To say day trading is difficult is to be guilty of understatement. It can feel like swimming with sharks, constantly fighting over every drop of blood.
It’s a fast-paced, stressful, and high-stakes endeavor, especially in the already-volatile world of microcap stocks. And it’s not just about technical analysis and strategy execution.
It requires mastering the psychological aspect, according to successful traders who’ve been in the game for years, even decades, and took time to learn from their mistakes..
Many times, a trader’s worst enemy isn’t the market – but themselves.
“If you can learn to create a state of mind that’s not affected by the market’s behavior, the struggle will cease to exist.” – Mark Douglas, author of ‘Trading In the Zone.’
The emotional roller coaster of gains and losses can be mentally taxing, making it crucial for day traders to cultivate the right mindset and understand limitations in order to stay focused and ultimately succeed.
Easier said than done.
There’s a graveyard full of speculators who confused luck with skill or got overly emotional and made rash decisions.
Yet, there are those who continue to compound steady returns from day trading due to mastering the mental aspect involved.
There are techniques that may increase trading skill in such a challenging space.
Understanding the Psychological Challenges
Day trading demands split-second decisions, rapid execution, and the ability to handle the stress of uncertainty. These pressures can trigger a range of psychological challenges.
The problem is that humans are complex creatures – full of cognitive flaws and biases – that distort our rational decision making. Science has already identified over 150 cognitive biases that humans fall prey to constantly.
And these ultimately impact trading decisions, for instance –
- The Emotional Aspect: rapid price fluctuations can lead to a roller-coaster of emotions – from euphoria after a successful trade to despair following a loss. Traders may experience greed, fear, and impulsivity, all of which can cloud judgment in such a fast-paced environment that requires clarity.
- The Confirmation Bias: Traders may end up seeking information that supports their existing beliefs while ignoring data that contradicts them, reinforcing their views in the face of risk. This can lead to poor decision-making and exacerbate losses.
- The Sunk Cost Fallacy: Traders are reluctant to abandon a strategy or trade because they have invested heavily in it already, even though cutting loose from further losses would appear to be more beneficial. Beware over-positioning and holding onto losers.
- The Recency Bias: Traders tend to overvalue the importance of recent experiences and information, believing it will continue well into the future. This often misleads traders, and more often than not, leads to folly.
- The Hindsight Bias: After an event occurs, traders may falsely believe they predicted it all along, causing them to neglect the role of uncertainty in decision-making.
- The Outcome Bias: Traders may judge a strategy solely on the outcome, and not the quality of the decision. This can create false confidence and encourage a trader to repeat the process with higher stakes, when in reality it might’ve just been a lucky trade. Or, vice versa, a trader may abandon a sound strategy because of one unlucky trade.
- Loss Aversion (Prospect Theory): Traders tend to value gains and losses differently, placing a higher value on losing money. Or put simply, they’ll tend to feel the pain of losses more intensely than the pleasure of equivalent gains.
- Disregarding the Margin of Safety: Traders may oversize positions, risking large amounts of capital, just to make a small gain. This is similar to the old saying, “picking up quarters in front of a steamroller.” It’s important to size a trade appropriately so that if it goes wrong, the downside is limited.
- The Need To Overtrade: Impatience and the desire to maximize profits can lead to overtrading, where traders make too many transactions, often resulting in poor outcomes due to impulsive decisions. Sitting on the sidelines and waiting for the right pitch is more prudent than swinging at everything.
- Anchoring: Traders become fixated on certain price points or targets that can prevent them from adapting to new market conditions and adjusting their strategies appropriately.
These are just a few of the inherent biases that plague traders. But understanding them and preparing mentally allows for better decision making and greater results over the long term.
Cultivating the Day Trading Mindset
Jesse Livermore said it masterfully in his book, ‘Reminiscences of a Stock Operator.’
“A man must know himself thoroughly if he is going to make a good job out of trading in the speculative markets. To know what I was capable of in the line of folly was a long educational step. I sometimes think that no price is too high for a speculator to pay to learn that which will keep him from getting the swelled head.”
Traders must develop a mindset that allows them to navigate these psychological challenges effectively and while learning from past mistakes.
There are many ways a trader can improve:
- Controlling Emotions: Successful day traders learn to manage their emotions effectively the best they can. They understand that emotional decision-making can be detrimental and aim to remain rational – even in the face of volatility.
- Self-Awareness: Recognizing cognitive biases and how they might influence decisions. Regularly reflecting trading behavior and assessing whether trading choices were based on rational analysis or biased thinking.
- Having Patience: Patience is a virtue in day trading. Waiting for the right setup and not succumbing to the urge to trade excessively can significantly improve outcomes. The world is full of foolish and impulsive traders. Gain from their mistakes.
- Set Clear Goals: Having well-defined goals provides a sense of purpose and direction. Whether it’s a daily profit target or a monthly goal, these objectives can help traders stay focused on their purpose.
- Create a Routine: Establishing a daily routine can create a sense of structure and discipline, which is pivotal for day trading. Starting the trading day with specific rituals that help you mentally prepare for the challenges ahead.
- Mindfulness: Practicing mindfulness techniques can help traders stay focused on the present moment and prevent emotional reactions from clouding their judgment. Things like yoga or meditation have been shown to help traders reflect and calm themselves.
- Risk Management: Accepting that losses are a natural part of trading is crucial. Traders should define their risk tolerance and set stop-loss orders to prevent catastrophy.
- Continuous Journaling: Many of the best traders recommendkeeping a trading journal to record thoughts, strategies, and emotions after each trade. Writing down these experiences help with contemplating and identifying patterns to improve decision-making over time.
- Taking Breaks: Continuous screen time can lead to burnout and decreased focus. Schedule regular breaks to recharge your mind and avoid decision fatigue. Taking a brief walk or reading a book outside may help.
Day trading is a challenging pursuit that requires not only technical and fundamental knowledge, but also a strong psychological foundation.
The mental game revolves around managing emotions, understanding biases, staying disciplined, and maintaining focus.
“You need to know very well when to move away, or give up the loss, and not allow the anxiety to trick you into trying again.” – Warren Buffet.
Take it from the Oracle of Omaha. Traders who can cultivate a mindset of emotional regulation, mindfulness, and continuous learning are better equipped to navigate the turbulent waters of the financial markets.
- Thinking Fast and Slow by Daniel Kahneman
- Trading in the Zone by Mark Douglas
- The Diary of a Professional Commodity Trader by Lewis Peter Brandt.