This is a really excellent book on trading psychology. The book covers the reasons why traders find it so difficult to following their trading plan, and what they can do to fix those issues. Much of this is covered from the behavioral therapy point of view, and Bernstein is a trained psychologist.
Some very good insights include:
Bernstein identified “random schedules of reinforcement” as a key reason why many counterproductive and pathological behaviors are maintained. In the market, it is very common for bad behaviors to be rewarded just due to luck, and that reward actually compels the individual to commit the same mistakes again and again.
“If, for example, a behavior continues, we must assume that the consequences of it are rewarding even though they may appear to be negative”. For example, if you go drinking with friends or have a good meal to ‘get over your losses’, you are actually rewarding your losses, which will make it more likely for you to commit those mistakes again. The same thing occurs when you share your losses with others to get their sympathy, etc.
We must reward our good behaviors immediately so that your emotional mind can associate the action with the reward.
I highly recommend readers to get this book to read. It is chock full of great, detailed advice which helps traders to really deep dive into their psychology so as to improve their trading.
Why Too Many Traders Lose
Trading systems, methods, and indicators comprise perhaps 25% of the total equation for success; 15% is good fortune; and the remaining 60% depends on trader response to the system he or she is using; and to the markets.
All traders are not created equal when it comes to trading discipline. It is the response of the trader which constitutes the single most important variable in the equation for trading success. Too many traders lose money int he stock and futures markets simply because they do not possess the skills necessary to implement a trading system effectively, systematically, or in a consistent fashion.
Once you have pinpointed the reasons that you have failed to realize your full potential, you must act immediately or the opportunity will be lost — you will fail to seize the opportunity and time will be lost. The longer you wait the less capable you will be of taking action because lack of action will become comfortable to you.
Behavioral Law of Learning
Stimulus-Response-Consequence: The outer environment acts on an organism, which then responds to the external stimulus. The organism’s response results in any number of consequences. The positive or negative quality of these consequences determines the future history of the response.
If the consequences are pleasurable, then it is more likely the given response will occur again. If negative or painful, then it is likely the frequency of the given response will be decreased.
In-between the stimulus and the response, there is a perceptual filter. Our perceptual filter, molded by our genes and a huge variety of environmental stimuli combined with developmental experiences, shape our perception of the world around us.
Why Losses from Misperception Doesn’t Change Behavior
The more frequently rewards are given, the more permanent behavior will become.
You might then ask why perception does not change as a result of the losses that follow misperception. Simply, the misperception does not always result in a loss. There are times when, perchance, a profit results. Thus the investor is maintained on a random schedule of reinforcement for his maladaptive perception. And this, as you remember, is one of the reward schedules that helps create strong habits.
The upshot is simply that misperception is maintained on a very effective reinforcement schedule. It is a difficult quality to change, and accounts for considerable losses.
Most Fears Don’t Motivate Positive Behavior
Behavioral psychologists have demonstrated that learning as a function of grossly negative consequences can occur after a single exposure to the intensely negative consequences.
An intensely negative experience in the markets, on the other hand, will not, in and of itself teach you anything. There are only a few things you can do right in the market but the list of errors is, by comparison, immense. By adding disapproval to the already negative experience of a loss, you have added nothing constructive. In fact, you have added a destructive element since it may cause you to generalize the fear into a fear of trading. Fear of trading is just that; you will avoid the disapproval and rejection that comes with losses by avoiding the markets entirely.
Best Defense Against Faulty Perception Is Adherence to an Investment Strategy
The answer lies in adherence to a predetermined and systematic investment scheme. The best defense against faulty perception is a strong offense in investment strategy.
The best way to avoid losses due to poor perceptual development is by making your trading plans in a structured fashion and carrying them out accordingly. This will help minimize the possible negative effect of extraneous inputs. By not allowing them to enter into the investment scheme, we eliminate their negative consequences.
Inconsistent Application of Trading System + Partial Reinforcement = Road to Failure
Faulty learning begets more faulty learning, and more faulty learning will obscure the true path to success.
Imagine the individual who does not stick to one specific trading plan. The combined effect of partial reinforcement from the market itself and faulty learning resulting from acceptance of signals and trades from other sources can create a confused, frustrated, addicted loser.
B. F. Skinner demonstrated unequivocally that a random or partial reinforcement schedule resulted in learning that was the most difficult to extinguish. He proved, beyond a doubt in fact, that behaviors that are learned on a random schedule of reward are actually never forgotten or extinguished and that the organism can slip right back into them even after many years of “perfect” behavior.
It is best, therefore, never to begin on the road to failure by the inconsistent application of your trading system or rules or you will find it very difficult, near impossible, to take a different tack.
This is due to the nature of learning as just described. This is why most losers will always be losers and this is why most winners will become even bigger winners.
How to Change Inappropriate Behavior – Principles
The ultimate answer is simple: Remove the positive consequences, apply negative ones, redirect the behavior to a productive end, and reward it.
Behavior is maintained as a function of consequences. If, for example, a behavior continues, we must assume that the consequences of it are rewarding even though they may appear to be negative.
By changing the consequences of behavior, we can change behavior itself.
In order to change consequences, we must analyze them as specifically as possible. This can be achieved by the use of a trading record.
Record date, buy or sell, signal for entry, date of exit, P/L, and reason for loss (classify it under a few categories).
Keep a running total of which mistakes are most frequent.
Note any particular rewards or punishments [consequences] that followed the error(s) and any noteworthy events that preceded them [stimulus].
Note any errors that seem to be very frequent. Also make note of any previous conditions that are repetitive. Look for a pattern or patterns of behavior inherent in your trading. Once isolated, these patterns will become your target behaviors.
How to Change Inappropriate Behavior – Steps
Isolate target behaviors by keeping trading records
Isolate stimulus by noting conditions that precede target behaviors
Determine reward by noting consequence of behavior
Set a clear goal of the new behavior to replace the errant behavior
If possible, eliminate or sidestep the stimulus
Give reward immediately if target behavior is performed successfully, to attach positive consequence
Once the new behavior increases in frequency, fade out the rewards.
Monitor new behavior to check that it has taken hold.
Example: Liquidating a Position Too Soon
Stimulus: Tension, anxiety, opinion from others, uncertainty of your trading system or analysis, etc.
Behavior: Exiting a position before the time specified by your trading system.
Faulty positive reward: Relieve of anxiety / tension of carrying a position.
New behavior: Only liquidate when the trading system so dictates.
Change stimulus: Don’t expose yourself to others’ ideas.
Reward: Solicit immediate rewards from others, yourself, and from the market when new behavior executed.
Behavior Change Should be Progressive
Example problem: Not using stops.
Step 1: Record the stop on paper each time, ask a friend to help monitor, get reward from a friend.
Step 2: Step 1 + Give the stop to the broker each time, but don’t enter the orders so you don’t have the fear of your stops being hit.
Step 3: Step 2 + ask broker to enter the stops.
Step 4: Keep practicing.
Reward Your Good Trades, and Don’t Focus on Your Losses
Too many of us believe that the money made from trading will be sufficiently rewarding to keep us trading well. That is not the case. For those who are in touch with their goals and motivations and for those who have few conflicts in their home life, money can serve as a great consequence. For many traders, the money gained from investing is just not enough to maintain winning behavior.
Apply additional positive consequences for a profitable closed trade. The best time to apply is immediately after the profit has been taken. Each victory, if based on the trading system, must be fully and totally enjoyed.
Avoid everyone who seeks to punish or otherwise negate your positive consequences. If such negatives are permitted to enter into the behavioral chain, they will reduce the rewarding power of financial gain and thereby decrease the overall success rate of your trading system.
Too much attention to a loss will reward it. Avoid all attempts by yourself or others to soothe the losing experience.
See if You Can Devise a System to Signal the Error Before You Make It
Another way to correct errors in implementing your trading system, review the error to make certain that you were indeed at fault, then relive the situation from start to finish, and see if you can devise a system to signal the error before you make it.
The Trader Must Respond Appropriately to Assess a System’s Value
In order to evaluate a system, we must focus exclusively on its actions and results. We must therefore be certain that the results are a true reflection of the system itself — not contaminated by influences due to a deficiency on the trader’s part.
The most appropriate action for the serious trader to take would be strict adherence to signals and decisions regardless of input from any other source. Any deviation from it once again jeopardizes the learning process.
If You Keep On Losing, Stand Aside, Else You Will Become Immune to the Pain
The best way to end a losing situation is to get out of the situation, at least temporarily. This is why I recommend standing aside.
If you continue to beat your head against the wall, you will become immune to the pain and won’t realize that you are destroying yourself and possibly your family as well.
Recognize Telltale Signs of Negativity
Successive losses either in the market or issues in your personal life.
Lack of willingness to keep charts, data, or other technical work up to date.
Finding your market studies boring, possibly anxiety-provoking, and your level of motivation to keep current diminishing considerably.
Oversleeping in the morning, late for work, and leaving work early.
Having a “so what” attitude.
Hoping that the market ends quickly so you can stop trading.
Having negative self-statements.
Escaping, e.g. eating junk food, spending too much time playing games, etc.
Family members telling you that you are acting different
What to do
There will be a tendency to avoid dealing with the problem even though it has been recognized. You will want to fight yourself every step of the way and will do everything possible to make the job even more difficult.
The essence of the treatment is, brute force. A negative cycle feeds on itself and you must break into the chain.
Gather all of your effort and strength, force yourself to work on those charts, read those crop reports, make those trades, or calculate the signals. This is the time to respond in an opposite way from the manner in which you are inclined to act. The more you want to leave your office early, the more you must stay. The less you want to work on your charts, the more work you must do. The more inclined you feel to put yourself down, the more positive you should be.
It is especially difficult the first time you do it, but it takes less and less effort each time you practice. It will become clear to you after a number of such experiences that the harder you fight yourself, the more likely you are to succeed.
How to Reward Yourself
Pat yourself on the back. Tell yourself how well you did.
Enter the winning trade in your record book.
Tell others about your trade. Seek out their verbal praise.
Celebrate. Have a party; treat yourself to an expensive meal. Buy something.
Immediately tell your broker to send you a check for 25% of the profit.
Put some of the profit in your savings account.
Gloat over the profit for several days.
Don’t feel any guilt about being immodest.
Avoid Negative Consequences of Doing Well
Do not minimize the profit in any way, shape, or form.
Do not allow others to minimize your accomplishment. Do not accept any guilt from anyone.
Do not refuse praise from others.
Do not attribute the trade to luck.
Do not feel sorry for the person who lost.
Do not worry about the taxes you’ll have to pay.
Do not allow the profit to cause you anxiety about the next trade.
Do not allow any negative fantasies to enter your mind.
How to Handle a Justifiable Loss
Accept the loss and forget about it.
Record it in your record book and do not rehash it.
Do not discuss the loss with anyone.
Do not recruit anyone’s sympathy or sorrow.
Do not feel sorry for yourself.
Do not soothe your loss by going overboard on food, drink, or sex.
Do not feel as if you have been punished.
Do not punish or hate yourself for losing.
Do not allow yourself to accept any punishment from loved ones.
Do not accept ridicule or blame from your broker.
Do not blame your trading system.
Do not alter your technique, system, or methods.
Do not fear making the next trade
Do not respond by allowing your market studies to fall behind.
Positive Mental Attitude Is a Way of Life
Positive mental attitude is more than just a rote repetition of positive phrases; it is a way of life. The individual who practices positive mental attitude seeks out experiences that will provide the necessary rewards. Experiences that are negative are avoided, ignored, or eliminated.
Essentially the individual who has a positive mental attitude is attempting to control both the stimulus and consequence events in his learning chain. He will not only disallow negative stimulation to enter into his lifestyle, he will also make certain that positive consequences follow positive experiences.
Enter the Market With the Belief That You Will Win
Burton Pugh: Enter the market with the belief that you will win. Surrender no advantage to the natural human indolence. Money is made by aggressiveness and determination.
Don’t Take the Market Home With You
If you trade for a living, you must take great care to leave the market when you leave the office. The market must be seen as a means to an end. It should not become a way of life, and it should not dictate your every move.
Make certain you take vacations. Take time each year to close out positions and get away from it all.
Always Keep Your Next Goal in Sight
In working toward goals, you will be moving in a positive direction. Keep goals in mind at all times. If goals are forgotten or overlooked, negative thinking can become dominant.
Set yourself a month-by-month or year-by-year plan, review your specific goals and progress monthly, be as specific as possible.
Expectations Can Be Dangerous
Reality is not what it seems to be, but rather what we have learned to expect it to be.
If I expect a given situation to occur I will be set, or primed, to react to my expectations. And in doing so, I can be fooled.
Techniques to Cope with Stress
Ventilation (talk to yourself on the anxiety / pain / frustrations felt, jot down ideas and tensions in a diary)
Relaxation techniques (yoga, meditation, hypnosis, biofeedback, Jacobson’s muscle relaxation, reciprocal inhibition)
Diet (more vegetables, less red meat, alcohol, nicotine, caffeine)
Schedule (plan time for adequate rest)
Sleep (drug-induced sleep is not effective)
Working condition (think about your desk, chair, lighting, temperature, wallpaper, paint, telephone)
Fear Grows if You Don’t Fight It Immediately
I have found fear, regardless of its source, to be one of the most destructive emotions to which a trader can fall victim. It forces a host of losing behaviors; it paralyzes traders, it distracts from constructive action and thinking and it forces traders to actions they might not otherwise take.
While fear of failure is a potent fear, it is also a fear that can feed on itself. You become afraid of fear and the fear is magnified. You are so afraid to fail that you magnify the consequence of failure many fold until you are unwilling to attempt any solution.
The only way to overcome the fear is by facing it. If you intend to trade tomorrow, then every error must be systematically eliminated and every fear must be faced and overcome today. If you become aware of the fear early enough and if you admit to it early enough, it will not grow, and you will overcome it while it is still very weak. But if you wait too long, you will allow it to grow strong and it will be impossible to eliminate without professional help.
Make a list of your worst market fears (e.g. fear of losses, failure, rejection, disapproval, bankruptcy, ridicule, success, giving back profits, successive losses, etc.). Make a few notes and attempt to understand the source of your fear. Once the source or stimulus is recognized, take decisive action(s) to limit the source or to avoid it if it is impossible to eliminate it.
Overcome the Fear of Losses by Assuming the Worst
If you have broken one of the cardinal rules of trading by risking capital which you cannot afford to risk, then you have every reason to be fearful. If, however, you have been sensible in your decision to trade by using risk capital only, then your fears are clearly illogical and given their lack of rationality they must be totally ignored or they will become your undoing.
Accept the fact that the capital is nothing but risk capital and that it is gone before you started trading. If you assume at the outset that the money you have put up for the purpose of speculation is lost before you even begin trading, then you will not fear losses and they will not cause you to act irrationally. The best way to overcome the fear of losses is to be prepared for the worst before it happens. The best defense for fear of losses is a strong offense.
Another way of overcoming the fear of losses is to be familiar with your trading system. If you have thoroughly researched your trading system, you will know its limitations. Specifically, you will be aware of how many losses your system has taken in the past and what its worst dollar drawdown has been. You must assume that your worst case will be worse than what the hypothetical system test has revealed. Always assume that things will be worse. In so doing, you will be prepared to what may come. And the preparation will help you avoid the fear.
Don’t Discuss the Markets with Negative Individuals
Don’t discuss the markets with anyone, particularly with those who are supposed to be close to you. Stick to this rule rigidly if the people in your family or if your closest friends are inclined to be negative toward you when you fail. You are sufficiently negative toward yourself and don’t need any additional disapproval.
Make an assessment of the “negative” individuals in your life. Be especially careful to avoid any negative comments from them by avoiding issues related to the markets, your trading, your successes, your failures, and so on. Negative individuals can give you negative ideas about yourself whether you accept these consciously or not.
Key Items to Be Covered in Your Schedule
Market update and analysis
Making trading decisions
Studying trading rules
Testing and developing systems
Implementing behavioral change programs
Planning and operationalizing long-term goals.
Spending time away from the market
Make Certain That You Have a Set Time for Your Market Analysis
The most consistent and concerted effort must be applied here. Scheduling this activity should always be foremost in your mind.
Failure to keep up with one’s market work quickly will lead to losses. You have most likely found that many big moves begin when you have fallen behind in your work. Once your attitude changes and you update the missing material, you will say to yourself, “I never would have missed that move if my charts were up to date.”
Make Decisions After You Have Updated Your Work
I advise you to make decisions after all technical and/or fundamental work has been updated. This necessitates scheduling a time slot for decision making. I recommend this separate time slot because of the importance of the decision-making process. I have found that having a special time slot for this process makes the results more reliable.
Typically a trader’s mind will be cluttered with information and data on all markets when he or she is updating work. This tends to interfere with effective and rational decision making. It is possible to be more objective when making decisions after all market studies are complete. Each market then can be viewed in its totality without competing with input from your other work.
Isolate Yourself From All Outside Opinion
If an investor places himself in the position of reading the given opinions, then he may very well be influenced to act on the information, without knowing that we are being influenced by factors outside our conscious awareness.
Note that in this case the information is certainly within the visual threshold of the reader, but it may stimulate him to action after it has been forgotten. It is therefore even more likely that unwanted influences on trader behavior will result. The same holds true for auditory inputs. Listening to the opinions of others can, and most likely does, have an unwanted competitive effect on the independent investment response of the individual.
Don’t listen to the news, your friends, opinions of brokers, etc.
Don’t read government reports unless you are a fundamental trader.
Avoid the opinions of newsletter writers, market analysts, unless you have found one or two whose methodology and style are compatible with your work.
Don’t discuss your positions, opinions, results, or research with anyone. Talking about your work will either give another individual an opportunity to undermine your self-confidence or, by agreeing with your conclusions, give you false confidence.
Read Your Trading Rules Once Weekly
When things appear to be heading in a negative direction, you can help improve them by reading your list. This will remind you to be positive when the desire to fail is greatest.
90% of All Price Activity Is Due to People Acting on Their Perceptions
The human element stands as the intervening variable between stimulus and response. Economic fact must inevitably pass through the perceptual filter called the human brain. People will act on what has been perceived, whether the interpretation is or is not correct.
Ultimately economic law will take hold, but it is all too often a long, hard journey from fact to reality. It is the time spent between economic fact and market realization of truth that accounts for more than 90% of all price activity.
Were it not for the fact that people must act on their perceptions of situations, price response would be virtually immediate and almost always correct. There is no mystical truth in the fact that human weakness rests at the base of most stock, commodity, and real estate price moves.
How Will You Know You Found Your Niche
You’ll make money and you’ll be happy. Both elements must be present. And one does not necessarily lead to another.
W. D. Gann, Truth of the Stock Tape
W. D. Gann, How to Make Profits in Puts and Calls
W. D. Gann, How to Make Profits in Commodities
W. D. Gann, 45 Years in Wall Street
Burton Pugh, A Better Way to Make Money
Burton Pugh, Mastering Cotton
Burton Pugh, Science and Secrets of Wheat Trading
Burton Pugh, Trader’s Instruction Book
Jesse Livermore, Reminiscences of a Stock Operator
Bernard Baruch, My Own Story
Adam Smith, The Money Game
Important books on major bull and bear markets
R. H. Mottram, A History of Financial Speculation
Dana Thomas, The Plungers and the Peacocks: 170 Years on Wall Street
Gerald Loeb, The Battle for Stock Market Profits
Robert Sobel, Inside Wall Street
Victor Sperandeo, Trader Vic
Richard Tewels, The Futures Game: Who Wins, Who Loses, & Why