Trader Psychology

One of the most important yet often overlooked steps on the road to becomming a successful trader is understanding the psychological pitfalls every aspiring trader suffers from. This subject is handled extensively in books "Trading in the Zone" by Mark Douglas (which I consider a must-read!) and on sites like the one of Brett Steenbarger.

Below are some of the pitfalls I experienced personally.

Pride

Many traders have a very hard time taking a loss. Instead, they hang on to losing positions or (even worse) average down. Although this might work in some instances, it usually is a very bad idea.

Before becoming an active trader I used to manage a stock portfolio for many years, and I based my decisions for buying and selling purely on fundamental analysis. Two examples:

• I bought a stock around 10, doubled the position at 8, added a third part at 4, and finally sold them all after a takeover bid at 12 (making a profit of 4.66 per share or about 57%). A nice profit on a position 3 times my normal size, and the proof that averaging down works!
• Later, I bought another stock at 22, doubled up at 16, added a third part at 8 and a fourth at 6. I finally liquidated at 2.5, making a loss of 11.5 per share or about 90% on a position 4 times my normal size! The worst trade I ever made! Still sure avering down works? Note: 2 years later the stock is trading at 1.8, I could have kept on averaging down!

So the best advice I can give: when entering the trading arena, leave your ego at the door and swallow the loss when proven wrong!

Greed

When I first started day trading, I used to always hope that this would be THE killer trade. I entered into a trade, saw it go in the right direction, didn't close it because I wanted more, just to see it reverse and having to close it at break even. I wanted more, but got less in the end.

Now, when I enter into a trade I take some profit at the first major support/resistance and trail stops for the rest. When price bounces at the level where I took profit and triggers my break-even stop, I still have some profit. When price breaches the support/resistance and runs, I have some more profit. Over time, not being greedy gets you far better returns than always going for the home-run.

Fear

Fear is another pitfall I have experienced firsthand. Some examples:

• I used to pull my stop-loss to break even as soon as price went slightly into the correct direction. More often than not price came back to take out my stop just before running as expected. Now, I only move my initial stop-loss to break-even after I took some initial profit at the first support/resistance and then trail it at natural places (above a previous support, above a previous swing high ...). You can't make money when you are afraid to lose some!
• After entering a trade price makes a large swing in the correct direction and I am sitting on a nice profit. The fear of losing that profit often makes me want to pull the trigger and close the trade, instead of taking partial profit and letting the rest run. This one I still struggle with. Don't take (full) profits, trail stops at natural places and get stopped out.

Overtrading

When I first started daytrading, I felt that I always needed to be in a trade and I became restless when not in a trade. This made me jump on every little thing I saw, and resulted in a lot of bad trades. I still have this problem, but counter this by watching several markets for nice setups. This way I can trade frequently without having to jump on bad trades.