The market is not your enemy. You are. Well not you, but some of your innate biochemistry is. I want to point out one of the major buggers that messes with your head: Dopamine. It’s a neurotransmitter chemical that drives so much of our motivations and behavior. Call it nature’s motivator drug.
Casinos know all about it. In fact, the gambling industry’s entire business model is designed around how to maximize how much fun dopamine is having in people’s brains to extract value from the gullible millions. Scientists have studied the effects of dopamine in detail and came up with some surprising results:
We all know when something nice happens to us we experience feelings of bliss and joy. Gamblers get excited when the lights go off at a slot machine and coins fall into the slot below. Traders experience giddiness when they have a nice winning trade. So far so good, but here comes the wicked revelation: Studies show that the ‘near-miss’ effect triggers dopamine levels not only as equal but they even grow stronger over time versus a winning experience.
In short: If you win every single time the thrill diminishes, but keep the prospect of the win just close enough at hand and they keep coming back for more as dopamine levels spike through the roof as the prospect of a win is within reach.
This is nature’s motivator drug to keep you hunting for that deer in the forest even if you have to try over and over. That’s why brains addicted to gambling simply can’t quit while they are ahead. Recognize: Dopamine can work as a drug that negatively impacts your decision making. But without it of course you wouldn’t have a conceivable reason to get up in the morning.
On a subconscious level, a big winning trade can mess with your head. Your brain is seeking to repeat the thrill of the hunt for the next big trade and, in process, the hunt can become more important than the win itself. And this is, in short, the road to trading doom. 500% winning option trades sound nice and they are when they happen, but if you then try to trade for your next big one you will eventually get hammered in the pursuit of the next great white whale. So be very weary when people try to entice you down that path.
Let’s walk through some of the most critical psychological components that can impact our trading:
Overconfidence
What most traders often don’t realize until it is too late is how quickly one can lose a lot of money in a single trade often with disastrous consequences. More often than not this painful experience comes from poor risk management following a period of successful trading. It is natural of course. We are pattern seeking mammals and when something starts working for us we get confident in our abilities and quickly forget we know very little what the market or a given stock may do at any given moment. In short: We easily become overconfident.
It is after a period of successful trading that traders tend to loosen up on good intentioned rules of discipline. They start thinking in term of money as opposed to the trade discipline. In short they think they can fly. “Look how much money I would have made if I had traded using 10X Leverage my Broker provides”.
Stop yourself right there. While it is tempting to play mind games like this no good will come of it. Why? Because you just stepped overtly into the realm of one of the greatest sins of trading:
Greed
Once you get greedy you will start abandoning necessary discipline. Nobody, I repeat nobody, no matter how smart they think they are has a fail proof system or process or secret trading technique that guarantees 100% success. You are an individual trader and as good as you may be: You will have losing trades, things will go against you and oddly enough this will happen when you are at your most vulnerable: When you are overconfident, greedy and overexposed. Something curious tends to happen though when the losing trade occurs
Denial
One thing humans are particularly good at is rationalizing. We can rationalize anything, especially our mistakes, because mistakes go straight to ego and ego is the last to go. We want to believe we are in control when in fact nothing could be further from the truth. The illusion of control provides comfort. We feel more comfortable when we think we are in control, and of course feel very much uncomfortable when we feel we have no control. Denial is an easy way out to avoid confronting the reality that this trade just went bad because something happened that we didn’t foresee. The method we had so much confidence in suddenly stopped working. Or did it? Maybe it was just a fluke? So traders often dismiss the losing trade even though it hurt. The typical response: I’ll just make it up in the next trade. Another cardinal sin of trading:
Revenge Trading
The second you start initiating trades to make up for a previous losing trade you may as well go outside and burn your money in the yard. Every trade needs to stand on its own set-up and rationale and cannot be emotional linked to a previous trade. If it is then you are trading emotionally and feelings of anxiety, pressure and stress will start to creep in, none of which have anything to do with finding a good trade set-up. Often then another losing trade or set of losing trades starts to chip away at the confidence of the trader which often then exacerbates the situation, especially for a brain that is still fresh on the hunt for another dopamine high. You see where this spiral is heading.
It is just about in this point in time then where things slowly start going array for many traders. This may happen quickly, or it may take time, but unless addressed traders will start circling the drain that is their account. Frustration builds, discipline gets abandoned, anger, fear, panic, paranoia can set in. Traders start taking things personally and are projecting of what could happen as opposed to what is happening, they sleep less, signs of mental exhaustion are building. In short: Nothing of what worked before is working any longer. Not to scare anyone, but this spiral can literally ruin people.
But there is good news. Awareness breeds action, meaning there are specific action steps one can take to minimize the pitfalls of negative psychology impacting your trading. We will discuss in Next Article.