Trading Psychology: The Key to Successful Trading

You may know that the failure rates for new traders are extremely high, especially for retail FX traders. But why is this? The answer lies in the focus of their learning. For example, if we have two traders, and the first trader is a complete newbie who has decided to trade from home using various internet-based courses, it is highly unlikely that this trader will get much training on the topic of psychology.

They may hear famous clichés or even read a book or two, but generally, the focus on psychology will be extremely light compared to other pillars, especially technical analysis. The reason for this is that technical analysis is visual and interesting, but unfortunately, it is also totally useless without the other pillars. This is the top mistake that most retail traders make. On the other hand, if we look at a graduate trader who has just joined a professional trading firm, they will also get some education and training in technical analysis. However, the biggest point is that they will have massive exposure to training and development of their trading psychology, which will be an ongoing process over the course of their entire trading career.

The exposure rates of technical analysis and psychology are at opposite ends of the scale for retail traders and young professionals. So why is trading psychology a key pillar, and why can’t you succeed without it?

The Importance of Trading Psychology

To answer this, let’s use an illustration to help you understand not only the importance of trading psychology but also why so many people tend to overlook it at their great cost. Imagine that you are learning how to play the sport of golf. What are the first things that you need? The latest set of clubs, a membership to a prestigious golf club, or maybe some really expensive golf shoes? When we say this in context, it all sounds ridiculous because the obvious thing that anyone needs before any of that is training. Working with an experienced golfer who can show you all of the mistakes that people make and how you can overcome them, and what you need to do right, is crucial. You will learn things like having the correct stance and positioning along with the all-important swing.

The next thing you need is practice. Your training will be ongoing, and maybe you’ll have coaching once or twice a week. In between, you’ll try to get as much practice as possible because there is a saying that you’ve probably heard: “Practice makes perfect.” This saying is famous for a reason. Following this routine with dedication will lead to guaranteed success over a sustained period. Eventually, when you play golf, you’ll no longer be thinking about how to swing or where to put your feet because all the practice and training will have instilled the habits you need to play golf competitively.

Being able to play golf naturally without thinking is your main edge. Professional sports players refer to this process as getting into the zone. You’ve probably heard of that as well. After you’ve mastered this, the next step is to try and increase this edge in small ways. But no matter what clubs you use or what shoes you wear, your core skills will always be there, and you’ll perform better than people who do not have these skills and habits developed. Now imagine, instead of following that path, you went down the road of buying expensive clubs and better shoes in the hope that this would improve your overall performance. This sounds crazy, but this is what a lot of traders do when they focus all of their education on the system they are using, the broker they trade through, or even the information provider they use for their analysis.

The true key to trading does not lie externally but firmly inside your mind. The way you develop your trading skills is exactly the same as in golf. You start by focusing on the skills and the actual process. As you learn these things, their importance drops dramatically, and the most important thing becomes your inner game. The mistake most new traders make, particularly retail traders, is that they focus all their efforts on the skills and process, thinking they need more skill to improve. In reality, the basic skills of trading are simple. In fact, we’ve broken it down into just four pieces in this course. Once you have those concepts down, it is simply practice and working on your inner game that will improve your results. The true key to successful trading is being able to get into the zone and trade in your natural state without thinking too much about what you’re doing.

Professional training coaches call this emotional state mastery, and we will look at how to achieve this state. Of course, this is analyzed in much greater detail during the main training program, where you will work with professional psychology coaches to help you overcome any issues because it’s such a crucial element to successful trading. Let’s get an introduction to this by looking at emotional states.

Emotional States and Peak Performance

It’s important to understand that some states are perfect for enjoying peak performance, while other states are not. Some states actually stop you from performing at your highest ability. When trading, we want to be in good states that are conducive to us performing at our best and ultimately making money. If we want to understand how to perform under pressure, there are no better examples than that of military special forces. They have a solid combination of endurance, navigational skills, determination, persistence, problem-solving, decision-making strategies, and emotional state mastery. In the special forces, it is recognized that they need highly skilled soldiers and a good mission strategy, but what is considered most important is being in the right state to deliver.

Even the best soldier will be ineffective if they are not in a fit state to perform. Therefore, creating the right state is vital for the success of those soldiers, and the same applies to traders. You could have taken every course in the world and know all of the theory and maybe even a few strategies, but if you’re not in the right emotional state, then you will fail. This state is probably the most important thing of all because without it, you will not be able to use the skills that you have anyway. Like a soldier, we need to have three major components: state, strategy, and skills. All three are required, but none more so than state. When you are set at your trading desk, you’ll have a strategy to make money and use a whole set of skills such as market analysis, identifying trade opportunities, and filtering out random information. But what truly underlies and influences your overall performance is the state you’re in while trading.

Understanding and Managing States

States are the consequences of the things happening in your mind. They are also dynamic processes, which means that you change your state regularly throughout the day. Things like confidence, anger, motivation, and anxiety are all dynamic processes, feelings, or states. Your personal performance in everything from trading to relationships to sports is majorly influenced by your feelings. How you feel affects how you will perform. These feelings don’t just happen; they are choices. Professional sports stars have learned how to choose which state they want to perform in to succeed.

The Role of Speculators

Speculators, including you and me, fulfill several vital functions by facilitating the marketing and trade of futures. Speculators don’t create risk; they assume the risk from hedgers and other market participants in the hope of making a profit from subsequent market fluctuations. For example, a large bank (Bank A) may have 50 Eurodollar contracts to sell to cover some risk in their outstanding debt and are only prepared to sell at 94.25. Another bank (Bank B) wants to buy 50 Eurodollar contracts but will only pay 94.15. Speculator X thinks the Fed will cut interest rates soon and is prepared to pay 94.20 for those contracts, while Speculator Y is convinced no rate cuts are coming soon and is willing to sell at 94.22.

In this scenario, the speculators narrow the market gap from 94.15/94.25 to 94.20/94.22, providing crucial liquidity. In a market without these risk-takers, it would be almost impossible for other participants to agree on a price because sellers want the highest price and buyers want the lowest. Speculators bridge this gap between bids and offers, making the market more efficient and competitive. In short, speculators increase the number of ready buyers and sellers.

Understanding Risk

Investment risk can be defined as the exposure to the chance of loss. This possibility is higher when the potential returns are greater. There are two types of risk:

Specific Risk: Risks specific to a particular investment.
Nonspecific Risk: General market risks present in all portfolios.

A primary feature of futures is that they can be used to diversify away from risk in an efficient manner with lower transaction costs. For example, in FX markets, currency risks can be hedged with currency futures. In the stock market, portfolios of stocks can be hedged with index futures such as the FTSE, S&P, and DAX.

Futures were one of the first methods used in risk management, making them popular and vital in their modern forms.

The Concept of Leverage

Leverage is another primary feature of futures contracts. For a small sum on deposit, known as the margin, a trader can control a significantly greater valued asset. Measured as a percentage of the capital invested, the profit or loss potential on a futures contract is much greater than a similar investment in the underlying asset itself.

For example, to hold a basket of stocks in the FTSE 100 index trading at 7450 would require holding physical stock at a cost of £74,500. However, holding one FTSE futures contract requires an initial deposit of just £3,000. A 5% gain in the price of FTSE would give both the shareholder and the futures trader a gain of £3,725. The percentage return is significantly different: the shareholder has a 5% return on capital invested, while the futures trader has a 124% return. This leverage works similarly for losses.

Potential and Performance

To understand this better, let’s look at two words: potential and performance. How often do you perform at your potential? The ultimate goal for all of us is to consistently perform to our potential. A famous equation helps explain this process: at any given time, we are performing to our potential minus any interference. In the ideal scenario, there is no interference, and this is the state often called the zone or the flow. A prominent US psychologist and expert on flow and performance found from his extensive research that there are eight key factors evident when someone is in the zone:

A challenging task matched to your capabilities.
Merging of action and awareness, losing track of time.
Clear goals.
Immediate feedback.
Total concentration on the task.
Feeling of control over actions.
Loss of self-consciousness.
Transformation of time perception.

From this research and other studies, we can break the process of getting into the zone down into three key elements: matching the challenge to your capabilities, ensuring that you have clear goals, and focusing on the task at hand, which in turn gives you a feeling of control over your actions.

The Importance of Practice

Another point we looked at in the illustration earlier is the importance of practice. To become truly skilled at golf or anything else, it’s not only training you need but also practice. From a psychological perspective, this is powerful because being in the zone is automatic, and performance transcends consciousness. To achieve this automatic performance, you need to have a high level of skill. To summarize, in order to trade in the zone, we need to have a high level of skill, and to get that skill, we need to practice.

The Four-Stage Learning Model

We can further illustrate this with a famous model called the four-stage learning model. There are four stages to becoming extremely skilled at a task or process:

Unconscious Incompetence: You can’t perform the task and are unaware of it, most likely because you’ve never attempted it.
Conscious Incompetence: You know what the task is but also know that you can’t do it. This can produce stress or anxiety.
Conscious Competence: You can perform the skill but only when completely focused on the task at hand, generally producing a state of calm because you know you can do it.
Unconscious Competence: You have reached a level where the skill or task can be done without thinking. Thinking about it often hurts your performance.

Achieving the fourth level requires focused practice based on correct training.

Practicing Trading Skills

For trading, what exactly is it that we need to be practicing? We talked about the importance of your state. Being in the correct state is far more important than your skills, system, or broker. A famous author in the trading world, Mark Douglas, specializes in trading psychology and has authored some of the best-selling trading books of all time. In one of those books, he discusses that trading in the zone involves operating with a complete lack of fear because fear is mostly retrospective based on past events or predictive based on future events that have not yet happened. It’s very rare that fear is in the now.

Douglas also suggests that entering this zone is achieved more easily when certain beliefs are in place:

Your edge is strong, and you have an unshakable belief in an outcome with an edge in your favor.
You truly and deeply accept loss.
You know that once you’re in the trade, anything can happen, and you remain neutral and flexible.
You expect positive results for your efforts with an acceptance that whatever results you get are a perfect reflection of your level of development and what you need to learn.

Overcoming Trading Fears

Aside from these beliefs helping you enter the zone, there are also barriers to getting into that state. Trading psychology suggests that the majority of trading setbacks result from performance anxiety. Emotions like anxiety, stress, fear, anger, and frustration are all states that most traders feel but are states that work against peak performance. For example:

Anger causes our perception to change.
Frustration makes us feel like no other possibilities exist.
Fear stops us from seeing opportunities.
Anxiety causes us to freeze or run.
Stress narrows our attention and eliminates focus.

These negative states cause the interference mentioned earlier and stop us from performing at our potential.

Four Main Trading Fears

Mark Douglas identifies four main trading fears:

Fear of being wrong.
Fear of losing money.
Fear of missing out.
Fear of leaving money on the table.

These fears can be made into the five core obstacles that stop us from getting into the zone:

Fear of Loss: Accept that loss is a part of trading. It’s not losing that really hurts but trading badly.
Fear of Missing Out: Realize that no matter how great a trader you are, you will always miss opportunities. You don’t need to get on every opportunity to be profitable.
Focus on Profit and Loss Rather Than the Trade: Start measuring your success on how you traded, not how much you made. Focus on the process.
Losing Objectivity: Constantly ask yourself, “If I was not in this trade, what would I do? Buy, sell, or do nothing?”
Taking Inappropriate Risk: Think in probabilities while considering risk-reward. Trade a size that matches your capabilities, allowing you to trade to your potential. Eradicate your ego.

These main barriers must be managed, but there are also lesser obstacles that can affect your trading:

Lack of preparation
Lack of practice
Lack of discipline
High levels of general stress
External distractions, such as personal life issues

Creating the Correct Beliefs

A lot of this inner game is about creating the correct beliefs. It’s vital to operate in the correct state, a state that allows us to operate under those beliefs and ultimately trade in the zone of psychological success. The next logical question is how to create the optimal states for our trading performance. There are fourteen strategies we can implement to achieve this.

Fourteen Strategies for Optimal Emotional State

1. Energy Management

Energy is the foundation of all emotional states and is critical to sustaining concentration. There are four key factors to having a strong energy base:

Nutrition: Balanced diet and plenty of water.
Exercise: A balance between cardio and weights with maybe five thirty-minute sessions each week.
Rest and Relaxation: Allowing yourself to switch off and have downtime.
Sleep: A minimum of seven hours per night consistently.

To sustain your concentration throughout the day, take regular breaks. Our bodies work on ultradian rhythms, naturally occurring ninety-minute cycles of peak focus and energy followed by a recovery dip of around twenty minutes. This dip is often signaled by hunger pangs, daydreaming, and a general loss of concentration. This mind’s idling time enables the unconscious to process information and integrate learning. Denying your mind these breaks, even with positive intentions, results in subsequently lower peaks, explaining the feeling of declining energy throughout the day. To combat this, use the following ritual:

Rest and Relax: Get away from your screen, rest your eyes, mind, and body.
Eat Something: Preferably something healthy.
Drink Water: Stay hydrated.
Stretch: Move around, go for a quick walk, get your muscles mildly active.

Keeping your energy levels up and maintaining your body’s natural recovery cycle puts you in a much better position to trade successfully.

2. Centering (Breathing Techniques)

Centering is a very effective technique that traders can use to control stress and muscle tension, block out negative or distracting thoughts, and refocus their attention on relevant tasks. Here’s how you can practice centering:

Sit in a comfortable but upright position with your legs and arms unfolded and uncrossed.
Take a deep breath in from your abdomen, imagining the air circulating around your entire body.
Exhale slowly and completely, feeling your neck and shoulders relaxing, spreading through your entire body.
Think about the single most important component to focus on right now.
Breathe in for a count of five through the nose and out for five through the mouth.

Focusing your breathing through the diaphragm is highly effective at centering emotions and achieving clear, focused mental states. Practicing this technique regularly will make it more automatic.

3. Focus on the Process and Control the Controllables

When you arrive at your trading desk each morning, what’s your goal? Is it to make a certain amount of money, make a certain number of pips, or maximize the opportunities you take? Consider two types of goals: outcome goals and process goals.

Outcome Goals: Focus on end results, such as how much money you make or the number of pips.
Process Goals: Focus on specific actions, behaviors, feelings, and processes required to achieve the desired outcome.

Outcome goals are like the jigsaw puzzle, and process goals are the pieces of that puzzle. By putting process goals in place, you complete outcome goals. The key is knowing when to focus on outcome goals and when to switch to process goals. Generally, think about outcome goals in the run-up to or after performance and process goals immediately before and during performance.

Define your desired outcome and the reason for it, then determine how you will achieve it through process goals. Process goals include preparation, picking and entering trades, managing trades, exiting trades, and evaluating. Being goals include feelings and thoughts important to have. Your process goal should be 100% under your control. The most important aspect of focus is remaining process-focused, taking each trade trade-by-trade. Different tasks require different focuses, such as broad external focus for monitoring trades and narrow external focus for being in a position.

To make this effective, write out your goals as if they are happening in the present tense, phrase them positively, and mentally rehearse them. Visualize yourself experiencing them afterward. Examples include:

“I am coming to the office feeling energized, positive, and expecting to make money.”
“I am doing my daily research and preparation, updating my knowledge, and calculating my levels.”
“I am entering my trades according to my strategy.”
“I am feeling calm, confident, and composed during my trades.”
“I am objective and positive when evaluating my trades.”

4. Managing Self-Talk

When researchers interview top sports stars, most report zero self-talk when performing in the zone, indicating that performance is externally oriented with no internal dialogue. This reinforces that being in the zone is an externally focused experience. If engaging in self-talk, keep it brief and extremely positive. These are known as performance cues, short, simple words or phrases linked to specific positive actions.

Using performance cues correctly can maintain focus and act as triggers for desired states or actions. A performance cue consists of three key things:

It is performance-focused.
It is positive and based on what you need to achieve.
It is very short and simple.

Examples of performance cues used by professional traders include:

“Patient and profit.”
“Focus.”
“I am calm and relaxed.”
“Focus on the process.”
“The how is in the now.”
“Trade by trade.”
“I am alert and prepared.”
“Anything can happen, anything is possible.”
“Control the controllables.”
“Tune in.”

Create your own performance cues using these examples as inspiration, attaching each cue to a particular situation.

5. Identifying Your Ideal Trading State

Identifying your ideal trading state and learning how to access it is crucial. This is a personal process, so spend time thinking about what your ideal trading state is, how you will create it, your ideal physiology for trading successfully, and the thoughts and focus that get you into that zone. Your physiology, thoughts and talk, and focus are the three key factors.

Go through the strategies until you find the combination that works for you. In the main program, you will have extra help with this training, and psychology coaching workshops will be invaluable.

6. Tapping into Your Awareness

Keep tabs on your emotional state. Notice how you are feeling in the moment and use the following five questions to create the best states for yourself:

How resourceful a state am I in?
Where is my energy level?
Where is my physiology?
What am I focused on right now?
What and how am I thinking?

Make any necessary changes to create the desired state or feeling. If you experience negative emotions during the day, stop, take time out, review the five questions, rewind, and write them down if it helps. Pay attention to how you created the negative state. For example, anxiety before entering a trade may mean you are entering for the wrong reasons, and your unconscious is signaling this through anxiety.

7. Creating Peak Performance Triggers

In trading and other performance-oriented environments, you can create triggers to enter your ideal trading state on cue through neurolinguistic programming (NLP) and the concept of anchoring. Anchoring is the process of stimulus-response conditioning, creating a specific response to a predetermined stimulus. We all have a host of anchors built into our minds, developed unconsciously over time. Some are empowering, while others work against us. Examples include the smell of certain perfumes, the sound of a whistle, or a red traffic light.

To create these triggers manually, follow this four-step process:

Remember a time when you had a desired feeling or state. Fully return to that time now. See what you saw, hear what you heard, and feel how good you felt. If you cannot remember such a time, imagine how much better you would trade if you were confident, focused, calm, and positive.
Make the colors brighter and richer, the sounds louder, and the feeling stronger.
As you feel these good feelings, squeeze your thumb and middle finger of either hand together.
While holding your thumb and middle finger together, think about a situation coming up during which you want to experience this state. Imagine it working perfectly, see what you will see, hear what you will hear, and know how good it will feel.

Keep this routine up, and eventually, you’ll be able to recall the state at any time by pressing your thumb and middle finger together.

8. Asking Resourceful Questions

Your experience and states are strongly affected by the quality of the questions you ask yourself. A trader having a tough time asking, “Why am I trading so badly?” will uncover unhelpful information. Instead, asking, “What do I need to do to trade more effectively?” or “How will I trade more effectively tomorrow?” leads to positive insights. High-quality questions include:

What am I grateful for today?
How will I trade well today?
What is going well for me?
What am I happy about today?
How will I develop my trading ability?

Quality questions often start with “how” or “what.”

9. Handling Losses Like Winners

Winners accept losses as a normal part of the game. After a loss, they:

Fully accept the loss and the nature of trading.
Keep their perspective and the bigger picture in mind.
Understand that there are valuable lessons in every trade.
Review trades from a third-party perspective.
Put losing trades behind them and move on.
Do not link losing trades to being a loser.

To handle losses, use the ARIA method:

Acknowledge: Accept that the trade did not turn out as expected.
Release: Note the feedback and then discard the trade.
Imprint: Mentally rehearse the ideal outcome you would have preferred.
Affirm: Tell yourself this is what you will do next time.

10. Regaining Focus

Everyone loses focus, but winners regain it quickly. Monitor your performance state on a scale of one to ten. If you need a quick refocus, use a performance cue. For major distractions, take a time out and follow this refocusing routine:

Stop: Get away from the computer.
Review: Assess your performance, feedback, and lessons learned. Be objective.
Breathe: Conduct centering exercises to refocus.
Refocus: Use a performance cue or process goals.
Visualize: See yourself trading successfully.

What am I grateful for today?
How will I trade well today?
What is going well for me?
What am I happy about today?
How will I develop my trading ability?

Quality questions often start with “how” or “what.”

11. Managing Risk

One of the quickest ways to create an unresourceful state is by taking on too much risk. This alters your state negatively, resulting in performance far below your potential. Imagine how you would feel if each pip was worth ten cents on a trade. Now imagine the same trade with each pip worth a hundred dollars. The emotions are completely different, affecting your decision-making and performance. Manage your risk to match your trading capability, maintaining a positive state.

12. Physiology

Think of your physiology as a set of clothes you wear for specific situations. Recognize which physiological states you need for trading success and adopt them. Posture, breathing, heart rate, gestures, facial expressions, and muscle tension are all factors that can change your state.

13. Beliefs, Attitudes, and Perceptions

Your beliefs, attitudes, and perceptions directly impact your state and behavior. Positive beliefs about your goals and abilities are crucial for success. Look at proven examples of people who have achieved what you are trying to achieve to positively change self-limiting beliefs.

14. Mental Rehearsal

Mental rehearsal involves imagining yourself trading well and visualizing it repeatedly until it becomes your normal self. Mentally rehearse your process goals, visualizing success. This technique programs your desired behaviors into your unconscious mind, which operates best with visual imagery. Successful performers in all fields use mental rehearsal to prepare for success. Follow the four R’s of mental imagery: Reason, Relax, Realistic, Regular.

Summary

We have covered the essential aspects of trading psychology, including how emotional states influence performance, the importance of energy management, centering techniques, focusing on process goals, managing self-talk, identifying ideal trading states, creating peak performance triggers, asking resourceful questions, handling losses like winners, regaining focus, managing risk, utilizing physiology, beliefs, and mental rehearsal. Understanding and mastering these elements are crucial for long-term success in trading. Use these strategies to create and maintain the optimal emotional states for trading, allowing you to perform at your peak potential.