Trading psychology has become so widely discussed and promoted through books and consultants that it has become a very convenient rationalization and excuse for losing. Why take the responsibility for a lack of work ethic and for trading without any concept of plan -- an honest assessment that would be a “hit” on the trader’s self-esteem -- when you can just blame it on trading psychology instead?

Trading psychology is “something” a trader creates from existing personality traits not initially related to trading but that surface from trading without an understanding of method. The outcome of trading this way, of course, is fear. However, isn’t this the case when we do anything perceived as “dangerous” and without the necessary understanding and skills? Trading, with its inherent requirement of accepting financial risk while participating in unknown outcomes, is certainly “dangerous” and, thus, demands preparation and understanding.

A Trading Scenario

Consider a trading plan that has the following three setup types:

1. An initial intended trade entry
2. A first continuation, which is used to enter a trade in case you have missed your initial entry or decided that you wanted more confirmation because it was a counter-direction trade
3. A second continuation, which is intended as a trade addon setup but is also one “last” chance to enter a trade

You get an initial sell setup that triggers, but you do not take the trade; that’s trade 1. The trade breaks cleanly and goes to what would have resulted in a partial profit, and, then, before the price goes down further, it retraces back to the area where the sell was done. This price holds, so the swing remains short, and, from this hold of what is now resistance, you get the trigger of your first continuation setup, BUT…

…you don’t take this trade either, hence, it’s trade 2. Why didn’t you take the trade? You decided that, after missing the initial entry, you have missed the trade; your emotions and biases tell you that the “move” has gone too far. Again, this trade breaks cleanly, not only adding to the gains of trade 1, but also giving a partial profit on trade 2.

Price now consolidates between the lows and the price resistance that you would typically be using to stay short if you had taken either the initial trade or the first continuation trade. Instead of the swing reversing after consolidating, it continues down again, and, with this continuation, your second continuation setup triggers, so trade 3. AND, AGAIN, you don’t take the trade. After all, if you didn’t take either of the first two trades, how can you possibly take this trade? Maybe you were wrong when you thought that the move had gone too far to take trade 2, but certainly that’s the case for trade 3!

As with trades 1 and 2, trade 3 is a profitable trade. This swing has really turned into a great directional move, with each break holding on weak retests -- a textbook example of the strengths of your trading method, but YOU have never entered a trade. You are going nuts! You are going to get into this swing, no matter what! You just can't take it any more.

Another retrace holds as a lower high. You don’t have an entry setup, but that doesn’t matter; the other three trades were profitable after a lower high. Isn’t it interesting? The same emotions that wouldn’t let you enter your plan trades are now “forcing” you to take a non-plan trade.

Instead of YOUR trade going to a lower low and to a profit, it instead goes to a higher low and then reverses into an initial buy. Bad just got worse. You also don’t exit when the swing goes into buy. After what you went through to finally get into the trade, you have to try to make it work, and, after all, the trend is down, right? Trader A uses this initial buy to exit his or her profitable sell and sell addon; Trader A decides that he or she wants more confirmation of swing reverse before trading the counter direction. A first continuation setup triggers, and Trader A goes long. Sure enough: The swing has reversed, and this trade reaches its first profit target.

Trader B finally “gives up” and exits his or her short, although with a two-point loss instead of the intended one point and without taking into account the next plan trade, the first continuation buy. This trader is done for the day, but at least he or she was “right” all along; the swing had gone too far to enter, and Trader B’s fears had been warranted; this was a losing trade he or she should not have entered.

Is this a trading method or a trading psychology issue? What “message” is Trader B going to take from what has just happened? Will this person take the attitude that he or she should not be blamed because of trading psychology? Or, will Trader B acknowledge that the method did win, that the resulting loss was not a method trade, and even if it were, the loss would have been offset by the prior winners? Will Trader B acknowledge that he or she made his or her worst fears come true and not only turned this into a losing trade but also increased the size of that loss and then avoided another method winning trade?

Granted, psychology was involved with what happened in the trading scenario just described, but that is a function of the individual’s “core” personality and would, most probably, be an issue, regardless of what was being done. If there is risk involved, there will be an emotional response. Thus, it is first necessary to separate personal psychology from trading psychology and the use of this concept as an excuse for trading actions.

Then, if trading psychology is going to be controlled, this will be done through the development and implementation of a tested plan the trader is willing to follow. Do not trade with “built-in” excuses for failing; you will have lost before you begin and will continue to do so with a “snowballing” of emotion, to the point where trading will no longer be possible.

*Reprinted (and modified) with permission from Barry Lutz of Tactical Trading, LLC (www.tactrade.com)