THE SHIFT TO MENTAL ANALYSIS in Trading

Article from “Trading in the zone” by Mark Douglas

If technical analysis works so well, why would more and more of the trading community shift their focus from technical analysis of the market to mental analysis of themselves, meaning their own individual trading psychology?

The most likely reason is that you’re dissatisfied with the difference between what you perceive as the unlimited potential to make money and what you end up with on the bottom line. That’s the problem with technical analysis, if you want to call it a problem. Once you learn to identify patterns and read the market, you find there are limitless opportunities to make money. But, as I’m sure you already know, there  can also be a huge gap between what you understand about the markets, and your ability to transform that knowledge into consistent profits or a steadily rising equity curve.

Think about the number of times you’ve looked at a price chart and said to yourself, “Hmmm, it looks like the market is going up (or down, as the case may be),” and what you thought was going to happen actually happened. But you did nothing except watch the market move while you anguished over all the money you could have made. There’s a big difference between predicting that something will happen in the market (and thinking about all the money you could have made) and the reality of actually getting into and out of trades.

I call this difference and others like it, a “psychological gap” that can make trading one of the most difficult endeavors you could choose to undertake and certainly one of the most mysterious to master. The big question is: Can trading be mastered? Is it possible to experience trading with the same ease and simplicity implied when you are only watching the market and thinking about success, as opposed to actually having to put on and take off trades?

Not only is the answer an unequivocal “yes,” but that’s also exactly what this.

I don’t think I could put the difference between the consistent winners and everyone else more simply than this: The best traders aren’t afraid. They aren’t afraid because they have developed attitudes that give them the greatest degree of mental flexibility to flow in and out of trades based on what the market is telling them about the possibilities from its perspective. At the same time, the best traders have developed attitudes that prevent them from getting reckless. Everyone else is afraid, to some degree or another. When they’re not afraid, they have the tendency to become reckless and to create the kind of experience for themselves that will cause them to be afraid from that point on.

Ninety-five percent of the trading errors you are likely to make—causing the money to just evaporate before your eyes—will stem from your attitudes about being wrong, losing money, missing out, and leaving money on the table. What I call the four primary trading fears.

You don’t have to know anything about yourself or the markets to put on a winning trade, just as you don’t have to know the proper way to swing a tennis racket or golf club in order to hit a good shot from time to time.  But, to improve my overall score, I needed to learn technique.

We need technique to achieve consistency. But what technique? This is truly one of the most perplexing aspects of learning how to trade effectively. If we aren’t aware of, or don’t understand, how our beliefs and attitudes affect our perception of market information, it will seem as if it is the market’s behavior that is causing the lack of consistency. As a result, it would stand to reason that the best way to avoid losses and become consistent would be to learn more about the markets. This bit of logic is a trap that almost all traders fall into at some point, and it seems to make perfect sense.

But this approach doesn’t work. The market simply offers too many— often conflicting—variable s to consider. Furthermore, there are no limits to the market’s behavior. It can do anything at any moment. As a matter of fact, because every person who trades is a market variable, it can be said that any single trader can cause virtually anything to happen.  This means that no matter how much you learn about the market’s behavior, no matter how brilliant an analyst you become, you will never learn enough to anticipate every possible way that the market can make you wrong or cause you to lose money. So if you are afraid of being wrong or losing money, it means you will never learn enough to compensate for the negative effects these fears will have on your ability to be objective and your ability to act without hesitation. The hard, cold reality of trading is that every trade has an uncertain outcome. Unless you learn to completely accept the possibility of an uncertain outcome, you will try either consciously or unconsciously to avoid any possibility you define as painful. In the process, you will subject yourself to any number of self-generated, costly errors.

Now, I am not suggesting that we don’t need some form of market analysis or methodology to define opportunities and allow us to recognize them; we certainly do. However, market analysis is not the path to consistent results. It will not solve the trading problems created by lack of confidence, lack of discipline, or improper focus. When you operate from the assumption that more or better analysis will create consistency, you will be driven to gather as many market variables as possible into your arsenal of trading tools.  But what happens then? You are still disappointed and betrayed by the markets, time and again, because of something you didn’t see or give enough consideration to. It will feel like you can’t trust the markets; but the reality is, you can’t trust yourself. Confidence and fear are contradictory states of mind that both stem from our beliefs and attitudes. To be confident, functioning in an environment where you can easily lose more than you intend to risk, requires absolute trust in yourself. However, you won’t be able to achieve that trust until you have trained your mind to override your natural inclination to think in ways that are counter productive to being a consistently successful trader. Learning how to analyze the market’s behavior is simply not the appropriate training.