We trade to win, and most traders define a “win” as a trade that makes money. However, most aspiring traders over-focus on the money, which, paradoxically, causes unnecessary losses. I call this vicious circle the Money Trap.
The Money Trap runs on automatic, because we are wired to react to the risk of monetary losses in a certain (problematic) way that actually makes them more likely and more serious.
Trading well requires that we condition ourselves to do the opposite of what human nature demands that we do. It’s not easy; it is like training ourselves not to laugh when tickled.
A Charged Topic
In trading and in life, money is a “charged” topic. A study of 4,500 couples revealed that arguments over money are by far the top predictor of divorce. Why?
Because attitudes toward money are deeply intertwined with core issues such as security, power, status, self-worth, trust, etc. In other words, a power struggle over money is really a proxy for these other battles.
In my experience as a trading coach, just as in a marriage, ongoing conflict with the market about money leads to trader failure, if not corrected. Here’s why.
The Slippery Slope
Traders with money “issues” generally go through a 5-Step process when facing a potential loss.
1- Denial that the loss or risk of loss is real or might become real.
2- Anger, once the reality of the potential loss is recognized.
3- Bargaining with the market to get out of the trade at breakeven.
4- Depression at the eventual realization that things are not turning around.
5- Acceptance, which, in trading, results in an act of liquidation.
This process delays the inevitable and turns small losses into large ones. It begins because the trader is overly reactive to the possibility of loss and refuses to accept it, even though it is relatively small.
It turns out that this is an all-too-human foible that behavioral finance experts such as Daniel Kahneman have proven to be the norm. According to Kahneman, we are wired to take small profits and let losses run.
The Bottom Line
You might as well accept it – most individuals lack the ability to be rational when it comes to taking losses and you are probably not an exception to this rule. As long as you are focusing on the money, you are likely to trigger your biological imperative to avoid taking the loss. Then things get slippery.
To avoid the Money Trap, I suggest you shift focus away from the money to your method, and define a “win” as a trade in which you actually followed your method (assuming your method has a positive expectancy.) The more you focus on proper execution, the better you will do.
