Trading Mindset & Psychology - Part 2

Introduction

Welcome back to part two of our deep dive into trading mindset and psychology. In this continuation, we'll explore the importance of developing a mental framework for trading success.

The Mindset's Dominance Over Technical Skills

Before I proceed, there is a question that I would like to ask you: do you want to become a high six-figure trader? Have you really got what it takes to trade a seven or eight-figure account right now from tomorrow? How would you feel trading a seven or eight-figure account? I would argue that you can do it. If you want to become a seven or eight-figure trader, you can do it. Genuinely, you can do it. If others can, why can't you?

What's stopping you? It's not about the market. It's not the strategies. It's not even about the economy. It's you, your mindset, your approach, your lack of self-awareness. It's your failure to understand that your emotions are wrecking havoc on your trading. How often do you trade and you experience emotions such as fear, greed, impatience, but you're not aware of them? You think you've got control of them, but they're silently guiding your decisions and dictating your outcomes.

If you're not ready to trade a seven or eight-figure account, then you know exactly why. Because you're not in that right mind frame. You don't have the right process. You don't have the right experience. You don't have any edge or statistics to prove that you are at that level where you can go ahead and trade seven or eight figures if somebody gave you that responsibility. So, it's time to take control of your mind. Understand your emotional triggers and start trading from a place where you have a level of clarity, discipline, and resilience. If you can master your mental game up here in your brain, then I'm fairly certain that the success of your process, your strategy, and eventually the financial success will follow.

What is a Trading Mental Framework?

A trading mental framework is a structured approach to managing the psychological and emotional aspects of trading. It's a set of principles, strategies, and practices designed to help traders develop the necessary mindset needed to handle the inevitable ups and downs of the market.

In trading, success is not just about your strategy or analysis. You can become a proficient technical master when it comes to price action trading, but it's irrelevant because the underlying foundations for success extend beyond your technical skill set. I'd argue technical skills probably contribute only about 20% towards your success, with the remainder being about mastering your mind. A strong mental framework allows you to stay focused, disciplined, and resilient in the face of challenges. It helps you reduce the impact of emotional biases that cause poor decision making.

The importance of a trading mental framework cannot be overstated. Without a clear mental structure, traders can easily fall prey to emotional impulses like fear, greed, and overconfidence. All of these can lead to significant losses. A mental framework helps you remain grounded and process-driven, ensuring that your decisions are based upon logic and a set of guidelines, helping you achieve consistency. By creating and maintaining a solid trading mental framework, you become better equipped to deal with the unpredictability of markets and significantly improve your chances of long-term success.

Embracing Market Uncertainty and Randomness

As traders, we need to accept a fundamental truth: we can't control what markets do. What we can do is understand them. Many traders, especially beginners, fall into the trap of trying to predict every market move. But the reality is markets are unpredictable, and no amount of analysis will ever provide absolute certainty. This is because anything can happen at any time.

Global events like wars, unexpected economic policy changes, or even a single major news announcement can shift markets instantly. Consider the crypto market in 2022 with the collapse of Luna and the subsequent impact, especially with the FTX situation. Liquidation events where traders are forced out of their positions create cascading effects. Even external shocks like exchange hacks that shake investor confidence impact price. In the forex world, central bank policy changes such as interest rate decisions can drastically alter the market landscape.

Instead of focusing on prediction, we should shift our mindset towards adaptability. The key to understanding markets is embracing uncertainty. Even with the best analysis or setup, unexpected events can disrupt everything. Market moves are unpredictable with a high degree of randomness. You have to stay humble, open-minded, aware, and avoid speaking in absolutes because it doesn't matter how good your analysis is or how perfect your trade setup looks. Markets are unpredictable, and there's always a high degree of randomness in market movements, which means no prediction is ever likely to be 100% right. This is why having rigid expectations can be very dangerous for traders.

To truly grasp this, you need to embrace an open mindset, stay humble, be adaptable, and avoid speaking in absolutes. The more flexible you are in your thinking, the better you'll become at managing risk and making sound trading decisions. The market doesn't care about your positions if you're not flexible. The market doesn't even care about you. But what you can do is understand and be respectful towards the markets. You need to embrace both uncertainty and randomness.

Many traders struggle because they don't fully appreciate or accept uncertainty and randomness. This leads to stress, frustration, and poor decision making, which makes you question yourself as a trader. Common emotional reactions include questioning your analysis, believing the market is rigged or manipulated, or blaming algorithms—all because you're not thinking objectively about price and markets.

If you want to develop as a trader, you need to start thinking objectively first and foremost and embrace this mindset of uncertainty and randomness. These two key concepts must become part of your trading psychology.

The Truth About Trading: Expectancy

Let me ask you a very simple question: What is trading? What does it mean to you? In a nutshell, what is trading? Take a moment to reflect on this question.

The truth about trading is it comes down to expectancy. And so what you're really looking for is positive expectancy. Remember this because we'll explore this concept further. I'll demonstrate how it's not about your win rate. It's about how big your winners are and how small your losses are. You can have a 30-40% win rate in trading. In fact, some of the best traders in the world have a 35-40% win rate. But why are they successful? Well, because their average winners exceed their average losses significantly because their losses are very, very small.

On the flip side, when you look at some of the CFD brokers, traders who trade on CFD platforms have anywhere between a 60 to 65% win rate, yet they're not profitable, yet they have a negative expectancy. Why do you think that is? It's simply because of the fact that their average loss size exceeds the average win size.

So to measure success in trading comes down to expectancy. Expectancy summarizes everything we've discussed about the importance of having a positive expectancy. You want to be successful in this game, you've got to have a positive expectancy. How many of you out there right now know your expectancy for the last 12 months? If you don't know your expectancy, what are you doing in this game? And if you're not tracking your expectancy, it's time to wake up.

So, you want to be tracking your risk-to-reward ratio. You want to make sure that your losses are small and your average wins far exceed your losses. Then we come into the compounding effect where larger wins help to build your trading capital more effectively with fewer winning trades. Your strategy should be able to survive three, four, five losses in a row because the focus is more upon capturing the larger moves when they happen. You only need a good few trades in a month to outperform all those losses, and therefore you can have a very low win rate.

My win rate hovers around 46-47%. That's because I've got a nuance to my system, which is a three-strike rule on trade execution. I will take very, very small cuts before I can get into my desired position. I believe that the probability is in my favor. And when the move happens, my average win size exceeds my average loss size because I take very, very, very small losses. In fact, risk management and taking small losses is one of my strengths. It's what's allowed me to survive in this game and build and compound my own account over the years. I've been trading for nine years now, of which the last five years have been profitable.

This image concept comes from "Mastering the Mental Game of Trading." Look at the number of wins and look at the size of the wins. You can see more L's on this diagram, but there are probably 10 wins and far significantly more losses. This is an example of positive expectancy. So don't beat yourself down if you're constantly losing trades. What it really comes down to is how much you lose on those trades. If you can stop the rot and stop the bleed and stop losing money on your losses, you're halfway there to becoming a good trader. Because the number one reason why people blow up is because they take those big significant losses. And when it comes to winning trades, they can't capture the big wins.

Now, let's take a step forward. When you see a diagram like this, how do you envision the P&L curve to look like? Any ideas? Any guesses? Have a think about what the P&L chart would look like for these stats. You'll be surprised to see it's a lot of sideways. A big spike up. Significant sideways. Another move up. Slow sideways again. Another move up. This is what positive expectancy looks like. Look at the control of the risk management. Look at the control of the account draw down. Again, look at this consecutive losses right by the decline in the graph. But it's a very, very slow decline which demonstrates fantastic risk management and the ability to lose very small amounts. But yet, when those big wins happen, look at the significance of what happens to the P&L.

Trading with positive expectancy entails trading with high risk-to-reward setups. I personally aim for at least two R, sometimes three R, maybe more if it's a range trade. I can easily chalk up a 4R trade when the setup is there. Profits really depend upon identifying occasional opportunities for aggressive risk taking. We'll talk about risk taking and position sizing in another section focusing on risk management.

Self-Recognition vs. True Control

So I hope you've had a good understanding of the importance of, number one, expectancy, and two, why we need to have a positive expectancy. Now let's talk about expectancy and managing the psychological toll. To manage the psychological toll, it requires you to have a bargain with yourself to stay committed during challenging periods. There will be dry periods in trading where you go through loss after loss after loss. Sometimes I've been on four or five losing streaks. It involves accepting periods of losses, underperformance, erratic returns, and P&L volatility in exchange for potential long-term gains. You have to go through this. Don't think that you can watch some videos such as this and other videos, and that's it, you've mastered the art of trading. It's a gradual learning process.

Before we can develop a mental framework, I need you to understand the importance of everything we've just covered in today's video. Understanding markets through to embracing uncertainty, embracing randomness, being able to think objectively, understanding the truth about trading. What is trading? Taking everything away, ultimately, what is trading? It's expectancy.

Don't fall into the trap where because you keep hitting a losing trade, then another one and another one, you think, "s***, the next trade setup, I'm a bit hesitant, I'm a bit scared or fearful". Or perhaps you're going to start revenge trading. Think, "you know what? f*** this. I'm just going to double up on my trade size here. Let me just floor this next setup. I really need to get that count back to break even or back to where it was last week". And before you know it, like I said in the previous video, you're 4K underwater. You've gone for the juga, and now you're 8K underwater. Your account has just suffered a 10% drawdown in a week. You have a few more weeks like that, your account will be down to 30-40%. And then it's an uphill struggle thereafter.

Recognizing your emotions in real time doesn't mean that you can stop them, as emotional patterns have very, very strong momentum. So you get this perception of false control. You know, initially, you may recognize that you have a level of control, that you're fearful at a level, or that this urge to revenge trade, "No, I'm curving it back in. I've got a control of it". But it's temporary, and it's driven by novelty, not real correction. It's because over the last two or three days, you've been thinking about your trading. You've been thinking about not revenge trading. You've been thinking about not acting impulsively. But the minute you stop thinking about who you are as a trader, you will go back to your old habits because you've not really addressed the root issue or the root cause.

And so, most traders need more than recognition or self-recognition. True change requires more than just mapping your emotions. Deeper performance flaws need to be addressed in order to see yourself progress as the trader that you aspire to be. To achieve that sustainable level of control in being able to work with your emotions, it requires a much greater, deeper level of work.

Equally, if not more than all the effort and time that you've put into learning the technicals of trading, of price action, of whatever system you've adopted, you need at least that much effort, if not more, on the mental side of trading to achieve that level of mastery and consistency that you're striving for.