Mastering Trader Psychology

Articles on Trader Psychology by Rande Howell, Trader Psychologist

People (including traders) like to believe that they are rational beings who have to deal with emotions.  And they want to deal with them by pushing them away or pretending they are not there.  The opposite is actually true.  You are an emotional being who rationalizes what the Emotional Brain has already decided.  Nowhere is this more evident than in the transition from paper trading (where risk is not real) to live trading (where risk becomes palpable).

Managing the transition from paper trading to live trading is one of the most challenging moments in a trader’s evolution.  Few do it well.  But why?  On the surface, it looks so straightforward (you just leave your emotions at the door, right?).  The logic goes like this:  You learn on paper to get competent in trading – so you don’t hurt yourself.  While you are on the learning curve and making the mistakes that inexperienced traders make, it doesn’t cost you dearly.  Seems logical.  It’s like playing a video game, where, when you get killed – you just hit the reset button, and all is good again.  It was just a game, after all. And you’re learning how to get good at it. You’re learning the knowledge skills you need to play the real game, so that when you do go live – you are ready.

Then, as you gain the competency in whatever system you are learning, you can begin to risk capital AFTER YOU KNOW HOW TO TRADE.  You conserve your capital until you have the skill sets that is required when trading live.  This logic makes sense until you try to do it.  What typically happens is that the trader’s mind gets hijacked when the money becomes real, and he takes losses.  Something happens that is not logical.  And no matter how hard the trader tries to push through the flak storm of live trading, what the trader runs into is a primitive and instinctual emotional brain that has been lying back quietly as long as there was not real danger out there in the jungle of the markets.  And that instinctual emotional brain does not perceive the same situation as the thinking brain sees when the trade goes against you.   This is what you cannot prepare for when you are paper trading. 

The Emotional Brain and Risking Money

The Emotional Brain has a very different agenda than the Thinking Brain.  By the way, your Emotional Brain is the brain that you share with all other social mammalians.  The Thinking Brain can envision risking capital when probability is on the trader’s side, and the trader knows that he can limit his losses if his educated guess is wrong.  This is the probability-based mind that the trader needs to be using as he trades.  But the Thinking Brain is not in charge under stress – the Emotional Brain is.  And therein lies the problem.  Your Emotional Brain cannot do this on its own.  First, the concept of money or capital is alien to it.  In the world within which the Emotional Brain dwells, there is no such thing as capital.  It does not grasp legal tender.  In the world of our hunter-gatherer ancestors, money did not exist.  But risking your life as you met the challenges of living did exist - in a big way.  And that’s what your Emotional Brain was built to do – protect your life for short-term survival.  It is a mismatch for trading.

What your Emotional Brain does understand about money is that, to it, money equals power.  Money equals safety.  Money equals status in the clan.  And risking money (right now) equates to an extreme life-or-death situation that has to be acted upon RIGHT NOW if the organism (the human being) is going to survive the challenge of risking his life (his money).  If you lost your power (money) you, most likely, were about to become a saber-toothed tiger’s next meal.  So risking money is like risking your life to your primitive caveman brain.  It’s not just you (the modern human being that you are) that’s doing the trading.  You bring along your caveman brain with you also.  He’s quiet until risk, equating to potential loss of life (capital), is real and there is no reset button.

So, when you move from paper trading to live trading, you have triggered ancient neural circuitry in the brain that activates your fight/flight response to life-threatening danger.  Without the perceived threat (paper trading), this circuitry is not activated.  You can be calm, cool, and collective as if you were playing a game of Monopoly – after you finish the game you can put it up or play another game.  And when you add the threat of risking capital (and what it means to the survival instincts of your Emotional Brain), your very existence is being threatened RIGHT NOW. 

The Emotional Brain’s survival instincts were not activated until the potential of loss when risking capital (and what that means to this ancient part of your brain) became part of the equation.

How Do Traders Try to Solve This Problem? 

Most people come into trading with some misguided assumptions, beliefs, and biases about how to fix the problem and train the Emotional Brain to react differently to risking capital.  First, they try harder.  Then harder.  And then even harder, when they don’t get the results they want.  They believe they can simply push through the problem and defeat it by force.  And what they discover is that the Emotional Brain pushes back.  And when the Emotional Brain pushes back, the trader gets hijacked. 

But the strong-willed trader is going to push harder because he has learned to keep pushing until he wins.  This creates a cycle of doing the same thing over again and again – but expecting a different outcome.  Albert Einstein called this the definition of insanity.  I don’t.  I call this normal.  This repetitiveness is what emotional adaption does.  It finds success, wires it into circuitry, and it is habituated.  So, you keep doing the same thing over and over again because it is the automatic response.  This is what has to change.

The fight/flight response is activated and usually the person is in full fight/flight mode trying not to lose his capital (his life).  The problem is that reason is now gone.  And the Emotional Brain does not want to lose, because losing means that his life is being consumed by the saber-toothed tiger.  So, he fights for his life.  This is what happens in an emotional hijacking.  The Emotional Brain activates the fight/flight response to threat and reason is taken offline.  When the smoke clears after yet another episode, you wonder, “What just happened?”  Now you know.

Can an Old Dog Learn New Tricks?

First, don’t get sucked into the folk misinformation that an old dog can’t learn new tricks.  The old dog and the evolving trader are both very adaptive creatures.  My dog, for instance, during Covid has learned to chase UPS, Amazon, and Federal Express trucks because he has learned that the driver always brings dog treats.  He has even learned not to pay attention to me when those trucks are delivering to our house.  He is an old dog and is learning new tricks.   The good news is that, with effort, you can retrain your brain to engage uncertainty very differently than what it evolved to do as a reactive pattern. 

The first step is to humble yourself.  Your primitive and instinctual Emotional Brain has to be accounted for even if you don’t like emotions.  They are your partner every time you engage uncertainty.  Your Evolutionary Psychology will always trip you up in trading.  It is built for short-term survival and the probability-based mind needed for trading has to be oriented to long-term success.  You have to become emotionally intelligent before you run out of cash.  Most traders don’t like that idea.  But it is true.

The second step is to recognize that you are an emotional being that has incredible potential.  This is where the brain/body/emotion/mind connection has to be established.  If you get around elite performers in athletics, you discover they practice a lot in the areas where they have the most trouble.  They don’t ignore it.  They master their fears.  And especially, they master their egos.  The ego, being right, will get you in trouble.  Grasping that you don’t control outcome, no matter how badly you want to win, is the first true step.

That actually allows you to start focusing on what you can control – the mind you bring into the act of performance.  Not winning and losing.  Partner with your Emotional Brain.  Teach it that winning and losing is not the game plan.  The game plan should ALWAYS be performing well.  And over time, your caveman brain will begin to trust you.  It is here where you must stay stable during challenging moments.  And losing must change its meaning to you.  Losing, to the elite professional trader, is simply landing on the wrong side of probability.  That’s all.  It does not say anything about you as a human being. 

It is here that you experience emotional freedom while trading.  Your Emotional Brain begins to trust your leadership.  And it knows you will not let it get ensnared by the saber-toothed tiger lurking in the shadows of the trading mind.  And, as Richard Branson once said, “Money is for making things happen.”  Money is not about your power.  It is only the currency of making things happen in trading.  Caveman can standdown.  There is no threat to his life.   And you and your thinking brain get to experience calm, patient, even boring, trading.  And you can make that happen.

Maintaining Emotional Control When the Money is Real