The human mindset is guided by our belief systems.
Therefore, the profitable mindset of a trader will be subject to these same belief systems.
Here are 3 powerful belief systems used by some of the greatest traders of our time.
Van Tharp points out very insightfully in his famous book, Trade Your Way To Financial Freedom.
“People don’t trade the market, they trade their beliefs about the market.” – Van Tharp
This offers a very true and insightful perspective about trading that all traders must eventually realize.
However, traders must learn to hold belief systems of somewhat opposing natures, when approaching different aspects of the trading business.
Long Term Mindset
For long term success, the trader must hold a rather optimistic mindset about the future.
The law of large numbers presides over the long term success of any trading career.
So the trader has to hold the mindset that by consistently executing his trade plans, regardless of any current short term drawdowns, in the long run, he will be profitable.
“Cut losses fast, and add to your winners” – Larry Hite
Larry Hite’s rule aims to reduce the impact of losses, while also magnifying the impact of winners.
Sure, hit rates will be low, resulting in frequent periods of drawdown, but the next trade could be that monster winner which more than makes up for the numerous small losses.
While this approach may not be for everyone, but it is an angle to give confidence in the long term belief system needed in successful trading.
Short Term Mindset
In the short run, during the lifespan of each trade, a trader must hold a rather pessimistic belief system, that the trade is likely to be a loser.
“I believe the current trade I am in will be a loser… a big loser at that.” – Larry Williams
Larry Williams elaborates that having this belief, we err on the side of caution instead of conviction.
Conviction of what is in reality, an uncertain future, leads us to trade too large or hold on to a trade too long.
If you have strong conviction that your trade will be a winner, that triggers a need to confirm this belief in your mind.
This will cause you to let losses run or stay with losers too long.
Cognitive biases are the bane of objectivity, hence the rise of systematic trading which dramatically reduces discretionary decision points made by a human trader.
Medium Term Mindset
In the medium term mindset, drawdowns are part of the business.
If you refuse to accept any drawdown periods and neglect to manage your risk, eventually you’ll encounter a significant loss.
“If you can’t take a small loss, sooner or later you will take the mother of all losses.” – Ed Seykota
Ed Seykota couldn’t have said it any better.
So work on accepting the necessary insignificant losses, it’s not personal, it’s just business.
Your mindset is going to determine how far you travel on this journey, or whether you’ll be going round in circles.
So how far do you want to go?
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