How Psychology Can Help You Not To Be A Loser

My new book "Naked Trader 4" is out this very week! You can buy it from my website nakedtrader.co.uk or Amazon.co.uk. There’s lots of new stuff in it from the last three years since I wrote the last one.

And in it is much more about psychology than the last one because since I wrote edition three and meeting lots of traders I have realised understanding psychology is more important that you could possibly imagine. After all, it is your brain that makes your trading decisions in the end and obviously each of us has brains that work in different ways.

But remember, more people lose than win at trading. So we really have to have a go at understanding psychology, to figure out why most people lose. So if we can grapple with that and try and work it out, simple psychology will help us.

I think I have a pretty good handle on market psychology because of the thousands of emails I’ve had and the thousands of you I’ve met at seminars. I’ve seen it all. Fear, greed, stubbornness, self-destruction, gambling instincts, whatever – I’ve read it or talked it.

Probably the number one reason most people lose?

Easy. It is GREED. The desperate desire to make big money and to make it NOW! That leads to buying crazily risky companies in huge amounts.

I met someone who put £200,000 in ONE risky oil company. It’s all the money he had. The bloke down the pub assured him this company was going to find tons of oil. It didn’t. Bet he is still holding the shares. Which leads me to…

STUBBORNESS – I bought the share and I was right and I am only going to sell it once I have made a big profit.

FEAR – A big reason for losses. Some people are so scared they never make money because once they make even a tiny bit of profit they take it without allowing a trade time to breathe.

Now we are going to talk about "confirmation bias". Yeah, I know, it sounds like a psychiatrist drivel kind of phrase. But worth a look nevertheless.

I came across confirmation bias when I was idly reading The Times Magazine and there was an interview with Derren Brown, the hypnotist and showman. I like Derren Brown, you should go to one of his amazing shows, simply terrific entertainment. He does amazing tricks, it's impossible to know how he does them and he freely admits he is no psychic and they are all tricks.

Here's the bit of the interview that made me sit up and take notice:

"At uni I spent a lot of time telling people why God exists and why they must become Christians. I believed it.

“But there is something called confirmation bias where once you got an idea in your head it's hard not to look out for things that confirm it whether it's that you believe someone doesn't like you or that you believe you have a gambling system, it's a very human urge and you are no less prone to it if not religious."

A lightbulb went off in my head. Yes, of course, I thought. This must be one of the major reasons so many people lose trying to trade shares.

When we go in and buy a share we think we are making the right choice. After all, we made an effort. We did our research, we did TA, we looked at the charts. Waiting to get our timing right.

But who knows? Some of you may have even looked at the bollingerband stoastics macd crossover elliottwave deadcrossricepudding signals. And any other cobblers you could find to validate your choice.

The trouble is, you see, once we made up our mind and pressed the buy button, that is it. We are now "in". We expect this share price to rise because we are pretty good at stock picking, right?

And once we are "in" the next thing is to look around and make sure our choice is validated by others. So it is off to the bulletin boards to check everyone else agrees the share is going up. And boo sucks to any moron who thinks differently.

Anyone who thinks the share has got problems is a total turdbrain. We're right. The charts say so. And the fundamentals. And the tipster bloke. And anyway there's going to be a bid next week!! That bulletin board bloke knows his stuff.

And so despite the share price continuing to go down we will continue to scour the internet for more validation of our choice.

Sell it? Are you crazy? Time to buy more!! Look how cheap it is now!!!! It is purely money lent! The markets always get things wrong. The market is such a moron!

Now it's got even cheaper, well that is GREAT news. Look at the price I can get it for now, it's like the sales. I'm in for MORE.

Okay so you know what I'm getting at.

What should we do instead of trying to get the validation that we are right about the share? Instead of always thinking we got it right? We should do the opposite. Indeed, the hardest thing in the world to do. Start again and maybe, just maybe, consider we were wrong. And perhaps even worse, consider getting out before it gets worse.

We should look at the alternative argument. In fact we should imagine looking at this share in six months’ time. It has fallen 50%. Why did it happen and could it happen? How could it happen?

Could we end up with a stinker on our hands?

What if we were wrong? What if the oil it is supposed to have turns out to be water? Hang on, what about the big debt? Never noticed that. Hang on, when I looked at the chart the gapuphangingmancrossover was pointing up. Now, well maybe…

And maybe the one guy on the bulletin board who was spelling out the problems with the share, is it possible he was right and the rest of us wrong?

But then there comes another problem. If we sell it now we validate the fact we got it wrong and we took a big loss. Now we can easily talk ourselves out of selling it. "There'll be a bid the minute I sell it".  "Oh well I lost a lot already might as well stay in". "Too late to sell it out, I'm stuck with it."

In the end it is always the same story: it is always better to cut the loser quickly and realise you got it wrong. And you can always go back in lower.