I recently thought about the similarities between becoming a successful trader and successfully losing weight. Both of them can be very challenging and need a combination of knowledge, discipline and persistence.
One thing I found fascinating was a psychology experiment carried out by researchers at Stanford University. This experiment tested the willpower of students and has some very interesting lessons for traders.
In this article I discuss my thoughts about the experiment and give some suggestions for how to deal with this issue.
The Psychology Experiment
Students were divided into two groups and told that they were going to be tested on their memory. The first group was asked to remember a two-digit number. The second group was asked to remember a seven-digit number.
The students were then told to go into another classroom one by one and write down their number. However, on the way to the second classroom, the students were stopped by another researcher. They were offered a choice of food as a ‘reward’ for doing the experiment. They were allowed to have either a slice of chocolate cake or a fruit salad.
In fact the researchers were not interested in the student’s memory. They were actually interested in what food choices they made. In particular, they wanted to see whether the two groups of students made different food choices.
The results showed that the students who were asked to remember a seven-digit number took longer to make a decision about food. Interestingly, they also found that that the students were more likely to choose to eat cake. Conversely, the students who were asked to remember a two-digit number made quicker decisions and were more likely to choose fruit.
Mental Stress Reduces our Willpower
It appears that our ability to make decisions becomes impaired when our brains are mentally stressed. Even the relatively minor stress of remembering a number makes a difference to our mental abilities.
When our brains our stressed we are also more likely to make decisions based on emotions or for instant gratification. We might feel compelled to have that slice of cake, frosted donut or ice cream sundae.
How does this relate to Trading?
Traders have to make important decisions all the time.
Unfortunately trading is inherently stressful. We see the financial markets going crazy and we start to panic. This leads us to make bad decisions. Despite the fact that we have studied and developed an excellent system.
When we get fearful we close positions early and lose the opportunity to make big profits. We enter at market extremes in the wrong direction and sit and watch the market swing against us. When we are feeling elated we can become greedy and take on too much risk.
Developing a trading strategy that works for you is a long process. But all that good work can be undone by mistakes made under pressure.
What Can We do About it?
Being aware of this issue is crucial. I have a few simple rules that will help you to avoid mistakes. Feel free to comment below to let me know your thoughts about this.
Keep your decisions simple
It is so easy to fall into the habit of relying on our memory of how to trade. This is a mistake. When you are testing and developing a system, write everything down and refer back to it. When you are trading live and hit a new problem. Write this down and write down how you solved it.
When all the trading steps are down on paper, your brain can relax. This frees it to make any difficult decisions that come up.
Avoid trading at stressful times
We have all watched the market react crazily to new information and jumped in at the wrong time. Always be aware of what is coming up. If there is a major data release or policy announcement think in advance how you want to play it.
Trade at the end of the day not the beginning. At the start of the trading day the market is moving fast and erratically. Spreads are often higher and it can be difficult to get the best price. Wait until the end of the day when it is calmer.
Make sure your strategy fits your lifestyle
In my eBook: How to Develop a Trading Strategy I discuss Time for Trading. This is a very important. Everybody has demands on their time. If your trading strategy needs too much time you must simplify it. Try trading on a higher timeframe or think about automating it.
Traders do not face exactly the same problems as dieters. When the markets are going crazy and you need to make a quick decision. You can always reach for that chocolate bar to give your brain the sugar boost it craves.