Trading Mindset & Psychology - Art of the Trade

Introduction

This section on mindset and psychology is detailed and important because without a solid mental foundation, no strategy will succeed. Think about that for a moment.

In terms of trading, when we start out, we often focus on the technical aspects of price. Throughout the first few years, we're constantly trying to refine our understanding of the game, whether it's price action, order flow, market profile, or other approaches. We're always searching for that "edge" in trading, and it's natural that so many of us focus heavily on technical analysis, always looking for that next strategy that can make us money.

The Overlooked Foundation: Mindset and Psychology

I can speak from experience that when I first started trading in 2018, and even until not long ago, I was heavily reliant on technical analysis and market sentiment. I was seeing some results and some consistency, but every now and then, I noticed I was making many mistakes. Deep down, I thought the issues were with my technical ability, maybe my inability to read price effectively.

Personal Revelation

However, when I really looked beneath the surface, I later understood that many of the mistakes I made were not because of the technical setup or my inability to read price; they were purely driven by emotions. My emotions were holding me back from developing further in my own trading career.

There's a tendency for so many of us traders to overlook the psychological discipline required. We need a level of emotional control, sharp decision-making under pressure, and the ability to handle losses and uncertainty.

The Real Balance of Trading Success

Overall, based on my reflection and conversations with many traders, so many spend a large amount of time, probably most of it, on the technical aspects, maybe journaling and understanding who they are. But very few I've encountered truly focus on the importance of the mindset.

Looking back on my own career, I would say the technicals of trading probably play only a 20 to 25% role in your performance, while the remainder, the 75%, the core of your performance, comes down to:

Understanding who you are as a trader
How your mind operates
Your ability to handle emotions
Essentially bringing the very best version of yourself to the desk every single day

We can conclude that technical skills matter, but without the right mindset, success is impossible. It doesn't matter what system you trade. I could give you a winning strategy that's performing well, making monthly returns, with a good profit factor and expectancy. If you don't have the ability to handle your mindset and the emotions of trading, then no matter how effective a strategy might be for someone else, it won't make any difference to you. That's the reality, and we have to accept that.

Why Most Traders Fail: Psychological Pitfalls

Here are five reasons why most traders fail:

1. Lack of Trading Edge

Many traders fail because they don't have a clear methodology or a proven edge. It's essential for long-term success and provides an advantage in the market. Without it, you're essentially gambling. Having an edge means understanding probabilities, knowing what works for you based on data, and knowing when to stay aside.

2. Emotional Instability

Trading is psychologically demanding. High levels of emotional instability, like overreacting to a loss or chasing a winning streak, cause emotions to take over, especially when focused on goals instead of the process. Developing emotional resilience is essential for success. It's about executing the plan and not being swayed by temporary market fluctuations. How often have we traded impulsively, opening our phone and taking a trade because we see price moving, or being afraid to pull a planned trade due to volatility?

3. Overtrading and Impatience

Overtrading is often a direct result of impatience. As aspiring traders, we often feel the need to be in the market all the time, leading to unnecessary trades. This happens when traders believe they can force profits or can't resist clicking. We sit at the desk, looking for an opportunity, asking, "Where is it?". Before we know it, we've taken a substandard trade because we lack a process or a system. We don't know what we're looking for, take poor trades, don't plan position sizing or invalidation rules. Or maybe we front-run a level because we're impatient.

4. Ego-Driven Decisions

This is probably the biggest one for most, including me. I've been there; when I successfully ride the market trend within few days after trading cryptocurrency, when was successfully shorting the bear market, I let my ego get to me due to overconfidence. My ego and personal pride started influencing my decisions. Ego-driven decisions can also manifest as refusing to cut a losing position. How often have we been significantly offside in a trade but refused to cut it, hoping it will turn around because our ego is getting in the way of rational thought? We hold on because we don't want to take the loss, hoping for break-even, only for price to blow through support levels.

5. Ignoring Market Context

How often do we see traders trading against the trend or not understanding the difference between range-bound and trending environments? Context is key to understanding where price is. We need to leave emotional bias outside the trading room and trade what is in front of us and what the market is telling us. This requires understanding where, according to our process, we can effectively trade in the current context.

As a result of these failures, some common discipline problems we often experience include:

Frustration with our progress
Being obsessed with outcomes (like P&L goals) instead of process-driven goals
Delayed actions in execution due to fear (failing to execute a good setup when price comes into a level with volatility)
Lack of engagement (emotions holding us back, being distracted or stressed)
Mental distractions (exerting time and focus elsewhere)

Maybe we're overloading on information, jumping between order flow, market profile, data like open interest or CVD, trying to find an edge without enough sample size or a quantifiable strategy. We're constantly tweaking our system, but perhaps the system isn't the issue. As I said, someone could give us a winning strategy, but do we have the mental capacity, ability, psychology, and mindset to execute it? Only a small subset can trade for a living using these concepts.

The Role of Biology and Understanding Emotions

Let's look at who we are as human traders – the role of biology in trading. Trading success isn't solely about skill; human biology plays a significant role in our decision-making. Our brains' natural wiring often works against us in those high-pressure trading environments. The same instincts that evolved for survival can cause emotional reactions that hurt trading performance.

A classic example is the fear of cutting a losing trade because we don't want to experience another loss, or hesitating to execute a trade when price comes into a level, thus missing a good setup. Studies show the brain struggles to make optimal decisions under pressure. The stress of the market often leads to poor judgment and choices we didn't plan to make. We can have the perfect strategy, but if our emotions hold us back, we likely won't execute our plans. This leads to hesitancy and regretting trading due to the fear of making a wrong choice. That fear prevents us from acting when good opportunities arise.

Impulsivity also takes over with risk-to-reward decisions, especially under stress. Traders make poor risk-to-reward decisions, sometimes acting too quickly without considering the downside because urgency overrides rational thought.

This is where nuance, experience, and calmness come in, achieved by understanding our emotional flaws. High stakes emotions change our brain activity. Trading emotions include fear, greed, hope, impatience, overconfidence, and regret. These are felt every time we're at the desk looking to take or manage a trade.

Key Emotions That Impact Trading

Greed

An overemphasis on P&L, purely focused on holding for more gains. A constant need to make money from every trade, chasing unrealistic returns and pushing for maximum gains while ignoring risk. We only think of profitability, not the downside scenario or draw down.

Fear

Constantly doubting and second-guessing decisions due to lack of confidence. Emotions make us doubt execution. Excessive worry about downside risk and failure causes hesitancy. We stay on the sidelines due to the fear of being wrong, especially after recent losses. Over-prepping but failing to execute the plan is another common consequence. We ignore our instincts and go against our gut.

Anger or Frustration

Includes irritation, annoyance, and rage. Anger signals a conflict between reality and realistic expectations. If we don't understand our motivations, what we want, and our time horizon, it leads to frustration because expectations are unrealistic. This can manifest as hating to lose or injustice tilt – feeling angered by perceived unfairness, like market makers being out to get us or market conditions changing. These are often excuses to justify underlying emotions.

Revenge Trading

Acting impulsively out of anger or frustration after a losing streak, trying to make back losses in one trade, often leading to even larger losses.

Overconfidence

Happens after a successful streak. We feel "s*** hot," size up, go "all in" on the next trade, and break all risk management rules. This can wipe out weeks of account growth. Overconfidence inflates the ego, making us believe we are expert traders, but the market quickly humbles us. The market doesn't care about our winning streaks or positions; it behaves how it wants. We can't control the market, but we can control position sizing and risk management, curbing the desire to go big.

Lack of Confidence

Plays into fear. We have a pessimistic outlook, question our ability, constantly look for the next strategy, and dwell on losses and traumatic experiences. There's a lack of energy, feeling down or depressed, and struggling to take responsibility. This doubt in potential stems from not understanding why the confidence is lacking.

Finally, there's Trader's Tilt, which includes self-criticism, harsh self-talk, frustration spilling over onto family or friends, impacting mood. Signs of tilt are acting out of impulsivity, revenge trading, and risk blindness (reacting without considering further downside risk).

I'm sure these emotions are relatable during trade execution or management. Each emotion acts as a trigger. Fear can lead to exiting too early or failing to execute. Impatience can lead to entering too early. I urge you to consider how many you've experienced and if they're preventing you from becoming the trader you strive to be.

Working With Emotions: The Path to Self-Mastery

To move forward, what do we traders generally perceive will help us improve? It's often easy phrases thrown around like needing to be more consistent, having more determination, working harder, being smarter, or journaling more frequently. These were some of my thoughts back in 2019/2020. But really, all these are quite flawed. What does "consistent" actually mean? What does "better determination" mean?

Going Beyond Surface Solutions

Working harder, being stricter, journaling more frequently – none of these truly resolve the underlying issues, which are your emotions, your mindset. We need to work with them, not resolve them by creating rules to suppress them, because temporary fixes eventually fail.

Despite good intentions, these approaches won't help until we understand ourselves, our mindset, and our emotions, and have a mental framework along with the trading process.

Take journaling. Reviewing trades might show technical areas for improvement, like execution timing or needing to check order flow. But what was really holding you back was often an inability to execute, an inability to take profit sooner due to emotions. We need that awareness, be humble, and journal with a purpose.

The Truth About Emotion Control

We're often fighting our emotions instead of working with them. As a classic example, consider overtrading. If you take many trades a week and notice better results when trading less, you might write a rule limiting yourself to two trades a week. But what if those two trades are substandard, and then great opportunities arise later in the week? Will you not take them because of the hard rule? This rule counteracts overtrading because you failed to understand the emotions associated with it. Don't just create rules to suppress emotions; understand why you're overtrading. Understand why you perform better when trading less; why are you overtrading in the first instance?

A myth is that you can always control or suppress your emotions, but the reality is you can't. Emotional control is a mental process. You won't achieve it in 6 weeks or 6 months; it's a gradual process taking years of practice to truly appreciate how to manage your emotions during the trading lifecycle.

Don't think that having a mental framework and structure will instantly resolve all emotional issues just because it's written down. It genuinely takes time and experience to understand yourself and keep working at bettering your mindset and ability to work with your emotions.

Emotional control is about how we manage our response to emotions, not suppressing them. This is crucial to understand. Only through experience and working on your mental game will you reach a level where you work with your emotions, being fully aware during times of stress. Emotions can overwhelm us. When intense, they can hijack our decision-making process, making control difficult, regardless of effort. We have to accept this; we won't become immune. Sometimes emotions will be heightened, other times subdued. The power of emotion can shut down control, especially in high-stress situations. Fear, greed, and frustration can override logical thinking.

Finding the Optimal Balance

Applying the concept related to the Yerkes-Dodson law, there's an ideal level of emotional arousal for peak performance. Too little emotion (fatigue, disengagement) results in poor decision-making. Too much emotion can overwhelm cognitive function. We aim for that balanced level of using our emotions for peak performance.

Understanding your emotional threshold is key – that tipping point where emotions impair clear thinking and rational decisions. Recognizing when you're approaching this threshold is essential for maintaining performance. This requires a great deal of self-awareness.

When emotions rise too high, the prefrontal cortex, responsible for emotional control and critical thinking, weakens, leading to impulsive decision-making and a decline in ability. This affects trading performance because emotions are out of control. Recognizing emotional overload early is crucial. Signs can be physical, like biting nails, tapping feet, or fidgeting.

Maintaining the right emotional balance is important. Finding and maintaining the optimal emotional level keeps your brain engaged and focused, helping make better trading decisions, think with clarity, and avoid poor trades.

Emotions as Signals

So, emotions can cause problems, but maybe we just need to interpret what they mean. Over my six years of trading, I've heavily emphasized how emotions can fuel performance. Emotions are essential for reaching peak performance and provide the energy needed for success.

Even negative emotions like anger and fear can be useful, like how elite athletes use criticism to fuel their success. Maybe criticism from others fuels us to prove them wrong, not just to them, but to ourselves, driving us to become the best version of ourselves. Control and mastery of emotions are essential to optimize performance. Elite performers have amazing emotional balance. I've strived for this. Having emotions in check makes you much better at handling high-pressure trading environments.

Emotional balance is critical for long-term success. It's like navigating a boat in rough seas or a surfer on a surfboard during an adrenaline rush – requiring balance, the ability to think calmly, maneuver, and ride the flow.

Trading is very similar; we need to ride the flow and rhythm of the markets, manage our emotions with that rhythm to think in a balanced, humbled, open way about trading. Stable emotions lead to better performance, making it easier to get into the zone (optimal trade zone) to improve performance and reduce mistakes.

Building the Foundation: Mental Framework, Risk Management, and Process

To summarize everything we've covered: Ultimately, mastering emotions is key for trading performance. In trading, emotions are often triggered by external events like market movements, losses, or wins. These emotional responses lead to impulsive actions, such as chasing trades or overreacting to losses, which detrimentally impacts our trading ability. Recognizing what stimuli trigger these emotional reactions and understanding them is crucial to managing impulses. When they happen repeatedly, we can eventually work with our emotions and become aware of them.

Discipline With Purpose

Discipline alone isn't the answer. We can make a concerted effort to be disciplined, but it needs a purpose, a reason. Managing emotions plays a big part in remaining disciplined. Control your emotions, and the actions of being disciplined will follow.

This whole journey of becoming a trader, technically and mentally, requires a shift in thinking. To truly master trading, we need to change how we think about ourselves, the markets, and trading. This shift goes beyond controlling emotions or enforcing discipline; it's about altering our perspective so we don't emotionally react in the first instance. This deeper change is necessary to deal with the root cause of emotional triggers rather than just masking them with temporary fixes. Temporary fixes, like a rule to limit trades to counteract overtrading, do not work long-term because emotions will eventually re-invoke the reaction.

The key to lasting change in trading is reprogramming how we respond to market stimuli. This is ultimately about being aware of our emotions and emotional triggers and intentionally thinking and training our brains to respond in a more purposeful and controlled way. By shifting how we think and react, we can hopefully break free from impulsive actions and trade with a much clearer and strategic mindset.

So, what's the key to all of this? Essentially:

You need a very effective mental framework
You have to have a very resolute risk management system
And a trading process

These three components set the foundation for striving and achieving trading success.

The Trader Within: An Exercise in Self-Understanding

Now, for an exercise. I'd like you to go through these steps:

Identify the emotions: Think about a time you've experienced fear, greed, overconfidence, impatience, or tilt.
Provide an example: Describe a specific trade or scenario that triggered that emotion.
Explain how you acted: Describe how you acted while influenced by that emotion. Did you make impulsive decisions? Did you break your trading rules?
Reflect on the outcome: Assess the result of your action. Did it lead to a loss? Was it a missed opportunity? Was it poor judgment?

Example: "I entered a trade and was offside. I didn't cut the trade for a 1% loss because of my emotions of fear – the fear of losing. So, I failed to cut the trade when I should have, and my ego got in the way because I wanted to get out at break even. The result was that instead of a 1% loss, I suffered a 3-4% loss on my account overall."

This exercise is designed to help you understand the common emotional issues that surface and prevent progress in your trading journey.