Trading is 100% Psychology

The title of this article comes from Van’s legendary statement in the trading community. Van has been a renowned trading coach for many years and through my interest in capital markets and psychology, I found his work and met him for the first time about fifteen years ago. I came to know him personally and my experiences with his concepts led me to join the Super Trader program from which I graduated in 2010. From the beginning, I accepted Van’s belief about the importance of psychology, however, only since I have been trading full time and teaching other traders has the crucial impact of psychology on trading become more and more obvious to me.

Why is Psychology Such a Determining Factor in Trading?

There is a huge difference between understanding the idea that “trading is 100% psychology” and actually experiencing many varied nuances and implications of that idea in my own trading. That took some time but I have been able to witness this same progression with other traders who trade my systems after my workshops. Over the years, it has become clear to me that the more experience a trader acquires with a particular strategy or system, the more important effects psychology has on trading outcome.

Psychology indeed impacts many aspects of trading ranging from (1) system development, (2) fundamental trading beliefs to (3) trade execution and (4) reading price chart dynamics. Let’s focus on the first two areas in this article and see how psychology relates to them (discussion about the last two areas will be in the Part II article of this series).

(1) System Development and Psychology

In the Super Trader program, I learned to build systems from scratch based on a set of beliefs. Most systems in the trading world out there do not explicitly state the beliefs behind their operation but actually, inherent beliefs form the basis for every system. Beliefs determine how individual system components will be elaborated including setup rules, entry rules, exit algorithms, position sizing strategies and the rest of the system components. As general advice, you should not trade a system if you do not know or understand the beliefs supporting that system. If you do try, you are likely to find that it won’t “work” very well for you if at all.

Once you determine the primary beliefs for a system, you can then identify individual market edges related to those beliefs. I have a strong opinion that the more edges you can aggregate in a meaningful way into a system (without eliminating too much opportunity), the better the system will perform.

This is a bit comparable to a cooking recipe: once you determine what matches your taste (the beliefs), you can find next the right mix of ingredients (the edges) and combine them in a particular way (e.g. the rules and any indicator details). As with cooking, you might already have a strong sense of what ingredients fit well with each other. Cooking recipes have an exact order and timing that defines the outcome and that applies to the outcome of your trading system rules as well. Coming up with a final recipe is a process of trial & error coupled with experience, intuition, and discovery. For a more detailed description of the process of system development starting with the beliefs, please sign-up to my distribution list to access an article I wrote for Traders’ Magazine (‘How to Develop your Trading System’ / Traders’ Magazine).

(2) Fundamental Trading Beliefs and Psychology

While each system has a specific set of beliefs, some fundamental beliefs define your trading as a whole. These are independent of any one system and they define who you are as a trader. As you add a new system to your trading repertoire, pay attention if it is congruent with your fundamental trading beliefs. This will allow you to flawlessly execute it without trading mistakes (i.e. at a high efficiency level).

Let’s have a look at how a set of Fundamental Trading Beliefs might look like. The list below defines who I am as a trader, what fits me and how I approach the markets:

Source: Overview of my Fundamental Trading Beliefs (from my workshop material)

How do these beliefs affect my trading?

It does so in manz wayz such as…
I am a trader who believes in the power of the human mind so my trading style is rule-based discretionary in nature (combining the conscious and subconscious parts of the brain). I have a strong belief that prices trend which presents me with a strong edge (see Belief 1 above). Thus, I only trade systems that are trend-following in nature. Being a visual person, I found myself flogging towards the trading niche of visual chart pattern recognition (see Belief 6). The interaction and the relative strength of buyers and sellers can actually be determined by the “psychological footprints” that these market actors leave on the chart through imprints of certain price candle pattern formations.

Being a visual person, analyzing charts is my passion and charts are all I need to trade — the less news I see or hear the better (see Belief 1). I believe in the strong edges that Leading Indicators and Higher Timeframes provide (see Beliefs 3 and 4). Most traders focus solely on the chart timeframe they trade while ignoring what is going on in the next higher timeframes. This basically means that they are leaving important edges on the table.

Fundamental Belief on price patterns (6) comes especially from my experience trading the markets. Once in a while, I detect a repetitive price pattern about which I was unaware previously. When I find such a pattern, I try to develop a rule-set providing a clear entry and stop-loss level for low risk trading. I then look for ways to capture profit consistently from that price pattern.

My systems are developed so that they can be traded with the very same rule-set in any timeframe – from very short to very long periods of time (see Belief 7 on the fractal nature of markets).

I am a big proponent of price consolidations on a horizontal line (see Belief 5) that develop after a momentum move in trend direction has occurred. Technically, this appears as a half-mast pennant and provides a great opportunity to enter a trade during a consolidation phase (the so called Trend Refresher). While the decreasing volatility during this period allows for a tight stop, a follow-though with good prospects of momentum enables a break-even trade very soon after entry. The trade target for this kind of strategy is the flag pole top of the pennant, a measured swing move, offering nice profits above 2:1 reward-to-risk – when it works out.

Do any of these beliefs resonate with your beliefs? It may depend on what kind of systems you trade now — which might indicate your Fundamental Trading Beliefs. As an example: a band trader trying to trade a trend-following system like mine may want to take profits too early as he strongly believes that price will come back to the previous price levels (as they tend to do with trading bands). In this way, however, he actually misses the biggest chunk of profits inherent in a complete trend-based swing move.

Your Fundamental Trading Beliefs

Have you thought before about your Fundamental Trading Beliefs? It might be a good opportunity to do so now. What do you believe about the markets and trading them that influences your trading? If you have a passion for system development, why don’t you start developing a system from scratch based on a set of beliefs as the foundation? In this way you can custom-build a system that perfectly fits you. If you prefer, you can research other trader’s systems that might fit you once you understand your Fundamental Trading Beliefs.

In this 2nd part, let’s focus now on the next two trading aspects of psychological importance being Trade Execution and Reading Price Chart Dynamics.

Van has formulated two famous statements of which, I believe, a trader should be well aware of:
a) You can only trade your beliefs and
b) You are the most important factor in your trading.

(3) Trade Execution and Psychology

Once a trader can execute a trading system in a flawless, unconscious and seemingly automatic manner, he will be able to trade consistently profitably. Resistance towards inherent trading beliefs — be it the fundamental beliefs or the system-specific ones— will create inner conflict with the result of unconsciously wanting to deviate from the rule-set (to alleviate the “pain”). Not following the rules is a trading mistake and almost always a mistake translates into negative R outcomes.

Be aware that many great trading systems are counter-intuitive — which is why they work. Initially, when executing a new system, you are likely to experience some struggle, stress and resistance. This is very natural and part of the development process similar to learning any other complex performance activity such as tennis or golf. If the resistance persists, however, then trading mistakes and self-sabotage will find their way into the trading process. Successful trading needs to be learned and it is best done by applying the system rules in practice. While there are several ways to do so, I recommend combining simulation technology with the principles of Deliberate Practice. Both are powerful tools helping you to efficiently ride down your learning curve. Think how the learning stages can be broken down and then go step-by-step while allowing prior learnings to become fully integrated.

I learned how to play tennis in Germany this way,  in a highly competitive environment back in the 1980s. I remember well that my learning and growth came from practicing the individual shots while hitting a large number of balls over and over again during focused training drills. And the drills included executing the shots in a flawless manner even without a ball while repeating the motions hundreds times (as if playing on the court). The same method goes for trading: the more practice trades you take in a safe and focused simulation environment, the faster you will achieve flawless execution. How did you start to trade a new system in the past? Did you jump right into live trading trying to squeeze money from the markets? I hope not. One would never think of playing tennis or golf competitively right away without the proper preparation.

What is the best approach to learning-to-trade a new system? There are certain main steps of progression a trader needs to go through and each step will take some time and require effort:

1. Unlearn destructive trading behavior.

I’m a big proponent of learning-by-doing and achieving progress through trial and error having gone through many lessons myself. One of the earliest trading lessons to learn is to find the right mental balance. Starting out typical human behavior makes you to revenge trade (anger-based) and to overtrade (euphoria-based). You need to ‘unlearn’ these behaviors but I believe a trader needs to go through these experiences first-hand to some degree. Once fully experienced (including the negative consequences), this destructive behavior typically fades away.

2. Apply the rule-set in practice until it becomes second nature.

Trading a counter-intuitive system requires new neural pathways to be established. This is best done in a simulated environment with exposure to a fast succession of practice trades and repetitions of those. Cut out as much detail and complexity as possible to focus on flawless execution of the rule-set only. Trading simulation software allows you to do this and you can build expert experience quickly. This learning step takes about 2-3 weeks and it is complete once you master mistake-free trade execution in simulation mode.

3. Build an efficient Live Trading Process that fits you.

Compared to trade-simulating, trading the live markets is much more complex than traders usually estimate. Live trading is a fast moving multi-tasking environment where you will need to master a good number of additional sub-processes, tasks and activities (e.g. efficient scanning & analysis, trade alert setting & news management etc.). In my coaching experience, this phase takes most traders about two months and it can best be achieved in a progressive way following one step after the other (see A Good System Relies On A Robust Trading Process).

4. Define the rules of your Personal Trading Game.

In his Peak Performance 202 workshop, Van focuses on the games construct for many areas of life – including the Trading Game. Following the standard trading game, a trader is actually meant to lose together with the crowd. In Peak Performance 202, Van demonstrates how a trader can reinvent their trading game through establishing their own rules and how they define winning the game.

So how can a Winning Trading Game be set-up? One needs to unlearn some of the typical thoughts, beliefs and behavior that might be useful in the real world, but they lead to constant trading losses. As an example, when success lacks in many business ventures, “pushing harder” is often the right strategy, In trading, however, this strategy is more often a recipe for disaster (see The Boom-and-Bust Cycle).

Here’s an early warning sign about which version of the trading game you are playing: should you get confused, stressed or tense during your trading activity, then you are not playing the winning version of the trading game. You will find your profitable niche once you have fully defined your personal trading game.

5. Work on your Beliefs and Mental State.

The last step in achieving trader competence is to work on your beliefs and your mental state. While many of your beliefs might certainly be useful in life, some of those will be detrimental in trading. Focus and work especially on those beliefs that hold a negative emotional charge. Van’s Peak Performance Home Study Course provides many tools and exercises to get rid of an emotionally-loaded non-useful belief — once you take off the charge, you can change the belief, and follow it with constructive behavior.

My experience has been that good traders tend to be ‘happy people’ and their mental state rests in a general sense of gratitude. Truly, no system edge can compensate for a lack of a poor mental state for trading. During a private conversation once, Van mentioned that ‘in the end everything boils down to emotional stuff — beliefs & mental states’.

(4) Reading Price Chart Dynamics and Psychology

Market actors leave behind clear “psychological footprints” in the charts Just as with physical footprints left in the ground, these footprints can be seen and analyzed. With a focus on low-risk trading ideas, I am looking for price candle pattern prints that form a specific visual cluster. Some of these patterns repeat over and over again as buyers and sellers are interacting in a dynamic way with one trying to conquer over each other. These psychological traces can be the source of great trading system ideas.

While some traces are more important than others, typically the best and clearest footprints are those that involve some emotional pain from both the buyers and sellers. Thus the best trading ideas come from a situation in which both parties suddenly become trapped (for different reasons) at the same time at the same pricing level. This creates an optimal Market Trap. The emotional intensity of such traps leave psychological traces that are as obvious as ‘blood trails in the snow‘. A market trap price level holds significant importance until the pain (respectively the emotion behind) is gone. Sticking with the snow metaphor, it holds until enough snow over some time has fallen onto it.

In an article I wrote for the Traders’ Magazine, I described in detail how to read those footprints of price chart dynamics. The example used is the Forex System 1 – the “Busted Breakout”. It is a very powerful visual pattern. Please sign-up to my distribution list to access the article (‘Become a Hunter’ / Traders’ Magazine).

Welcome to the Psychological Game of Trading!

Experienced traders certainly already know that Trading is 100% Psychology. If you are more of a novice trader, rest assured that trading will “push your buttons” as you start out trading. This is even more true for those entering the fascinating world of Cryptocurrencies with the huge and rapid price swings. See this as an opportunity and something positive: the spotlight is revealing your strengths, weakness and your areas to work on.

I’d like to finish with a final word of gratitude to Van. I am very grateful you opened my eyes and have shown me the way for more than a decade now. You helped me completely transform as a person and as a trader. Thank you very much!

Note: The articles in the Traders’ Magazine (see above) provide details about how I came to develop the Forex System 1 — the Busted Breakout system. However, the system rules in the article had to be changed and simplified due to that publication’s large subscriber base. In my coming Forex workshop, I teach the original system rules for the system.

Video Analysis of the Forex and Cryptocurrency market

In this April 20, 2019 video, Gabriel’s analysis gives you a view on FX and Cryptocurrencies identifying the best potential moves in each group in the coming weeks. First, he analyses the Forex Market by providing a top-down view based on higher timeframes (valid for the next couple of weeks). The FX market is currently at an important cross-road with EURUSD potentially resuming its previous downtrend — meaning USD strength would resume as well. The EURUSD pair impacts the other Majors and cross-pairs — all of which should follow the lead of EURUSD and soon develop momentum. At the 5:28 mark, Gabriel then analyzes the Cryptocurrency market with a focus on the macro caps. The Crypto charts seem to “respect” the patterns he trades and he has found that his System 1 and System 2 in particular do very well in Cryptocurrencies.