Why is Trading Psychology Important?
Understanding trading psychology is one of the most important but also less often done tasks for investors. Of course, everyone realises that they need to analyse the investments they are considering buying. But many traders do not realise that winning in investment is mostly about successfully predicting what other market players will do. Before they do it. And that is a psychological task.
Most of the advice on the internet is not really psychology. It is quasi-psychology. You might get famous traders telling you things like “I always played tennis in the morning before my best trades to make sure I felt good.” This is useless. By all means, study what these guys do. You may get insights into how they look at opportunities and maybe any tricks they have for bouncing back from a loss. But famous traders don’t have any specific training in psychology. So, if you are specifically wanting to improve your own trading psychology, adopting their tips (such as the tennis one above) won’t really help you in achieving that goal.
What you need to look at is the psychological literature. This is published in the academic journals. You also need to do that having spent a decade on the trading floor. Fortunately, you don’t need to do that yourself since I have done it for you. So all you need to do is read the book.
The other sort of person who cannot help you is someone merely described as a psychologist. That’s better than nothing. But they need to be the right sort of psychologist, as I will set out in the next section.
Is that the right sort of psychology?
There are some actual psychologists who write on the topic and are experts in the field. But be careful about their specialisms. Someone who is a clinical psychologist may be an expert in schizophrenia. They may however not necessarily know any other aspects of human psychology. And of course these experts do not have any serious trading experience. So they definitely can’t help you improve your trading psychology. Unless you have schizophrenia. But in that case, you have more pressing issues to attend to than the performance of your portfolio.
There are also a lot of completely unqualified people who write on these topics. They don’t know any psychology and they don’t know anything about trading. These individuals are all over the internet. But you should not waste any of your time on them.
The right sort of psychology is actually called Theory of Mind. This is the label for the way we predict and explain the behaviour of others. This is exactly the area in which I specialise. You can check that out in my first book: https://www.amazon.co.uk/Simulation-Theory-psychological-philosophical-consideration-ebook/dp/B00S1DDMKI
To identify the right sort of person, you need to ask two questions. Does this person have significant trading experience? Are they qualified in a related field? I am one of these people.
How To Optimise Your Psychology
To convince you of this, I will outline my ideas on how to optimise your trading psychology. The first thing to know about is that we have a lot of cognitive biases. (Here’s a list on Wikipedia: there are hundreds! https://en.wikipedia.org/wiki/List_of_cognitive_biases )
These are mental shortcuts that are often useful when we want a quick and dirty answer. However, they are often very unhelpful when we are trying to get something right. One example is Confirmation Bias. This is where people look only for evidence that supports what they already believe. There have been many robust psychology experiments published, that show time and time again that we do this often.
This isn’t something which is optional. Cognitive biases are a fundamental part of our wiring. More intelligence does not make you immune to biases. At least if you know about them though you have a chance to counteract them.
The first thing to note here is that if you use this bias when making your own trading decisions, you will make bad decisions. Every time! So you will definitely not be optimising your trading psychology. But here’s the key point: everyone else in the markets will be doing it too.
So what does that mean? It means you need to know about Confirmation Bias. You need to think about it in a market context. Look out for it in yourself and be careful. Expect it in other market players and trade accordingly.
That’s how you stand the best chance of optimising your trading psychology.