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The
Three Vices of Trading
By Brett N. Steenbarger, Ph.D.
The following is a short article that
summarizes several of the psychological pitfalls that interfere with
accurate pattern recognition. My hope is that traders can focus on
these three “vices” as mental preparation prior to entering the
markets. One of the best ways of becoming an observer to your
negative behavioral patterns—rather than a trader lost in those
patterns—is to periodically take your emotional temperature. That
means standing back and asking yourself: Am I falling prey to one
of the vices below? Remember, observing and interrupting your
patterns are the first steps in altering them! Your patterns lose
control over you as you become better at not identifying with them.
When you become an observer to your patterns, you are separating
yourself from them. What great progress that is!
Vice Number One:
PERFECTIONISM
Perfectionism is often the chief culprit when the pain of
losing exceeds the pleasure of winning. Desperately trying to feel
good about themselves, perfectionists set unrealistically high
ideals. They think they will finally be OK if they just accomplish
X. (For X, you could substitute many things, including looks,
wealth, popularity, or achievement). Because X is an unattainable
goal, perfectionists ironically use their ideals as a basis for
self-criticism when their performance doesn’t match up. After all,
is achieving X will make me OK, then I must not be OK if I fail to
achieve X. The emotional theme of the perfectionist is “not good
enough”. Perfectionists are driven to do more and more because
they never feel competent, worthy, and loved as they are. Thus,
even when there’s a profit on a trade, perfectionists will look for
the portion of the move that they did not participate in. If they
caught most the move, they will reprove themselves for not trading a
larger position. And when trades don’t go well, perfectionists
review all the reasons that shouldn’t have made the trade, should
have known better, etc. By focusing on the portion of their
performance that doesn’t match their ideals, perfectionists
transform successes into defeats, losses into failures. They
rationalize their perfectionism as a drive for achievement, but all
they are accomplishing is an undercutting of their confidence.
Perfectionism shows up as negative self-talk and
self-blaming. Emotionally, we recognize perfectionism from
frustrated, angry feelings when trades don’t work out as planned.
“Beating myself up” is how many perfectionists describe their
self-talk. The way to beat perfectionism is to make a concerted
effort to talk to yourself the way you would talk to a good friend
in a situation where things went wrong. Most people know how to
treat others with respect, love, and dignity. They just haven’t
learned to do the same for themselves. If you would be more
nurturing, understanding, and supportive of a friend than you are of
yourself in the identical situation, then you know that you’re not
being your own best friend. If a trade doesn’t work out, the
constructive trader focuses on, “What can I learn from this?”—not
“What’s wrong with me?”. The best antidote to perfectionism is the
ability to reassure yourself, “There will be better trades down the
road.” The key is to not miss those better trades while you’re
beating yourself up!
Vice Number Two: EGO
Everyone likes to win in the markets. It’s only natural
to feel good when you’ve done your homework and end the day with a
profit to reward your efforts. Ego involvement in trading, however,
goes further than this. When the ego is involved, we write the
market a blank check for our self-esteem. If trading is green, we
feel good about ourselves; if we go into the red, we feel
diminished. That places tremendous pressure on our trading over
time. Not only do we have the burden and challenge of reading
complex market patterns; now we also have a psychological gun
pointed to our head ready to go off any time our pattern recognition
fails us.
Most traders are aware of the dangers of trading
with too much leverage. A trader accustomed to trading 2 lots,
where each tick in the ES is worth $25, would feel overwhelmed
jumping to 100 lots, where each tick now moves the account $1250.
With the stakes raised to such a degree, the same trade would now no
longer feel the same. It would be hard to let a position go against
you by a point ($5000, instead of $100), and it would be difficult
to let a profit run. When traders invest their feelings about
themselves in their trading, they are operating with maximum
emotional leverage. In the currency of self-esteem, they trade
100 lots. So much of their emotional account rides on each trade,
that it inevitably affects decisions about cutting losses, letting
profits run, and entering and exiting in a timely fashion. The
successful trader wants their trades to work out; the ego-involved
trader needs them to be profitable.
We know that ego threatens our trading when we
find ourselves needing to trade just to win back some
recently lost dollars; when we feel a desire to advertise our
positions; and when we find ourselves riding an emotional roller
coaster as profits wax and wane. Just as we can recognize traders’
perfectionism from anger/frustration, we recognize ego-involved
traders from euphoria/depression. If trading has us truly
depressed, we know that it’s not just our trading account that’s
hurting. The antidote to ego-involved trading is to place our
self-esteem eggs in many baskets: recreational interests; other work
involvements; relationships; and our spiritual lives. Many times we
pour our self-esteem into trading because those other facets of our
lives are not properly developed. A balanced life makes for
balanced trading. We can take some of the ego out of trading by
learning from others, by becoming a candle that lights other
candles, and by using a portion of market profits to help others
make a wish that will come true. If your good feelings in life come
from good relationships and worthy achievements, you won’t need
the markets for your happiness. Market success can be the frosting
on the cake of your successful life, rarely can it substitute to the
cake itself.
Vice Number Three:
OVERCONFIDENCE
It is common for traders to complain of a lack of
confidence in their trading, but very often it is overconfidence
that does them in. Overconfidence results from a lack of
appreciation of the complexity of markets and an underestimation of
the challenges of trading them successfully. In a sense,
overconfident traders lack respect for the markets. They think that
reading about a few setups or buying the newest software will
prepare them to make money. Overconfident traders don’t want to
work their way up the trading ladder: they resist the idea that
screen time is the best teacher. They also chafe at the idea of
growing their account. Rather than start with one contract and wait
until they’re profitable before trading larger size, they want big
positions—and profits—right away. Because they’re so eager to make
money—and so sure they can make it—overconfident traders generally
trade impulsively. They won’t wait for the setup to form; they’ll
jump the gun—and get whipsawed in the process. Instead of being
patient and waiting for short-term patterns to align with
longer-term patterns, they will take every trade, enriching their
brokers in the process.
The hallmark of overconfident traders is that
they think they are going to make something happen in the market,
instead of patiently waiting to take what the market gives them.
Spelling out profit goals for each day or week of trading is one
manifestation of overconfidence. Humble traders know that markets
expand and contract their volatility—sometimes the trade just isn’t
there. The overconfident trader, however, feels that he/she is
bigger than the market. Indeed, overconfident traders will often
take great pains to try to catch the tops of bull swings or the
bottoms of corrections. As a result, they often fight the market
trend—and can get run over in the process. If the emotional signs
of perfectionism are anger/frustration and the emotional signs of
ego involvement are elation/depression, then the emotional signs of
overconfidence are impatience/impulsivity. Overconfident traders
overtrade. They fear missing opportunities more than they fear
losing money. The antidote to overconfidence is rule-based trading
and the intensive rehearsal of trading rules. By making entries,
exits, stops, and position sizing rule-governed and vigorously
rehearsing trading rules during simulated trading (as well as in
real time with small positions), traders can greatly reduce their
impulsive trading. Very often this means training oneself to focus
on (and rehearse) what-if scenarios of being wrong in the market, as
well as forcing oneself to spell out the rationale, targets, and
stops for all trades. By making trading a more self-conscious
process, traders interpose thought between impulse and action,
gaining greater control of their trading. When the trading room
admonishes, “No boasting, just posting”, it is encouraging restraint
on overconfidence.
Summary
Clearly, the three vices are not completely independent of one
another. There can be significant overlap for traders. For
example, a trader might take a position out of overconfidence, then
hold onto it out of ego-related stubbornness and pride. Whether the
vice is perfectionism, ego, or overconfidence, the basic problem is
the same: Making the trade about oneself, rather than about the
markets. If you are thinking about yourself—how much you’ll make or
lose, how well or poorly you’ve done, how much you’re a success or a
loser, how much better you could have done—you can’t be fully
focused on the markets. It’s not about you. It’s about the setups
and the ability to read them. And to read them, you must be one
with them, immersed in them, so that you feel them, not just
observe them. You can’t feel the markets and become lost in
feelings of anger, frustration, elation, guilt, depression,
impatience, or impulsive need. The greatest vice in trading is to
take it personally, to become so focused on the outcome of trading
that you lose sight of the process. If you are fulfilled outside of
trading, your other needs will not infiltrate your decision-making
and sabotage your entries, exits, and money management. If you
build yourself physically, socially, spiritually, and
professionally, you will find that the markets won’t need to bear
the burden of carrying your identity.
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Brett N. Steenbarger, Ph.D. is a clinical
psychologist and active trader, writer, and
researcher for the past 20 years, Brett is the
author of The Psychology of Trading (Wiley;
2003) and numerous articles on trading psychology
for print and online financial publications.
Click here for full
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