The Psychology of Trading — Forget it!

For years traders have been bombarded by “experts” on the psychology of trading. If only you could learn to manage your emotional tendencies, you could improve your trading results, and live happily ever after. 


If you had a perfect trading system, that always generated profits with rarely a drawdown, would you really need to work on your “trading psychology”? No. So it’s really just a crutch to help you trade a methodology that is not full proof. Well, of course such a perfect trading system doesn’t exist, so professional traders DO need something to keep them going when their trades are going against them. 

Or perhaps there IS a great trading system, that is truly a winning system. But for some reason it is almost impossible for a normal human being to actually follow the rules. Actually, there are many computer generated systems that fall into this category. For instance, a trend following system that in the long run always is profitable — but can go for months with your account in the red. Yes, it works, but you would need a resident trading psychologist, putting you back together on a daily basis, to have any chance of adhering to the trading program. 

But there is a common element to both of these scenarios. It’s called “reality testing”. I posed the second example above of a “truly winning system” that required a great deal of pain to apply long enough to be guaranteed of winning. Yet when faced with a new, potentially successful trading strategy, you always begin with no personal historical experience of its performance. Sure, you can be presented with (or create for yourself) plenty of backtested results. But true confidence in landing a plane comes from having successfully landed one many times YOURSELF in training. It does NOT come from reading a manual or guidebook that “guarantees” faultless landings.

A successful organism does not make regular leaps of faith and expect to flourish. So if someone says this rope ladder or bridge is safe to cross, you naturally take a couple of test steps on it before committing to trusting it to get you across a gorge. 

So it is irrational to force your psychology to follow a trading approach that you’ve not already proven to yourself is a successful, profitable strategy. 

But it’s like getting that first job. You can’t get the job without experience, but with no job you can’t get the experience you need to get the job in the first place. 

So what if your lack of a good trading psychology is actually just a case of rational “reality testing.” Can you really be expected to follow trading rules before you’ve proven to yourself they work?!

But maybe there’s a resolution to the kind of paradoxes I’ve been discussing. Think of the concept of “signal to noise ratio”. If someone shows you a system that purports to win 60% of the time, then how long would you have to trade it before knowing whether it really does what it says it does? You have to find a “signal” (profitable trades) in the midst of a lot of noise (losing or so-so trades almost half the time). It’s hard to do “reality testing” when you’re listening for a faint signal against a background of a lot of noisy static. If you happen to have a bunch of losing trades early on, is that just the luck of the draw — or is the strategy actually not a valid one?

I think that for myself I’ve finally solved this set of dilemmas. What if I didn’t need a lot of “trading psychology” to stick to my trading strategy because it almost always results in a profitable trade? It’s not so hard to adhere to the rules when you are closing most trades in the green. And what if this strategy has a very strong “signal to noise ratio” — meaning that it wins such a large percentage of the time, that you only have to do 10 or so trades to know whether the strategy performs the way it’s been represented to perform? “Reality testing” becomes easy, confidence is built quickly, and following the rules doesn’t require some psychological judo to keep on track. 

Someone much smarter than myself came up with such a trading strategy. A very simple strategy that resulted in 8 out of 10 trades closing in the green. I’ve traded this approach myself for 8 years now, and have fine tuned my application of it to truly have a win rate of 90% — based on over 600 trades posted publicly in time for others to match my results. 

Years ago a famous master trader, Linda Bradford Raschke, commented in a seminar that she knew traders who had developed a single trading strategy, and perfected it enough to make a living from just that one approach. I’ve finally fine tuned a “swing trading” methodology for trading ETFs that matches my personality and my attention span — and enables me to make a living trading. Find the right strategy for yourself, that matches your trading personality, has a high “signal to noise” ratio, and that can prove itself with a short amount of “reality testing” — and you’ll find you won’t need that next course on “trading psychology.”

Jack Loftis PhD

P.S. If you are interested, shoot me an email at my personal address [email protected] — and by the way, I’ve just closed 31 winning ETF trades in a row, along with 14 winning ETF options trades in parallel.

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