We trade to make money, but most aspiring traders over-focus on the money, which inadvertently causes unnecessary losses. I call this vicious circle the Money Trap.
The Money Trap is an automatic process, because we are wired to react to the risk of monetary gains and losses in a suboptimal manner.
Specifically, we are programmed to cut winners short and let losses run.
To trade effectively, we must condition ourselves to do the opposite of what our gut instincts demand. Why so reactive?
A Charged Topic
In trading as in one’s general life, money tends to be a charged topic. In one study of 4,500 couples, researchers determine that arguments over money were the top divorce predictor.
I believe this is because money issues are actually security, power, status, self-worth and trust issues. A power struggle over money is actually a battle over these other core needs.
In my experience as a trading coach, a power struggle with Mr. Market over money leads to trader frustration and eventual failure.
The Nature of the Trap
Traders in the Money Trap often pass through a 5-Step process when facing a potential trading loss.
- Denialthat the loss is real or might become real.
- Anger when the potential loss is finally recognized.
- Bargaining with Mr. Market to exit the trade at breakeven or a bit better.
- Depression when the trader realizes that the situation is not getting better.
- Acceptance, which, in trading, means actually taking the loss.
This 5-Step process delays the inevitable loss taking and actually turns small losses into large ones.
In terms of trading psychology issues, the Money Trap begins because the trader is unwilling to accept the possibility of a loss. This, in turn, often comes from a deep-seated imperative to survive. That’s not something that can be easily over-ridden.
Bottom line: Most individuals lack the ability to be rational when it comes to taking losses. A focus on the money will inadvertently trigger one’s biological imperative to survive when the possibility of a loss arrives.
To avoid the Money Trap, shift focus away from the Money to your Method.
Assuming your method has a positive expectancy, the more you focus on proper execution, the better you will do.
Until next time,
Dr. Kenneth Reid holds a Ph.D. in Clinical Psychology. He is currently a trading coach and has published articles for Forbes, SmartMoney, and SFO Magazine. He has also appeared on CNBC and writes a column on The Trading Psychology for Trader Planet. Kenneth Specialized in trading stock and futures and is working on a futures trading book.