The biggest leap forward in my trading came when I began to think like a trader. This important realization was a result of training my brain to think in terms of probabilities. The best book hands down (for me at least) that helped me think this way was Trading in the Zone by Mark Douglas.
Thinking in probabilities did a lot more for me than just help analyze my trades. It allowed me to trade with more confidence because I knew the likely statistical outcome of a given series of trades. (A side note: in my nightly homework post you can see what I do each night as part of my trading routine).
I’d like to pull from some of Mark Douglas’s work in this post to help you better understand how thinking like a trader will lead to trading with more confidence and being more consistent.
Think in Sample Sizes
It is extremely important to look at the markets in terms of probabilities. This will help you understand your edge and calm your emotions from trade to trade. I like to think in sample sizes of 20 trades. Rather than look at my profit/loss for the day or week, I monitor my p/l in ticks for the last 20 trades.
Each individual trade you make is simply one of thousands of trades that you will make over the course of your trading. If you keep this in mind and limit your risk on every trade then mentally there is no need to fret over one or two losing trades, or even a string of losing trades.
Monitor your last 20 trades. What is your worst string of 20 trades? What is your best string of 20 trades? The numbers may surprise you.
Eliminate the Emotional Risk
Thinking in terms of probabilities also helps remove the emotional risk of trading. Mark Douglas talks about the 5 Fundamental Truths, they are as follows…
1. Anything can happen
2. You don’t need to know what is going to happen next in order to make money
3. There is a random distribution between wins and losses for any given set of variables that define an edge
4. An edge is nothing more than an indication of a higher probability of one thing happening over another
5. Every moment in the market is unique
When you train your mind to think in this way, the emotional stress and fear of pulling the trigger diminishes. You become less concerned with the outcome of each individual trade and more concerned with how it fits into the larger statistical set.
How to Create an Edge Like a Casino
The outcome of each individual trade is random, but the outcome a statistical set can create an edge. I found that approaching the markets with the 5 fundamental truths in mind; I am better able to focus on the bigger picture, and less on the individual winners and losers.
So how is it that a casino creates an edge? They put the odds in their favor. Creating a reward to risk ratio of 3:1 (or close to it) allows for you to be wrong less than half the time and still make money. This also allows for the costs of commission and slippage to be absorbed into your trading without taking a large hit to your bottom line.
All it takes is 51% to create an edge. In the markets, the ability to let those winners run and not cap your winning trades will make all the difference if you are successfully able to cap your losing trades.
Become an Observer: Exercise
Think about how objective we are when observing the markets with no money on the line. This is the state of mind we are looking to create throughout an entire trade. Win, lose, or scratch. One exercise I find useful is to visualize yourself standing just behind yourself, watching over your shoulder as you trade.
Does this trade meet your entry criteria? Are you taking this trade of boredom or because you’re afraid of “missing out”? Are you sure you want to break your rules? Why don’t you take a break for a bit.
These are some questions the observing self would ask your conscious self. Once you’ve identified your edge, practice executing your trades the same way, each and every time. Use this observer exercise to help keep you in check and remain disciplined.
The 7 Principles of Consistency
Mark Douglas talks about 7 principles which help beginning traders develop into consistent winners over time. The following are his list of guiding principles…
1. I objectively identify my edges
2. I predefine the risk of every trade
3. I completely accept the risk or I am willing to let go of the trade
4. I act on my edges without reservation or hesitation
5. I pay myself as the market makes money available to me
6. I continually monitor my susceptibility for making errors
7. I understand the absolute necessity of these principles. I never violate them.
So to think like a trader means to think in terms of probabilities, identify your edge, execute your trades the same way each and every time and take every setup that fits your criteria. Look to analyze your trades in sample sizes and not individually. Doing these things (over time), can help develop a level of confidence and consistency in your trading.
If you haven’t already read it, I recommend picking up a copy of Trading in the Zone. One of the best books on trading that I have been able to put to use.
Have you read Trading in the Zone? What other great nuggets have you pulled out of the book? Are the others you recommend?
thanks again for that article on Psychology which i think is most important.
I would suggest also:
-The Daily Trading Coach: 101 Lessons for Becoming Your Own Trading Psychologist
– The New Psycho-Cybernetics
Hey Tim I am 3/4 of the way through trading in the zone and I am loving this book I love the way he looks at the market like a casino it makes perfect sense to me. I am very new to futures trading so still looking for my edge via infinity practice account. Any advice you have on you found yours?
Hey Matt, in my experience I had some of the biggest light bulb moments after reviewing my trade data after the markets were closed so to that I would say take super detailed notes about why you entered your trades and how you feel during the trade along with run the #s and do the math to make sure you have a positive expectancy. After that, you just have to be able to pull the trigger and follow your guidelines.
Live trading adds so many more factors so start by mastering one method on a paper account. And remember, the markets will always be there so be patient.