All traders should have a good trading plan. One of the worst bad habits a trader can have is trading impulsively and without any guidelines. Traders who take the time to make a trading plan are much more likely to succeed, but even with a plan in place we can stgelop bad habits. A trader will make impulsive trades even with their plan taped to the wall next to them. They may exit winning trades too quickly or let losses go longer than their plan states they should. In this article we will go into how we can change our bad habits. The process involves how we personally view our successes and failures, as well as the rewards and punishment we give ourselves based on these views.
In order to break bad trading habits, traders need to base success or failure on each trade by how they stick to their trading plans and not simply on whether they make or lose money. If you make a bad trade (that is, an undisciplined trade, one not part of your trading plan), but make money on it, you still have to view that as a failure; you cannot congratulate yourself. By congratulating yourself, you are offering a small reward for something done incorrectly.
Also, if you make a good trade (one that fits your trading plan perfectly), and you lose money on it, you have to view it as a success because you followed our plan. It’s more likely we berate ourselves even though we followed the plan; in other words we punish ourselves for doing what we were supposed to do! If you lose money, you can then analyze the trades to see if the trading plan can be made more profitable. But, if you continue to reward yourself for undisciplined trades that make money, it will be very hard to change your habits because you are essentially conditioning yourself to make trades that do not fit within your trading plan. If we punish yourself for trades that you lose money on, but that fit within your trading plan, you are much less likely to follow our plan at all.
So, you need to be honest with yourself and avoid accepting undisciplined trades – no matter how profitable they prove to be. Making money on a “bad” trade – holding a massive losing position, only to have it come back leave you a profit – is one of the worst things that can happen to a trader. Tendencies such as these destroy traders over the long run. By trading like this, traders can come to believe that next time they are holding a losing position it will come back. Unfortunately, if this fails to happen just once, it could wipe out your trading account. The trader may also falsely believe that because jumping in and out of the market without paying attention made money yesterday, it might also work today. This is a risky way to play the market.
Changing Your View of Success and Failure
Traders must erase their selective memory. This means, you must remember the times when not sticking to the trading plan hurt you and view those spontaneous trades as a failure. By instigating a mild form of punishment for not sticking to your plan, you will soon realize that not sticking to your thought-out trading plan is a losing proposition over the long run. When you make a trade that does comply with your trading plan, you should pat yourself on the back, even if you lost money.
You can always go back and adjust a trading plan, but the more ingrained our current faulty process for analyzing success and failure, and reward and punishment, the harder it will be to change over time. Every trader can change, but the best time to start changing your bad habits right now.
Applying Reward and Punishment
Once you understand how you are personally defining success and failure, you need to apply a process of reward and punishment to change these habits as quickly as possible. The first step is to change your internal dialog. Traders should praise themselves when they follow their plan, and they should withhold praise when they don’t.
The next step involves your external rewards and punishments. Oftentimes, we treat ourselves to dinner or pamper ourselves on a bad day. This should not happen if the bad day resulted from not following the trading plan. So, you should reward yourself when you follow the plan, and whenever possible, withhold rewards (a form of punishment) when you do not stick to your plan.
The word failure in this article is used to show that making money on each trade is not the most important thing. Success for the purpose of this article should be viewed as executing the trading plan you have laid out for yourself. The rewards for success should encourage us to continue with this behavior. The punishment for failing to follow a plan should withhold something we want, but not be negative or self-damaging.
The Bottom Line
Break your bad habits by being honest with yourself about how disciplined you are. Don’t deceive yourself into thinking you made a good trade, when in actuality you may have simply gotten lucky. Always stick to a well-thought-out trading plan. Define success as following your trading plan and reward yourself for doing so, regardless of profit or loss. Define failure in your internal dialog as not following your plan, and apply some form of punishment to this action (regardless of profit or loss). By strengthening the rewards or punishments, changes can be made quickly.
Other articles in this week’s newsletter