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Empty your mind – Psychology of a Trader

Empty your mind – Psychology of a Trader

It was the autumn of the year 2008. I was on flight from Vienna to New Delhi at a time when Europe had just about started witnessing the tremors of what would later come to be known as the Great depression II. I picked up the Financial Times and read what the then French President Nicolas Sarkozy had to say about the efficient market hypothesis – “the idea that markets are always right was a mad idea”. He was not alone in discrediting the stock markets, or capitalism as whole for that matter. Everyone was clueless. Over the next few months, stock markets in India declined by over 60%. Most investors lost a lot of money.

‘Some’ traders became overnight millionaires. I say ‘Some’ because here too, a lot of traders lost money. Recently, a friend of mine who trades rather heavily told me this:

There is evidence that at least 15 times in a year, the stock markets move up or down by over 2% in a single session. These are the days on which I make maximum trades

Clearly, if you were following his approach around 2008, you could not have been amongst the ‘Some’ who made money. What is it that sets some traders apart? How do they manage to beat the broader markets and forecast better than the heads of central banks?

Psychology of a trader

I have always believed that the business of stock Investing thrives on 3 things – Intelligence, Psychology and Information.

If all humans had the same level of IQ and everyone was emotionally zero (i.e. had similar psychological traits) and if the flow of information to everyone was equal, then what purpose would the stock markets serve?

None whatsoever. In fact, it would become the most boring fixed income scheme you could invest in.

Nevertheless, of these three traits, human psychology has the maximum impact on the movement of stock prices in the short-medium term. It is the psychology of a trader to overcome biases and human emotions like greed and fear and envy and desire that sets him apart from the others. Mostly, a trader just reacts and makes a lot of money if he can correctly predict the behavior of others.

There are many emotions and biases that play on our minds and there is certainly no shortage of reading material in this area. I will try to list down the ones I believe are most relevant for stock traders and how one can rise above them:

Rise above it - Be emotionally zero. Don’t feel happy nor sad about profits and losses on trades. Tell yourself this - It's my job to trade. Period.

Never ever let your hopes decide your trades for you. Markets will never perform the way you hope they do. An experienced trader always works with a strict stop loss in mind and never lets a single trade result in a big loss. Remind yourself of the golden rule once again - you don’t have to be right 10 out of 10 times. If you are correct 6 times, you will be extremely wealthy. Just make sure that you are happy to take losses on the 4 occasions where the market beats you.

If you want to take it to an extreme then I will tell you what helps a friend of mine, apparently. He has a placard hanging right above his computer screen which says – There is no hope!

Rise above it – For the love of god, just stop it. I have 2 spare, relatively new phones now (and a few thousand less in my bank account). I know, I should have followed this before preaching.

Rise above it – Evaluate everything on an individual basis. No one is infallible. Remember that MTNL was considered one of the highest investment grade stocks until a few years back with its wide network and customer reach. Along came Airtels, Reliances, Vodafones etc., and MTNL seems to have no economic advantages anymore (In the last 12 years MTNL has lost 96% of its market cap!!).

Rise above it - Let me tell you a story I read in Nassim Taleb’s classic book, 'Fooled by Randomness'.

A group of people participated in a contest of flipping coins and predicting the side on which the coin would land. Each contestant would play against the other in rounds of elimination until they reached a winner. After a few rounds when only some contestants remained (who of course had correctly predicted the landing of the coin on all previous occasions), they were asked how they managed to be correct each time. Many of them answered that they had mastered the technique of flipping coins. Of course, the probability of the coin landing on either side remained an exact 50%, in each case. Remember, each trade is new and has nothing to do with previous circumstances, even if the script and the trader remain same.

There are many other emotions that play on our minds. Recent memories of success or failures begging you to try it again or avoiding what you did earlier? Wanting to short the stock after it fell by a few percentage points may be just a few moments after someone confirmed that he is shorting it? The fear of loosing it all? The desire to make more money?

Trading is the art of overcoming such emotions more than anything else. When faced with such difficulties, take a deep breath, clear your head . . . . may be take a short break from trading before you get back in. Good Luck for Good Trades!

Rajat Sharma is the CEO at Sana Securities, an independent equity research and financial advisory firm in India. Views expressed here are of the author and RKSV Securities has not verified any facts stated above.

From the author: I hope you enjoyed reading this post and found it helpful. I am always happy to hear from anyone who wants to share their views.

I have been using RKSV’s services for over 2 years and highly recommend them for their back office software and support. Thank you guys, keep up the good work!

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