Lesson 3: Habits In Trading

A habit can be explained as a behavior or routine that is repeated multiple times and happens unconsciously.

Researchers estimate that about 40% of the decisions that we make on a day-to-day basis are based on habit. If this is the case, then the outcomes of our lives are a sum of our practices.

Trading habits play a vital role in success or failure. Great traders have developed good trading habits.

In this lesson, we are going to answer two primary questions;

  1. How to develop good trading habits?
  2. How to break bad trading habits?

Anatomy of a Habit

In the book “Power of Habit,” Charles does a perfect job of showing how a habit is formed.

We can simplify that process in the following way:

Trigger – Routine- Reward

Every habit has a trigger. The trigger is the feeling of unease or anxiety that usually crops up just before performing a routine. It can be a prior action, time of day, location, or anything that triggers the habitual behavior. This could be anything that one’s mind associates with that habit and automatically lets a pattern come to the surface.

In trading, we can use revenge trading as an example. The trigger point of revenge trading is losing money. After a losing trade, a trader hooked to revenge trading may feel the urge to execute another position.

A routine is a habit or behavior that we have formed. It’s usually anchored to the trigger of the pattern. In most cases, habits are formed unconsciously.

Rewards usually come in the form of dopamine releases in the brain. It’s generally associated with a positive feeling. In some rare scenarios, a habit can cause either pain or pleasure. In such cases, there is a risk of addiction. Trading happens to be one of those environments.

If we can understand this three-step process, it can be easier for us to know how to cultivate good habits and break bad habits.

In our trading, most decisions are made out of habit. For example, most inconsistent traders don’t have a structured routine of trading profitably. Consistency of outcome requires consistency of process.

Trading Addictions

Addiction happens when we cannot stop using a substance or engage in a behavior even though it is causing psychological and physical harm.

Trading addictions are common due to the pain or pleasure effect we talked about earlier. Since we can’t tell whether pain or pleasure will follow at the execution point, many traders fall prey to random performances to pursue these rewards.

Signs of Trading Addictions:

  • Trading out of a need to make money instead of objectively accessing opportunities;

Forex traders often spend every ounce of their energy trying to access opportunities where there is none. In the markets, there is a time to buy, sell, and stay out. Most of the time, traders should be out of the market, not clicking either buy or sell.

However, traders will keep on clicking the buy and sell button to ensure they get the thrill from trading, which is highly addictive.

  • Trading out of emotions (Boredom, revenge trading, and losses)

Part of the game of trading is learning how to deal with your emotions. Self-awareness is critical in the management of emotions. Traders need to learn how to manage themselves to ensure they don’t succumb to addictive trading. Losses are part of the game. Learning how to deal with them will be crucial in ensuring you don’t end up with emotional trading.

  • Excessive screen time

New traders often assume that more screen time equates to higher levels of productivity. It takes one some deep losses financially and emotionally to understand that less is more. Scheduling screen time during the day to watch what the markets are doing is one of the precious traits of a trader. This will help you focus on the signal rather than the noise in the markets.

Bad Trading Habits

We are going to go through some of the most dangerous habits a trader can develop. Unfortunately, human nature will draw you to these harmful habits. This is because our brains are wired for comfort, and often what feels comfortable is wrong in the markets.

  1. Adding to losing positions, also known as “Averaging losers,” – Only losers add to losing positions. For us to be profitable, we need to avoid opening multiple positions in the event of losers.
  2. Over-trading- the habit of trading without a plan results in over-trading. We must develop sound trading plans for us to trade profitably. A good trading plan should show us how to find low-risk ideas, execute and manage them well.
  3. Holding Losses – Losses are a natural part of trading. Trading is a game of probabilities. We must therefore learn to cut losses early. We can easily do this by setting exit points for every trade execution.
  4. Over-position sizing – Trading is a game of risk and reward. Taking too much trouble does not necessarily mean high rewards. Suitable trading is about risk-adjusted returns. We must therefore aim to take low stakes in the market.

Good Trading Habits

Since habits contribute almost forty percent to our success, it’s worth the effort to develop good habits. I will start by listing some of the most valuable trading habits to share the formula we use to build these habits.

  1. Cutting Losses – Account blow-ups often occur when we fail to cut our losses. Human nature makes us hope in times of failure and run for safety when markets are working to our advantage. Trading success requires the opposite behavior.
  2. Sound money management principles – It’s hard to succeed in the markets without a successful money management plan.
  3. Systematic planning and decision making – Markets are by nature random. Our decision-making has to be organized for us to stand a chance to succeed in the markets. We need to pre-plan how to handle different market conditions.
  4. Journaling – It’s essential to keep records of our trading. These records help us in filtering out lousy trading patterns and cultivate awareness of our successful trading patterns. We shall cover trade journaling in other lessons.

Tips to form good habits

  1. Start with a goal – It’s hard to work toward something if we don’t have a target. To develop a habit like cutting losses early, we can always decide the exit point before executing any trade.
  2. Identify triggers of behaviors – It’s easier to change or reinforce a behavior once we understand what triggers it. For example, if we realize that we can have a productive day by starting our day early, we can begin our days earlier in the morning.
  3. Use of a scorecard – We can use a scorecard to rate ourselves on different behaviors in the markets. For example, when we want to cultivate a habit like holding winners, we can rank ourselves daily on how we performed. Minor incremental improvements are critical for forming habits.
  4. Be resilient – It is hard to accomplish anything meaningful without resilience. Building new habits is not a walk in the park. Failure is part of the process. We need to cultivate strength for us to succeed eventually.