The Correct Mindset For Successful Trading

Last Updated on December 1, 2020 by Oddmund Groette

Most traders focus on developing strategies in order to make money. So do we at Quantified Strategies, there is no other way around.

However, your trading mindset is often “the missing link” in order to perform well. To get steady returns you have to focus on the trading mindset just as much as the analysis and strategies. For those not into trading, this might sound a little weird. What does psychology have to do with quantitative trading?

The successful mindset is one that is dedicated, focused, disciplined, confident, has no ego, has no fear of losing, and feels detachment to money. 

When you get experience in day trading or other time frames you’ll discover that trading is certainly not as easy as it seems. Quite the opposite. If you can’t follow the rules of the strategies, you simply have no trading strategy. Trading discipline is what most traders need.

Below follows some advice we believe most investors should pay attention to:

Be dedicated

You should be relentless in developing skills in how to master yourself and your risk tolerance. Some traders love the action, others dream of easy money, but the really good traders think about how to develop trading strategies.

The work should be your goal. Money and action are just a byproduct for keeping score on your performance. The trading mindset should be about how to perform the best. Trading decisions are all about being truthful to yourself.

The success rate is in direct proportion to your talent, skills, work ethics, and truthfulness. Not everyone can become a trader. Mark Minervi was interviewed in Jack Schwager’s Stock Market Wizards. Here is a quote from that interview (page 176):

“The fruits of your success will be in direct ratio to the honesty and sincerity of your own effort in keeping your own records, doing your own thinking, and reaching your own conclusions. In other words, take 100 percent responsibility for your results.”

Dedication to your job is thus paramount.

Know yourself

This is vital in developing quantified strategies. You have to get an understanding of who you are and your personality traits. Are you introverted or extroverted? Are you disciplined? Are you able to work on your own? Are you confident by nature? What is your aim? Why do you trade? Trading is solitary, it attracts people that are introverted. The ones with intuition backed up by gut feel can get some kind of a game going in a few months or a year or two but not for the long term, in our opinion. The ones that back up intuition with thinking take much longer to get a game plan and they can last longer. Emotions can’t be part of any investment strategy.

Many want to “make a lot of money” when they start trading. They want to stay at home and have no commuting. The dream of an easy life seems so appealing. Occasionally go to the cafe and trade from there. They are about to get a nasty surprise when they understand the trading psychology is not as easy as it seemed.

Trading is an intellectual endeavor where most investors fail to make any money. Not only is it difficult to find trading edges and strategies, but you need to execute the strategies. The biggest obstacle is implementing your plans. You have to master yourself and undergo personality change in order to get your trading implemented properly.

Stay focused

If you decide to open a pizza shop, most likely you’ll set up some plans for how to proceed. Perhaps making budgets and even some marketing research to check the viability of the plan.

Do you think a potential trader do all this? Probably not. But you need to have a business plan and develop some kind of methodology if you want a trading career. The methodology and techniques have to be linked to your dominant personality trait.

It’s better to have a bad methodology than no methodology at all. This takes time, a lot of time. You first need an idea, some kind of hypotheses, and then you need to backtest the idea to check if it has any statistical edge.

For some, this is the easy part. The tricky part is to execute the trading plan. It all looks so easy when you have the answer in front of you in a backtest.

The problem arises when you are about to pull the trigger. The future result is uncertain. All you know is the past. Self-doubt kicks in. After a drawdown, you might lose faith in the system and stop trading, perhaps exactly at the wrong time. Therefore, you need to practice and stay focused on what you should do. Try to avoid thinking in terms of money. The focus should be on execution. We recommend you automate most of your trading.

Trading Discipline

Discipline is for many a negative word. We quote from Wikipedia:

Self-discipline can be defined as the ability to motivate oneself in spite of a negative emotional state. Qualities associated with self-discipline include willpower, hard work, and persistence.

Self-discipline is the product of persistent willpower. Whereas willpower is the strength and ability to carry out a certain task, self-discipline is the ability to use it routinely and even automatically. We can say willpower is like a muscle, where self-discipline is the thoughts that control the muscle.

Again, Mark Minervi gives a very good analogy:

“The first time I seriously watched a poker game in a casino I noticed that the average winning hand was over 50 USD, but that it only cost you 50 cents to see the first three cards. I couldn’t believe that for half a dollar I could get a pretty good idea of my chances of winning a hundred times that amount. If I folded fifty times and won only once, I would still win twice as much as I lost. Those seemed like terrific odds to me. That’s how I got started playing poker. My strategy was to only play super-high-probability hands. Schwager: Didn’t everyone just fold once you played a hand? No, and you know why? Because they were not disciplined, and they wanted to play. The key is to know when to do nothing. Most people, even if they have a winning strategy, will not follow it because they lack discipline.”

Willpower, willingness to work hard and persistence are not traits that many people have. No wonder this brings negative thoughts to many. However, trading is not a military boot camp, but be honest with yourself to check if you have any of these three traits. If not, trading can be quite hard.

A certain amount of rules are needed to trade well. Even the legendary trader Jesse Livermore used rules to limit himself from doing foolish trades. We advocate systematic trading based on quantified analysis, and this is of course rule-based. The tricky part is to execute the system because you need confidence:

Confident, but not overconfident

The key to trading success is emotional discipline.  Making money has nothing to do with intelligence.  To be a successful trader, you have to be able to admit mistakes.  People who are very bright don’t make very many mistakes.  Besides trading, there is probably no other profession where you have to admit when you’re wrong.  In trading, you can’t hide your failures. Victor Sperandeo

Trading is not different from any other demanding undertaking: It requires mastering the different stages of the learning curve and the quality of this learning process depends on how focused and disciplined the trader is in honoring his acquired skills. If you’re confident, it’s a lot easier to execute your methodology. To become confident you have to acquire the mentality mentioned above. Admit when you are wrong and realize that being wrong is the cost of doing business.

However, there is a thin line between confidence and overconfidence. Brett Steenbarger has written an interesting book about trading psychology and also has a blog. According to him, overconfidence is the worst trait a trader can have. Here is an excerpt from his blog:

Studies in behavioral finance find that about 3/4 of all traders rate their prowess as “above average”, despite the obvious reality that only half of us are better than the other half. This overconfidence, moreover, affects actual trading performance. Research by Terence Odean and colleagues finds that overconfidence affects frequency of trading, which in turn contributes to poor trading results. In one study of online traders, the group of traders favored high beta (volatile) small cap companies and tended to not diversify their portfolios. Their actual trading results slightly beat the small cap index, but after trading costs were factored in, they significantly underperformed the index. The most frequent traders were the ones who underperformed the index by the greatest margin…….One of my favorite studies of overconfidence came from the London Business School. Traders were shown price patterns and asked to figure out the market’s next direction and indicate their confidence in their prediction. The price patterns were generated entirely randomly. The traders with the highest confidence in their predictions traded the most frequently and incurred the greatest losses.

Steenbarger’s argument is a strong case for having a mechanical trading system. Certainly, this applies to those who tend to be extroverts and/or impulsive.

Don’t be a hero.  Don’t have an ego.  Always question yourself and your ability.  Don’t ever feel that you are very good.  The second you do, you are dead… my guiding philosophy is playing great defense.  If you make a good trade, don’t think it is because you have some uncanny foresight.  Always maintain your sense of confidence, but keep it in check. Paul Tudor Jones II

No ego and beliefs

They (traders) would rather lose money than admit they’re wrong…  I became a winning trader when I was able to say, “To hell with my ego, making money is more important” – Marty Schwartz

Some people have a big ego. They need to be right. Some are besserwissers. These people can find it hard to trade completely mechanical. Somehow they need to feed their ego. This trait is prevalent in online discussion forums. They brag about their prediction accuracy, how they have made 200% in 6 months and why others are wrong.

But your prediction rate is completely irrelevant. How much money you make is what counts. A mechanical system can have less than a 50% win ratio and still make lots of money. Such a low win-ratio is hard to execute. In trading, you have to accept that losses are a part of doing business. In order to make money, you have to admit losses. For some, this is very hard. It leads to overtrading, getting stuck in losing trades and taking home small winners. But to succeed you have to divorce from your ego. Leave feelings aside.

Detachment to money

Money is just a way of keeping score. A focus on money can be detrimental.

Brett Steenbarger has done a lot of research on trading psychology. In 2004 he published a paper with Lo and Repin called Fear and Greed in Financial Markets: A Clinical Study of Day-Traders. They investigated several possible links between psychological factors and trading performance in a sample of 80 anonymous day-traders. Here is a highlight of their findings:

…..supporting the common wisdom that traders too emotionally affected by their daily profits-and-losses are, on average, less succesful……..This suggest that large “emotional swings” occurring within a 24-hour time scale hurt trading performance the most (page 19)…..our results show that extreme emotional responses are apparently counterproductive from the perspective of trading performance, and large changes in emotional state within short periods of time are among the most detrimental. (page 19)……For example, in a recent study by Fenton-O’Creevey et al. (2004) of 118 professional traders employed at investment banking institutions, they find that successful traders tend to be emotionally stable introverts who are open to new experiences (page 20)…..Ultimately, we hope to provide a scientic basis for the kind of recommendations for trading success made by Gilbert (2004) in his summary of Fenton-O’Creevey et al. (2004): Be an introvert. Keep your emotions stable. Stay open to new experiences. Oh, and try not to be misled by randomness, stop thinking you are in control of the

situation….(page 21).

Money is a psychological obstacle. The best trader manages to detach from money and focus on trading. Think of your trading it as a long-term investment.

Fear of losing

For introverts, the fear of losing can be an obstacle. Instead of focusing on what to do, you think about how much you can lose. You take profits quickly just to feel well. You might even end up increasing risk, even though you’re trying to minimize it. The biggest risk in trading is not getting the maximum profits from your methodology.

The fear of losing will slow down your trading, especially after a string of losses. Every trader experience this feeling once in a while. If that happens it might be wise to take a break. If you can’t follow your methodology, step back and reconsider. However, this simple advice is much easier to give than to take.

Final thoughts

Trading is a probability game. Find a profitable methodology by testing and implement it. Diversify to several strategies (with the lowest correlation possible). Try to make trading as easy and smooth as possible. Ignore money. Feel detachment to money. Focus on what you should do. Keep it simple!

Trading is really simple, but still, most of us make it really complicated.