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vInside the Mind of a Trader

When I wrote my first book, there was a very good reason I called it ‘The Mind of a Trader’. Every one of the 10 leading traders I interviewed for the book told me that psychology was key to success. The criteria that I as the author, the Financial Times as publisher and my editor at the Financial Times used was based on the peer reputation of the traders, their records, and the capital they managed as a mark of success – eg Bill Lipschutz as Global Head of Forex Trading at Salomon Brothers at the time was probably one of the world’s largest FX traders self-evidently.

In this educational article to support my forthcoming webinar for Forex broker 24option, I will cover (A 24option account will be required to sign up. CFDs are leveraged products that involve substantial risk and may result in the loss of your entire balance).

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      1. Lessons on trading strategy and psychology from some of the world’s leading traders (as defined by Financial Times in my book ‘The Mind of a Trader’).
      2. The behavior that leads to failure.
      3. What winners do right based on 20 years of published Financial Times research in my books.

Detachment

Hedge fund manager, Bernard Oppetit, put it this way to me, “Whether I get out at a profit or loss does not matter.” And this surprised me. I expected the leading traders to be more attached to their results and performance. In fact what was a key characteristic of them all was their detachment to the outcomes of their actions; all were far more focused getting the processes right and concentrating on those.

A detachment was important for another reason. All those I interviewed were at the top of their professions. They were managers and leaders, not just traders. That sense of mental calm was a critical part of their success.

Pat Arbor, Chair of the Chicago Board of trade put it like this, “The trouble with the loss is not only the loss of money but it’s the ego.”

But detachment also meant, in the opinion of legend David Kyte, “I think the best traders are those who don’t read the papers”. These are people detached from broader noise in other words. He would look to see if the bulls ‘running out of steam’ and the bears taking over – regardless of what the news might be or what should be happening.

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Discipline

Linked to detachment, was their discipline. Again, as Oppetit put it, “it takes a lot of patience and energy and motivation”. You need to have a sense of discipline for that. But discipline for what? It was discipline in following their processes to get in and out of a trade as per their processes and system, and not deviate. This means not adding to losing trades in the case of all the hedge fund managers I spoke to. It means not making excuses when you know you are suffering a loss and should exit according to your system. It also means not being greedy when you know the profits have run their course.

Key to the psychology was having a systematic approach in mind and following it and ignoring extraneous matters which can play with your mind and seduce you from deviating from your discipline.

As Bill Lipschutz, Global Head of Forex at Salomon Brothers put it, “If most traders would learn to sit on their hands, they would make a lot more money.”

Tenacity & Fearlessness & Ambition

Do not think of these psychological traits, that successful traders are not passionate. Jon Najarian, a floor trader, put it this way, “Unless you are willing to bang your head against the door until you break through, you are not going to make it.” But there is tenacity and pushing your luck too from a psychology view. David Kyte, another legendary floor trader said, “You make your own luck. If you get in at 50, and it goes to 60, 70, 80, you were lucky and that’s also pushing your luck”.

Brian Winterflood, who has managed many traders in his life as a City of London legend, noted in the book how important ambition is for success. “You have to have a fire in your belly” and yes money is a driver, “in the big environment it was like going to sleep at the coal face, here it is a bit like waking up at a brothel.” His point being you do have to love what you do as a trader and give time and effort in order to have the odds in your favor!

Trade Size

You may think money management and trading strategy and psychology are different. Actually, they are inter-related. Again, what surprised me about the leading traders that I interviewed was that they did not take big risks or big trades. Of course, they had a considerable amount of capital, but in terms of how much of that was risked on any one trade, it was tiny.

This, traders like David Kyte, legendary floor trader, explained was not just in case they were wrong in a trade (they did not try to be right all the time) but also for the psychology – that with less at risk in each trade, it was easier to maintain calm and therefore your discipline, especially when it came to cutting your losses.

Therefore, these leading traders made their lives easier as a result of their trade size rules. They also had the benefit of avoiding therefore big losing trades, which otherwise could easily wreck a good record or month and additionally it also meant that they were not pressuring themselves to be right because if they were wrong, the loss was small.

It’s these small changes which allowed me, learning from these legends, some of whom became my mentors, to go from a University student to 10 years later a hedge fund manager.

In the words of Bernard Oppetit, “You do not need to risk a lot to profit a lot”.

In the words of Pat Arbor, then Chairman of one of the largest exchanges – the Chicago Board of Trade, “A good trader ends up being one who accumulates capital over a period of time”.

Risk Aversion

Those leading traders are well aware trading is about fear and anxiety. “You have to know what it’s like to feel pain, but you can’t be afraid of it.” Said Lipschutz. They had an aversion to risk, however. They ensured that they stacked the odds in their favor on any trade using their methodologies. Most of the traders I met were trend followers (either following trends after a breakout or a reversal).

The way they put the odds in their favour was to ensure that based on their experience of such trades before, they could start small, and if they were wrong, therefore lose small, but if in profit, could add to the winning trade from their profits and so risk their profits to make more, rather than risk too much capital. Capital preservation was the most important thing.

Martin Burton, another trading legend, this time out of London, said: “I am totally at ease with cutting out a position too early that I am at unease with.”

Biases

One of my favorite interviewees was Bill Lipschutz, who was Global Head of Forex at Salomon Brothers. His Chairman was Warren Buffett. I used these interviews as a source of my lectures as a Visiting Fellow in Business and Industry at Corpus Christi College, Oxford University. These were when for the first time the Nobel Committee recognized the significance of behavioral finance with their prize to Daniel Kahneman.

Your Mind is Your Performance

There are many biases that influence our reasoning. Popular literature recognizes 53 different types of cognitive biases (Hilbert, 2012); however, four of them are particularly important and significantly influence risk calculations and strategic decision making (Das, & Teng, 1999).

These cognitive biases are:

  • Prior hypotheses and focusing on limited target- this happens when a decision maker brings hypothesis and personal beliefs into decision-making process without previously inspecting the relevant data. Consequently, the decision-maker tends to overlook the information and evidence that can prove the opposite of what he thinks.

This is a major problem for traders because instead of being detached and dispassionate when looking at data, they let their pre-existing trades and losses affect their future decisions.

  • Exposure to limited alternatives– in the situation when data is incomplete, decision-makers tend to focus on limited numbers of alternatives because they usually fill in the missing data with intuition instead of trying to get additional information.

Traders do trades they shouldn’t. Instead of waiting for high probability trades, instead, they dive in impatiently.

  • Insensitivity to outcome probabilities– if a manager is influenced more by the value of possible outcomes then by the magnitude of probabilities, he/she will tend to make very risky and hazardous decisions that are not based on statistical calculations of probabilities.

Here the trader thinks how much money he will make, not how likely he is to make it. In trading, all we are trying to do is make small incremental gains, not huge windfalls.

In trading, we need high probability trades. In essence, we are trying to do this:

  • The illusion of manageability– when decision-makers intuitively believe that success is more probable than what statistical models predicted they can become overly optimistic. Consequently, they tend to overlook risks and develop illusion of control in uncontrollable situations. In addition, in these situations, they irrationally think that they can and will solve every possible problem that arose as a result of their decisions (Das, & Teng, 1999).

When it comes to trading, it is vitally important to be aware of the biases which inflict everyone.

Alpesh B Patel (@alpeshbp) –Alpesh is a hedge fund manager and Author of Trading Online (Financial Times). He is a partner to 24option (FX Empire Best Educational Broker 2017) who offer CFD trading on forex, stocks, commodities, indices, and cryptocurrencies.

The content of this article constitutes Marketing Communication and does not qualify as Investment Advice or Investment Research. This article is produced by Alpesh Patel. Any views or opinions presented in this article are solely those of the author and do not necessarily represent those of 24option. The article is of a general nature and does not take into consideration individual readers’ personal circumstances, investment experience, and current financial situation. 24option accepts no liability for the content of this article, or for the consequences of any actions taken on the basis of the information provided.

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