, but does not stop at the anticipated support, fear becomes prominent and when the market makes a further decline, the unprepared trader is faced with panic. The losses are on paper and if there is no margin call, the trader will in all likelihood liquidate his position.

There is a saying that the more experienced trader waits for the blood to flow and then gathers up the bargains. All of this emotional roller coaster can be avoided by learning to build a trading model that is properly constructed in terms of the trader’s goals, funding ability, time and temperament.

In the next article, I will discuss setting goals as a basis for building a proper trading model, so a trader can know he can expect realistically and confidently and therefore not expose himself to abrupt and unplanned market events, which ultimately destroy his confidence and his trading account.