Emotional Intelligence
“Accept everything just the way it is.” Miyamoto Musashi, A Book of Five Rings: The Classic Guide to Strategy
As you begin your trading career, it is wise to recognize that we humans are pleasure seekers and emotional beings first and foremost. You cannot escape your psychology.
In economic matters, it is generally assumed that man is rational and that there is an “invisible hand” pushing him towards rationality. However, Daniel Kahneman, who won the Nobel Prize in Economics in 2002, debunks this myth. His work in behavioral economics indicates that fear influences our decisions, and that when we are scared, we are anything but rational.
In trading, Kahneman’s Prospect Theory means that once you have a position, your fear of trading losses overcomes your rational self and the probability of success to the point that you may find it difficult to think of anything else. It is a human tendency to behave irrationally when it comes to taking profits and losses.
It’s wise to try your hand at paper trading to get a feel for the market and your trading approach. But once you start putting your real, hard-earned capital on the line, you quickly understand that trading for real doesn't feel the same as trading on paper. Everything is safe on a paper spreadsheet. Not so much when it's marked to the market in real-time.
Let’s say you’re watching the markets, and a pundit on TV says he likes gold. You punch up the chart and stalk it like gospel, wondering how he knows what he knows. Should you get in at this price? Should you wait until it comes back a little? Should you watch it? These are all emotional questions that deal with lack of confidence and self-doubt. Even if you have a trading system that is generated by a computer algorithm, it will not calm your nerves once your capital is on the line.
“If you can’t stand the heat, get out of the kitchen” is an apt adage for how to handle a lack of confidence and self-doubt when trading. When that happens, you'll be second-guessing yourself and putting on trades that you have no business being in and getting out of trades that you should be in. The best thing to do if you start losing money is to get out.
Then, you might be tempted to go back to reading and studying more…looking for nuances about the contracts that you've missed. Searching the Internet for more information about the contract. It can cause you to lose confidence in your methodology and "try something new." It can get you to question everything you're doing in the markets.
But the answer you seek is not going to be in any of those things. The answer is between your two ears.