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Friday Feature: Trading Psychology (Part 1): Becoming Emotionally Conscious in Trading

January 3, 2020

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Trading Psychology (Part 1) - Becoming Emotionally Conscious in Trading

You will always react emotionally because you are human, but the key to better trading is to catch yourself at that emotional moment and change course to align to better judgment.

Pearl Li —

We all know trading success is about emotional management and control to consistently make rule-based rational decisions to gain long term probability of winning in sustainable portfolio growths. This means you must stop being greedy, fearful, impatient, lazy, over-reactive, avoidant, angry, self-destructive and arrogant. Even as I’m writing this, I chuckle a bit at thinking how this process is comparable to becoming a saint. 

As difficult as this tall order of characteristics we must psychologically improve to be a stronger and more successful trader sound, I’m here to share my own psychological journey to provide concrete insights on the conscious steps I took that helps me to shift from my monkey brain to my investing/trading brain every day. Regardless of whether I’m able to become a trading saint or not, this journey is the everyday joy I get to experience to improve myself through trading.

80 percent of our decisions are made emotionally. We are 80% monkey and only 20% of rational human beings in this sense.

On top of that, our media culture, entertainment content and even news are all geared towards jacking up our heightened emotional state, which at times makes a rational decision an impossible task. The biggest driver is “fear”. Our sense of fear literally produces more adrenaline and stress hormones in our bodies and our brains. This is why animals are always so jittery and so reactive to everything. The sad truth is that many of us are not that different from animal reactiveness. There is no plan, no strategy and we simply do what we feel good in that second and produce negative outcomes long term.

This negative outcome delivers more fear and more reactiveness to produce more negative outcome. Thus, we are emotionally and subconsciously addicted to negative outcomes.

Yet, consciously we all know we don’t want negative outcomes with our trading or life. However, there is a great divergence that we need to close. Where the 80% animal brain needs to shift and align to the 20% rational brain. I’m not a psychologist, but I want to share with you through a specific trading example on how I continue to develop an emotional alignment to execute rational decision making in trading.

Train yourself to stay calm and be conscious to NOT react to your emotions.

The 80/20 Rule — Pareto Principle - img by @danewesolko on Medium
Image by @danewesolko on Medium.

$DLTR (Dollar Tree, Inc.) made a catastrophic gap against the Iron Condor I positioned on 11/25/2019. It literally blew through my $100 short put strike on the bull put side without a chance for me to even get out. The gap was something that is out of the norm for $DLTR.

First, an emotional reaction immediately took place in the morning when I found out. It woke me up. I’m usually a market closer, so morning actions really don’t interest me much. But that day was different for obvious reasons.

In my beginner days, I would immediately jump at this and try to close the trade in the morning and take max. loss. I used to over trade and overreact a lot to my own detriment. I used to have a sticky note that wrote PATIENCE on my monitor every day and I would stare at it whenever I want to react to my emotions in trading. Recently, I moved to a new place, so I no longer have this sticky note. But behaviorally, I’ve trained enough to where that morning after I felt the emotional urge to react, I immediately caught myself and slowed down. Even though I don’t have the sticky on my monitor anymore, but the word patience and staying calm came to mind automatically without the prompt.

You will always react emotionally because you are human, but the key to better trading is to catch yourself at that emotional moment and change course to align to better judgment. To do that, there are 5 steps for me:

  1. Realize you are having an emotional outburst and its not the best time to make a decision.
  2. Audit or prompt yourself to slow down, stay calm and practice breathing (meditation method). Whatever you want to do to train your behavior to stay still under emotional stress knowing this is better in the long run.
  3. When you can slow down and read the chart properly, then figure out your decision with a trading plan.
  4. When you execute this plan exactly, regardless of the outcome, applaud your effort to stick with a rational decision-making process. This will marry your emotion in the right direction and give more and more strengths to the rational side of your brain by enforcing it emotionally.
  5. Repeat steps 1-4 over and over until you are automatically shifting to a more rational side of the brain over time. You see how the coaches do it so easily. It takes years of conscious practice.
When the market shocks you, you will feel it, but how do you stop reacting to it? (Chart: Dollar Tree, Inc. - NASDAQ: DLTR)
When the market shocks you, you will feel it, but how do you stop reacting to it? (Chart: Dollar Tree, Inc. – NASDAQ: DLTR)

For me, I am proud to enforce a slow-down that day and figure out the end-of-day action, which in my better judgment understands on big surprise days like this, anything can happen. I still have 30+ days left and there is opportunity to slow down and decide what to do since I am already at max. loss with this catastrophic gap.

With that mindset, I adjusted this Iron Condor to a Put Butterfly at 100/95/90 strikes and waited for 30 more days to utilize Theta and short term neutrality after an enormous gap to recoup the losses on this trade with no additional cost. The trade closed on 12/31 recouping 80% of the original loss in line with my trading plan. What could have been a total losing trade turned out to be a “nothing” trade. I finally understood what Noah Davidson said about pad yourself on the shoulders for taking small losses.

A year ago, I could not imagine myself to have the emotional resilience to trade like this. Even as I am writing this blog on 12/31/2019, it serves as another behavioral training to recognize the progress I’ve made this year to consciously catch myself emotionally and shift gear to let rational decision-making drive my actions at the end.

This trade, regardless of profit or loss, befits the criteria to generate positive reinforcement that aligns with a rational decision-making process as one of my best year-end trade.

Pearl Li. The Theta Finder. In the Making.

Tackle Trading: Pearl Li.

Pearl Li previously has been a product management professional for more than 10 years working at well-known companies such as Amazon and Nielsen Company. She took the leap in 2016 with Elite Legacy Education to learn about building long term wealth through financial market trading/investing. In 2018, Pearl happily left her job to pursue investing/trading fulltime producing theta style trading that generates monthly cashflow. She is thrilled to be a voice on the Tackle Trading platform to share her transformation as she goes through various phases of her growing experience.

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2 Replies to “Friday Feature: Trading Psychology (Part 1): Becoming Emotionally Conscious in Trading”

  1. JenniePhen says:

    Thank you Pearl for the new year’s gems! I really appreciate your leadership and guidance in our STC! I had a couple of max losses before and was thankful that position sizes were small. Cheers. Binh

  2. DavidAranda says:

    Hi Pearl, thanks for sharing this, super helpful! Though I little bit late, I have been trying to model in the risk graph how you transitioned from the Iron Condor to the Put Butterfly, and I wonder if you could answer these questions:
    – Did you turn the trade into an inverted butterfly (credit), right?
    – Did you do something with the bear call or just let it expire worthless?

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