The mind can play tricks on us causing us to have day trading mind traps. The most common Mind Traps are Intuitive Trading, Hindsight Bias, and Competency Bias, These mind traps are how we as traders fool ourselves into thinking trading is actually a lot easier than it really is.
Intuitive Trading is an attempt to mind read the market, which makes us susceptible to whipsaws. Hindsight Bias causes traders to underestimate the difficulty of trading, while Competency Bias causes us to over-estimate our abilities. These are mental banana peels that set us up for a fall.
Intuitive trading is a natural response to excessive randomness and non-linearity in the market. But making informed guesses is not the same as formulating a rule-based pattern-recognition system that gives a trader a true edge. Without a rule-based plan, intuitive traders expend a great deal of energy mind reading the market, which will not improve your odds of success. In fact, professional traders make a good living exploiting the emotionally-driven behavior of intuitive amateurs.
Trading appears easy because when we look at a chart, the attractive low-risk entries and ideal exits are obvious, in retrospect. This gives the false impression that entries and exits would also be clear in real time. “Hindsight Bias” is the illusion that the past was predictable.
Trading for a living does not happen on ‘cold charts,’ but rather at what Alan Farley calls the “hard right edge.” Trading successfully requires us to get comfortable with uncertainty; being willing to take action when one still does not know quite enough.
Many people who come to trade have been successful in other careers and think their business skills will help them succeed. Unfortunately, this is rarely the case. Neither prior success, IQ, market savvy, maturity, creativity, management skills nor any other business leadership qualities will prepare you to succeed as a trader. Instead, they are more likely to set you up for failure. Why?
The world of modern business rests on principles of social order and behavioral predictability that simply do not exist in the trading environment.
For example, if you drive a car, you have been conditioned to expect a certain minimal amount of orderly behavior from your fellow motorists. Along with you, they will stop on red and go on green; they will stay inside the white lines; they will mostly drive near the speed limit.
That orderliness and predictability is just not present in the market environment. Quite the reverse. One is much more likely to encounter paradoxical and unpredictable reactions to news and other obvious catalysts. Markets can reverse on a dime for no apparent reason. Trying to make sense of the market can drain all your mental reserves.
Compared to the business world, the signal to noise ratio is much poorer in the markets and cannot be filtered to achieve a comfortable predictability. Perhaps the best preparation for trading is martial arts or combat experience because both teach us to expect the unexpected.
Eliminate these three common mind traps immediately so you can avoid less risk in the markets and trade successfully.
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.