HOW PSYCHOLOGY
AFFECTS TRADING
STRATEGY
A London Academy of Trading Guide by Paddy Osborn
BSc (Hons), MSTA, CFTe
June 2016
HOW OUR BEHAVIOUR MATTERS
We are all human … and we are taught how to behave in society
as we grow up. We learn how to react to certain situations; we
may become brave or fearful, aggressive or timid, happy or sad,
or a number of other emotions.
In the world of trading, it is important to recognise how our
emotions and behavioural patterns can sabotage trading
performance and we need to understand how our emotional
reactions to different events need to change.
Today we will examine Performance Anxiety. This is defined as the
fear of failure, either due to performing in front of an audience or
executing a task under pressure (for example trading).
HOW PSYCHOLOGY AFFECTS TRADING STRATEGY
JUNE 2016
HOW DOES PERFORMANCE
ANXIETY AFFECT TRADING?
Most trading problems are varieties of Performance Anxiety
Performance Anxiety occurs when a performance that is usually automatic
becomes the object of excessive scrutiny. This attention to the performance
creates an Interference Effect, in which the performance can no longer
flow naturally. Such Performance Anxiety frequently interferes with athletic
performance, public speaking, trading performance, sexual performance, and
test taking. Whenever fears about the outcome of a performance dominate
the performance, outcomes are apt to suffer.
Performance Anxiety occurs as much during times of market
success as during times of market loss
It is not at all unusual to find traders who are good at taking (appropriate)
losses, but who become fearful when they book a gain and take profits
prematurely (i.e., prior to reaching their profit targets). Interference Effects
following strings of losses are no more debilitating than Interference Effects
from pressure that traders feel when they are making money.
Traders usually try to replace negative self-talk with positive self-talk
This is a mistake! When traders are immersed in the market and focused on
the screen, they should not be engaging in self-talk at all.
Perfectionism is the most common source of Performance
Anxiety among traders
Traders tend to be achievement-oriented and often set lofty goals for
themselves. These performance goals contribute to tension when the goals
are not met. In general, it makes sense to replace performance goals with
process goals. Instead of setting a goal of making, say, £250 a day, a trader
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should, for example, set a goal of following their trading process (in terms of
trade set-up, triggers, execution and trade management).
Perfectionism leads to overtrading
Overtrading is the most common source of losses among the traders I’ve
interviewed. Traders overtrade when they feel internal pressures to make
money, and these pressures blind the trader to what is happening in the
markets at the time. Trading when volatility is low, trading outside one’s
trading plan or strengths, trading to make up a loss, and trading imprudently
large sizes are examples of overtrading.
Increased levels of trading size can reignite Performance Anxiety
Traders that master performance anxiety at one level of trading size (e.g.
profit/loss swings of up to $100) will frequently re-encounter it once they
meaningfully increase their size (e.g. profit/loss swings of $500). We generally
calibrate our emotions by the dollar amounts we make or lose. This makes a
larger trade much more difficult to manage (emotionally) than a smaller trade,
even though the setups may be identical.
Traders often think they have worse psychological problems than
they actually have
When performance anxiety patterns have interfered with trading for a
period of time, traders often become convinced that they have deep-seated
emotional problems that need intensive psychotherapy. Often, the belief that
one is damaged – that one is emotionally unfit –is a larger problem than the
performance anxiety itself. This is a very solvable problem.
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HOW PSYCHOLOGY AFFECTS TRADING STRATEGY
JUNE 2016
To be sure, there are other problems unrelated to performance
fears that can interfere with trading. The unique thing about
Performance Anxiety is that it can afflict highly successful traders
every bit as much as rookies. This is because the root of much
of the anxiety – perfectionism – tends to be present in the most
achievement-oriented and successful individuals. It is truly a
double-edged sword.
Somewhere between the extremes of performance pressure and
complacent laziness is a happy medium where traders can focus
on self-improvement without sabotaging their results. Trading
is like dating: You want to keep initial expectations reasonable,
enjoy it while it’s happening, and learn from it once it’s over.
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HOW PSYCHOLOGY AFFECTS TRADING STRATEGY
JUNE 2016
CONSIDER THE FOLLOWING
PSYCHOLOGICAL SCENARIOS
A
A student needs to pass an anatomy course
final exam in order to successfully complete his
first year in medical school. Because his first
several exams were on the borderline between
pass and fail, the course grade entirely rides
on the final. As the time approaches for the
big test, the student finds himself increasingly
worried about the test – particularly when he
misses questions from his practice exams.
The worry interferes with his sleep, which in
turn makes him even more concerned that
fatigue will prevent him from doing well. By
the time he takes the exam, he is tired and
nervous and misses many questions, often by
second-guessing right answers.
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B
A young woman who has never been
particularly uncomfortable in public speaking
situations is now asked to give the most
important presentation of her career. The
result of this presentation could spell the
difference between landing a major client for
her firm vs. losing the client to a competitor.
During the talk, she notices that the audience
members from the firm she is wooing don’t
seem especially attentive. This suddenly raises
her anxiety levels and she desperately tries to
spice up the presentation. When she loses her
place in the talk, she becomes flustered, and
finishes the presentation on a hesitant note.
C
A trader has several winning trades in a row
and, feeling confident, increases his size to
take advantage of his hot streak. The position
initially goes in his favour, but quickly reverses
when the market pushes lower. Forced to
liquidate his position, he realizes he has lost
all of the profit from his previous winning
trades. He is driven to regain the money and
re-enters the market, only to get slammed by
a second wave of selling. He now feels like he
has entered a cold streak and begins trading
hesitantly, with reduced size. By the time the
market closes, he is down on the day and
the week. He feels like a jerk for becoming
overconfident after his gains.
No doubt you can detect a pattern in
each of these situations. The individual
is in a performance situation where he/
she experiences pressure to succeed. The
situation has taken on extreme importance
in the person’s eyes, and now he/she is
focused on the results of the performance –
rather than executing the performance itself.
This dual focus - worrying (or focusing) on
the outcome of performance while trying to
stay immersed in the performance – is the
common element behind all Performance
Anxiety. Such anxiety is the single most
common trading problem I have encountered
in my interviews with traders.
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HOW PSYCHOLOGY AFFECTS TRADING STRATEGY
HOW CAN TRADERS
REDUCE THEIR LEVEL OF
PERFORMANCE ANXIETY?
JUNE 2016
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Focus on process goals when trading, rather than
actual profits and losses
Traders like to set goals for themselves, yet often as not
monetary goals end up creating unnecessary pressures.
More effective goals are ones that focus on the process
of trading, such as limiting losses with stops or holding
trades until a trailing stop is hit. A nice mind-set is, “If I
just trade the right way, the profits will come.” This takes
much off the pressure of the performance.
Tackle risk incrementally
Risk places a psychological magnifying glass on
situations and greatly increases the opportunities for
performance pressure. Traders who try to radically
increase their size quickly find that the trade that worked
out with 1 contract may not work with 10, because of
pressures to (too) quickly limit losses or take profits. A
gradual ramping up of size is far more effective than an
impulsive leap for which one is emotionally unprepared.
Step away from the screen
Any self-talk during periods of performance anxiety
actually interferes with the accurate processing of
market data, because the part of the brain responsible
for perceiving and acting upon market patterns is not
being activated. It is far better to step away from the
screen and refocus on what the market is giving you
than to act blindly on one’s fears and compound an
already-difficult situation.
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HOW PSYCHOLOGY AFFECTS TRADING STRATEGY
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Use mental rehearsals to make threatening
situations familiar
This is perhaps the single most effective technique
for reducing and eliminating performance fears. By
using guided imagery to repeatedly face threatening
situations and mentally rehearse how one would like
to respond, one can eliminate much of the stress when
those situations actually occur. The goal is to face the
performance so often that the coping response becomes
automatic, like a habit pattern.
Anchor mental rehearsals to distinctive mind states
By learning to place oneself in a state of unusual calm
and focus, and then by repeatedly rehearsing coping
strategies for threatening situations, a trader can
create a link between the mental state and the coping
response. When there is a stressful performance
situation, all the trader needs to do is invoke the
rehearsed mental state and the coping behaviours
that have been over-learned will come to the fore. For
instance, if you continually mentally rehearse a strategy
for holding onto winning trades while sustaining a calm
focus, recreating the calm focus during the next winning
trade will make it easier to summon the self-talk and
behaviour associated with holding the position.
JUNE 2016
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Perform a mental checklist before trading
Eliminating perfectionist expectations at the start of
the trading day can go a long way towards reducing
performance pressures. Any time the word “should”
enters one’s thinking about trading, it’s time to step back.
“Shoulds” include internal demands to make a certain
amount of money, to trade with a particular frequency, to
make back money that has been lost, to not leave money
on the table, etc. Because performance anxiety is often
fuelled by excessive self-demands, setting and affirming
reasonable trading goals through the trading day can go a
long way toward reducing performance pressures.
Get a life!
When something in life becomes all-important, the
pressures that accompany performance increase
exponentially. Traders who trade for a living and who
have little else going on in their lives are especially
vulnerable to performance anxiety. If trading is your
whole world and trading isn’t working, it’s going to feel like
your world is collapsing. By placing one’s self-esteem eggs
in a number of different baskets (e.g. sports, hobbies,
relationships, etc.), traders can mitigate the inevitable
drawdowns and cold periods will would otherwise disrupt
their self-confidence.
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HOW PSYCHOLOGY AFFECTS TRADING STRATEGY
JUNE 2016
Most traders who are convinced that they
have deeply-rooted psychological problems or
addictive trading patterns are actually caught
in a vicious cycle of perfectionist self-demands,
increasing performance pressure, mounting
anxiety, disrupted performance, and renewed
self-demands to compensate for their failures.
After a while, traders caught in such a cycle
begin to doubt whether they will ever succeed.
By addressing their problems at the source –
the expectations that generate performance
pressure – traders can often turn themselves
around in a surprisingly short period of time.
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WHO WE ARE
The London Academy of Trading (LAT) provides accredited, vocational programmes with
a focus on fundamental and technical analysis, trading psychology and risk management.
LAT attracts focused and ambitious students who are looking to become the next
generation of financial markets traders.
We are a privately owned educator within the
financial industry based in the City’s financial
district.
We teach through a combination of theoretical
and practical sessions, with continued
guidance available both in house and online.
We provide the financial market knowledge
and trading skills to enable individuals to
develop their career or to supplement their
main source of income.
Working in partnership with a number of
financial companies enables us to provide
cutting edge technology and up-to-the-minute
news and data.
Our faculty is comprised of experienced
traders and analysts from a range of
companies including HSBC, Merrill Lynch,
Credit Suisse and Bloomberg.
Whether you prefer to study on-line, on
the Academy trading floor, or via a blended
combination of both, we can provide the
flexibility for you to fit your studies around
your existing commitments.
CONTACT US
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