Nick Radge Explains The Psychology of Trading

The most important part of investing and trading is psychology. Investing is a constant struggle where the battleground is not the market or advice given but comes from within you.

You will face stress over losses. You will be in turmoil deciding whether to enter or exit a position. And you will be forced to confront who you are and what you’re trying to achieve. But the crux comes when you learn things about yourself that you’d prefer not to acknowledge. You will automatically push them aside into your subconscious and be left with the easy part, such as laying blame or exploring a better way.

This theme runs through all our lives in various formats. Unfortunately the decision making processes throughout our lives, including ongoing management of investments, are formed within our belief systems that in turn have been seeded by our early childhood experiences and, less so, our experiences since then. I say unfortunately because talking a person out of their misconceived investment beliefs is like trying to talk someone out of their religion. It doesn’t matter that they can’t demonstrate positive results. They believe anyway, and that is that. Of course that is good for the rest of us, because if some didn’t lose there would be nothing to win.

Identifying Your Beliefs

Your investment philosophy is driven by your beliefs. A person who uses fundamental analysis or technical analysis will not necessarily be any more successful or unsuccessful as someone who employs a monkey to throws darts.Investing is not a science where rules and laws apply but simply an arena where emotions determine what we want, how we approach it and how we deal with its outcome.

If you are to succeed in investing, and in all aspects of your life for that matter, you must consciously want to achieve your goal and believe in your method in order to remain faithful to it.

Our beliefs operate on two levels, the subconscious and the conscious. The conscious level is where we think the problem lies and is where we create our excuses. The real problem usually hides in the subconscious. It gets tucked away because we don’t really wish to face the reality of the issue.

Let’s use a simple, yet alarming, analogy: a habitual smoker who plays poker machines. This person has a serious conflict. In the first instance this person is bombarded by death rhetoric every time they light up. “Smoking Kills”, “Smoking Causes Cancer”, “Cancer Kills” and so on. Yet they continue to smoke. Why? Well the conscious part tells us that it’s addictive, it’s not my fault and I can’t stop. It’s the fault of the tobacco companies; they are to blame because they make the cigarettes addictive. The subconscious however is where the truth lies.

There may be various reasons and these will differ between individuals. The reasoning of addiction is more likely to be denial of habit. Denial of habit suggests that the person does not have the discipline to give up or alternatively the person may in fact not want to give up.

Probing deeper we may find that the person gets comfort from smoking, even though they know it may contribute to serious health issues. Why do they get comfort? Perhaps they feel it won’t happen to them. Smoking may cause cancer, but that happens to someone else. Here its ego at work, the “it can’t happen to me” syndrome.

Now lets look at this same person as they play poker machines. As we know these machines have a mathematical negative expectancy. You will lose money if you play long enough. No amount of luck will enable you to remain a winner, yet in our example our man continues to play.

Why? Consciously there may be excitement, an endeavor to pass time or a social activity. It can’t be monetary because it’s a negative expectancy game. So on the subconscious level what is occurring? It again may be varying issues. It can be comforting; after all, a poker machine will never give you negative feedback. Nice flashing lights, pretty noises, the occasional sucker win but overall the environment is designed to keep you playing and is therefore comforting with positive feedback.

The individual may not get positive feedback or the same attention outside of the poker machines. But ego may also be at work, in other words the “it won’t happen to me” syndrome. I am not a loser. I am lucky and I will beat the poker machines. But this is in direct conflict with their smoking habit. Cancer happens to someone else, yet winning at poker machines will happen to me…

The biggest difficulty for investors, and I see it every day, is giving back open profits. The market could, at any point of time, continue to go higher and increase those open profits, or it could go lower and decrease those open profits. Automatic thinking is that the market will go straight back down from where it came from and therefore these open profits will “evaporate”. I could tell you how to act properly in this situation but that won’t help because it’s your belief system that’s driving you to think like that, and as I’ve pointed out, I can’t change your belief system.

What is it in your belief system that makes you automatically think that open profits will evaporate instead of increase? Consciously it may be the fear of losing money or that you have earned the right to that money and you don’t want to give it back. Rarely when we go to work do we actually have to give our hard earnings back so why do it in the market? This is normal human thinking. But its also normal market behavior that prices gyrate back and forth and to dislike that is to lack understanding of how the market operates.

We can never sell the absolute high because it’s impossible to know what will occur in the future. To have the attitude that the unrealized profits will decline says that you have an expectation of the future direction of the market, which is impossible. This is your subconscious at work. Why do you think you know where the market will go if a collection of the worlds greatest minds have no idea? Ask yourself why you think you know…

If you have no expectation of the future direction of the market, then all you need do is wait until some type of confirmation before you exit the positions. What that may be should be a part of your investment plan. You don’t have an investment plan you say…?

What about being unable to pull the trigger because of analysis paralysis? The more noise or input into the decision making process, newsletters, magazines, opinions, etc is commonly known as analysis paralysis and will usually do more harm than good. Even if there is valuable information buried within your research, the decision making process becomes impossible because of the noise, as does success.

So is this conscious or subconscious? Probably conscious. So what’s driving it, what is the subconscious reason? It may be the fear of losing again, it may be the need for approval or it could even be the inability to take responsibility. If someone else has made the investment recommendation, then you are not to blame if it goes bad.

The easiest way to improve your psychology is to be aware of your own thinking. Before jumping into action that is not part of your investment plan, ask yourself why you are doing it. Then probe that answer some more. If you don’t have an investment plan then ask yourself why not.

These are my beliefs and I’m sticking to them. – Nick Radge