The Psychology Behind Casinos And The Stock Market

Traders don’t like it when their profession is compared to gambling (and vice versa) because they believe that in trading skills determine if you come out ahead, whereas gambling is seen as a pointless endeavor where skills do not exist and only the desperate people are hoping to hit the jackpot.

However, in today’s world, the stock market has become a topic that you can read about in the news daily or watch 24/7 TV coverage of what is happening in the markets around the world. The way the stock market and trading is displayed and talked about has shifted significantly from sophisticated investing to sensation driven entertainment.

The implications of such a presentation and the impacts on the mindset and on the trading approach can be significant, without people even knowing how and why their trading decisions are being manipulated and impacted. The following article has been inspired by a chapter from the book “The indomitable investor : why a few succeed in the stock market when everyone else fails” where the parallels between the world of casinos and the stock market are compared.

Casino vs. Stock Market

Casinos:

When people go to the casino, they often have a very detailed game-plan about how disciplined they are going to play, what their risk limit is, how much they are willing to lose at most and plans about leaving with more than what they came with. However, the casino managers are aware of the ‘preparation’ of the average gambler and they found ways to trick them into abandoning their good intentions.

• Free alcoholic drinks to seduce people to take more risk than what they had planned
• Women and other attractions to create arousal and to stop people from thinking too much about risk and potential losses
• Bright and flashy lights and sounds to create a casual atmosphere with lots of excitement
• Everything in a Casino is designed to make you want to spend your money, often created by professionals with a psychological background, including odors, sounds, patterns of the carpets, etc.
• Casino chips are used to make you forget you are actually playing with real money

The Stock Market:

Although trading and investing is a very hard thing to do successfully, the way the media presents investing in the stock market is comparable to a large scale casino where the only goal is to create attention, excitement and awaken the hopes of people who are looking for a fast buck. The following attributes of the mainstream media and trading websites often create a wrong impression of trading and can be the cause of a negative trading performance:

• TV channels and newspapers use attention grabbing headlines and slogans to attract people
• Pictures and photos of young , rich men are used to awaken hopes and dreams of a certain clientele
• The hosts of investing shows have often little to do with sophisticated investors, but are very emotional to draw a lot of attention
• If there are extreme rallies you can read and hear about it everywhere and you can witness that even  ‘the average Joe’ now suddenly sees himself as an investor

Research on investor behavior and media coverage

The fact that financial media and the media coverage is impacting investor behavior is widely researched and 3 findings stand out which highlight the impacts of financial media:

1) Attention-grabbing events lead active individual investors to be net buyers of stocks.

2) Individual investors are more likely to trade an Nifty or BSE index stock after an earnings announcement if that announcement was covered in the investor’s local newspaper.

3) Investors who have never previously owned a stock are more likely to buy when stocks reach upper price limits such as all-time highs.

Taken together, these three findings show that the media has a big influence on how the average investor makes his decisions. Furthermore, even if you think that you make your decisions completely independent, being exposed to very emotional and convincing reports or announcements can lead to trading decisions that deviate from your original plan. The next points will show how a trader can protect himself from such negative influences.

Implications for your own trading and tips to counteract the outside influence

#1 “Think slow to think at all”

Before you make a decision, think about what caused to you think in a certain way. Before entering a trade, ask yourself whether the trade idea is based on sound principles and your trading rules,or did get you the idea from an outside source? To be profitable over the long-term, a trader has to make his decisions self-determined and based on his own research.

“Give a man a stock tip, and you feed him for a day; show him how to trade, and you feed him for a lifetime.” – Modern_Rock

#2 Who do you engage with during trading?

It is OK to interact with other traders and talk about experiences or personal views. But during trading sessions, traders should be somewhat isolated. Being active in forums, trading chat rooms or listening to financial news can influence your own decision making process. Amateur traders often look for outside confirmation when a trade goes against them and then they ask other traders, often with completely different trading methodologies, why a trade is still good.

“When a trade goes wrong if you’re looking for confirmation bias instead of hitting stops, you don’t have the mental strength to be a trader.” – Assad Tannous

#3 Check your surroundings

As we have seen above, the atmosphere in casinos can have big impacts on how we perceive risk and act in situations. Therefore, be aware of the music you play while trading and avoid anything that is too arousing – some traders report that they listen to classical music during trading sessions to keep their level of arousal low. Do you really need to have CNBC running at all times? To bypass periods where nothing happens, do you watch funny YouTube videos or engage in any other activity that could have an impact on your mood?

This point might sound over the top, but everything around us, and the activities we engage in have a direct impact on how we perceive risk and make our decisions, even though we might not be aware of it at first glance.

#4 The colors on your chart

Although I wasn’t able to find a piece of research about this topic, it can be assumed that the colors we use in our trading platforms impact how we perceive the current price development. All our lives we are primed to respond to the two most commonly used signal colors red and green. Whenever we see green, it means go and everything is good, whereas red signals an immediate stop or danger.

Are traders more likely to engage in impulsive trading decisions when they are currently faced with a big green or red candle? Very likely. Are you more likely to close a buy trade when the current candle is red? Possibly. Even if the impact is minor, a trader should grab every possibility to put the odds a little more in your favor should be embraced.

Why Traders Do Dumb Things

Why do smart traders do dumb things? It is usually an issue with overwhelming emotions, and not intellect, when bad trades happen. Here are a few of the primary reasons that traders struggle.

~The biggest cause of trading a position size that is too big? It’s the greed of wanting the big win that makes you take on too much risk, rather than not having enough faith in your entry.

~Missing a great entry signal is often not due to being too cautious. Instead, it is usually the result of the fear of losing. A string of losses, a large loss, or a lack of faith in your trading system, leads to missing an entry that your trading plan indicates you should take.

~Not taking a loss at your initially planned stop loss, isn’t  because you believe it will come back, but is the result of having talked publicly about your positions, so that your pride keeps you from exiting and admitting that you are wrong.

“I think investment psychology is by far the more important element, followed by risk control, with the least important consideration being the question of where you buy and sell.” – Tom Basso

7 Reasons to Never Give Up Trading

Early on, new traders will want to give up. Particularly when they figure out that the first few years are more about studying and paying tuition in losses, than in making money. Trading is a two-sided competition, and you have to be on the right side of the trade to make profits. Not only does this not happen all the time, but many profitable traders only have 60% win rates. Rather, it is the magnitude of their wins versus their losses, and their fortitude that make them profitable. Half of the battle of successful trading is never giving up. Perseverance in trading is about learning, implementation, and dedication.

7 Reasons to Never Give Up Trading:    

1. Trading will educate you about yourself. You will learn your strengths and weaknesses.
2. Learning to trade well will make you a better person. Good traders do well with managing their ego, fear, greed, and with risk management in other areas of their life.
3. Trading is a good measure of your abilities. It is competitive, but happens on an even playing field.
4. A great trading system can be a stream of consistent income.
5. You can grow your capital through compounding, and significantly change your life.
6. Nothing else offers the personal control over your financial freedom like trading.
7. What else are you going to do? Work a 40 year career in a job you don’t like, making money for someone else?

Why Trading Is Harder Than One Thinks

                                               

Being a trader is not just a numbers game, it is a way of thinking, analyzing and outsmarting all the other players in the financial markets. Professional traders, as opposed to recreational traders, make cold calculated decisions and are not afraid to make a trade if they perceive an opportunity that offers a good risk-reward setup.

Let’s consider some personality traits of traders. First and foremost, one has to basically be addicted to trading and the intricacies of the market and short-term signals. It takes years of practice, real time trading and implementing methodologies to get beyond the basic level of trading.

As a futures day trader, I realize that you must have the ability and the curiosity to develop new methodologies for different market scenarios. Trading also takes a great level of patience, especially when it feels like you have not made as much progress as you’d like (i.e. at times when your account is not gaining). Additionally, you must love the challenge of problem solving, because trading presents plenty of setups, successes, and failures.

The smallest of details between buyers and sellers (and remembering these details) can help set your performance apart. No amount of charting, notes, etc. will give you an edge if you cannot recall these details when you are trading in real time.

Traders also must have the ability to determine what technical variables to use for each market scenario. Again, this is a game of details, so this can potentially play a role in determining your rate of success.

Finally, let’s discuss the life style and psychology of short-term traders.

There is a perception that traders only work during traditional trading hours of the markets. This couldn’t be further from the truth, especially with markets like Futures that are open and active 24/5 (with the exception of a number of minutes it is closed throughout the day). When traders do not trade and monitor setups, they are focused on research. I estimate that professional/serious traders need to dedicate 1-2 hours minimum each day to go through charts and build a trading plan for the next day. This requires an environment where your time is respected and without interruption. Note that trading leveraged products such as futures may incur a loss beyond your initial investment.

Luckily for many Futures traders, there are several futures exchanges worldwide that could potentially have enough liquidity to meet day trading hours regardless of where you are in the world.

Profitable traders have the ability to recognize how “losers” behave so they can cut losses quickly. When discipline isn’t respected, losses can mount. As well, we all need to recognize when euphoria or despair enter the market, so we can take advantage of the opportunities. Understanding market psychology and how the masses behave is on of the most essential assets a trader can possess.

But, above all, good traders are humble and realistic. Over the long haul, hard work may potentially pay off. As opposed to amateurs, the pros realize that “consistency” takes work and, although there will be setbacks, the methods that got them this far should carry them into the future of the world’s most competitive sport: day-trading.

10 Things Successful Traders Must Quantify

Subjective: Based on or influenced by personal feelings, tastes, or opinions. Proceeding from or taking place in a person’s mind rather than the external world.

Subjective traders are intertwined with their trades. They generally enter trades out of greed and exit based on fear. They believe in their opinions more than the actual price action. They base trades off how they feel about a particular market at that time. A subjective trade idea comes out of the imagination of the trader, from their own beliefs, opinions, and what they think should happen. Many times, reality is not even cross-checked. It is the subjective traders who see what they want to see instead of what is really going on. Their compass is their emotions, and they often have conflicting goals.

Objective: (Of a person or their judgment) not influenced by personal feelings or opinions in considering and representing facts. Having actual existence or reality.

Objective traders have a quantified method, a system, rules, and principles that they trade by. They know where they will get in a trade based on facts, and where they will get out based on price action. Objective traders have a written trading plan to guide them. The guides of the objective trader are historical price action, charts, probabilities, risk management, and their trading edge. They react to what is happening in quantifiable terms that can be measured. They go with the flow of price action, not the flow of their internal emotions.

1. What exactly is your entry signal going to be? What technical indicators will trigger you to enter a trade?
2. What will the perceived edge for your entries be based on? Will you quantify your entries edge with back testing of through trading principles?
3. Will you wait for an initial move in the direction of your trade entry or will you enter based on a technical indicator trigger?
4. How will you trade in different market environments and trends? Will you have better odds of success buying dips in bull markets and shorting strength in down trends?
5. What is the risk/reward ratio for the trade you want to take? How much are you willing to risk if the trade is a loser? How much could you make if you are right? Is it worth it?
6. What are the probabilities that this entry will be a winning trade based on past historical price data and charts? With the winning percentage in mind how big do the winners have to be and how small do you have to keep the losers for the trading system to be profitable?
7. Where should your stop loss be? At what price level will your entry be wrong and signal you to exit the trade with a loss?
8. How big of a position size should you take based on your stop level and total capital you are willing to risk on this one trade?
9. Is your position size small enough to enable you to hold the trade without emotions effecting your ability to follow your trading plan?
10. When you open this trade in addition to your other positions, how much of your total trading capital is now exposed to loss if all trades went against you at the same time?

Don’t succumb to the emotions of a trade, and don’t attach your ego to it. Be the trader that witnesses the trade from an emotional distance with curiosity. If you can find that space between yourself and the trade, you will become more accurate and more profitable. When you can approach the results of your trading with equanimity, then you are at the next level.

Changing Your Trading, Changing Your Brain

An excellent article from Alvaro Fernandez takes a look at how cognitive neuroscience and technology are creating an explosion of apps for the brain.  There's an important recognition in this work:  that in changing ourselves, we change our brains.  Nothing in coaching or psychology works--no journaling, no goal-setting, no self-affirmations, no attempts at discipline or self control--unless it results in our rewiring.

If you are trying to change something in your trading, the key question to ask is:  Am I going about this change in a way that is likely to rewire me?  If not, the change won't stick.  Sticking with the same wiring and hoping for different outputs is a formula for frustration.

Cementing a change in trading--or in any other facet of life--requires two things:

1)  A fundamental shift in state of mind and body - The most efficient (if not the most constructive) learning occurs during trauma:  a single event can alter personality in fundamental ways.  Successful change creates positive traumas.

2)  Repetition - Doing new things the same way over time is what turns positive changes into positive habits.  We know we have achieved rewiring when we have cultivated new habits.  If a change is something you are working on, you know you haven't reached rewiring.  It's when changes become habits that they are truly part of us.

What Traders Can Learn From A Professional Gambler About Managing Emotions.

Cathy Hulbert is a professional ‘gambler’ who made a lot of money playing blackjack, slots and poker professionally over decades. I recently read the book ‘Gambling Wizards’ where she was also featured, among other professional gambling legends, and one passage struck me immediately because adopting a similar attitude could help traders perform much better and avoid unnecessary mistakes. But, first of all, let me quote the passage from the book:

“Cathy: Before I go to play, I don’t engage in any other activity […] I don’t take phone calls. I don’t socialize. I don’t plan any social event afterward. I don’t want any time restrictions. I want my mind to stay as peaceful and restful as possible. I go to bed at exactly the same time every night and get up at exactly the same time every morning […] I don’t drink any alcohol the night before I’m going to play […] When I’m driving to the casino, I’m very aware of how irritated I am at other drivers […] The calmer I am, the better I know I’ll do […] If I’m driving like a maniac, if the light turns yellow and I’m rushing through, I’ll think, OK, you’re in a bad state today […]

Interviewer: Do you still play?

Cathy:  I play lower. I make a mental note to watch what’s going on with myself […] I don’t want to tak a $5,000 loss because I’m in a terrible frame of mind.”

Trading is a mental game

As a trader, you don’t have to be super smart, although you need to be educated to some degree, you don’t have to necessarily understand all macroeconomic factors, although it helps to form an opinion, and it’s not compulsory to be an avid accountant and being able to read through company balance sheets.

Although having a tested and sophisticated approach is very important, the difference between an amateur and a professional trader lies somewhere differently.The reasons for unnecessary and avoidable losses of amateur traders can often be attributed to the following 5 points:

• Revenge trading: you open a new position just after your stop is triggered, without seeing valid re-entry signals.
• Playing catch up: you want to make up for past losses, force trades and violate your rules.
• You flip through your charts without really knowing what you’re looking for and then take trades that don’t meet your criteria.
• You want to avoid losses and, therefore, widen your stop loss order or take it off completely.
• You miss a trading setup and then jump in too late, although you should have stayed out by then.

If you are honest to yourself, you will know that you have probably engaged in at least a few of these 5 negative trading patterns. There is nothing to be ashamed of because most traders commit to the same actions and repeat their mistakes over and over again. If you objectively look back on your trading performance, most traders will see that the reason why they are not making the money they could be making is not because of the absence of a good trading strategy, but their repeated engagement in impulsive, emotionally caused trading decisions. It is safe to assume that most traders had a much better performance – some losing traders might even be break-even or winning traders – if they just had avoided the 5 previously mentioned mistakes.

Trading is a performance game and it’s not the trader with the most sophisticated trading strategy that will come out ahead, but the one who can control his emotions and attitude most effectively.

Self-awareness

Self-awareness is a character trait that is important for being successful, not only as a trader, but in life in general. Self-awareness means that you are aware of yourself. This can include your strengths and weaknesses or your current state of mind and your emotional status.

Daily self-awareness and the ability to assess your current state of mind is important as a trader. Since being a trader means that you have to continually make decisions that can cost or make you money, and even result in major losses, making sure that you perform at your best level is important. However, most traders just see trading as a job where they HAVE TO sit in front of their desk from 9 to 5, regardless of how they feel.

Check your state of mind

Every morning, before you start up your trading platform, take some time to assess your current state of mind. The following points can serve as a guideline to evaluate yourself:

• Do you feel sick? Although it is obvious that you shouldn't trade if you are sick, most traders don’t think that way and still trade as normal.
• Have you had enough sleep? A sleep deficit has severe impacts on performance and how we react and interact with the markets. Dr. Steenbarger has a great article about sleep and performance. As a side note, this also holds true if you had too many drinks the night before.
• Are you angry or aroused? An argument with your spouse or a serious conversation at work can, and will, carry over into your trading routine and will create a lack of focus.
• Over-excitement, on the other hand, can also significantly influence your decision-making process. Being too euphoric can be dangerous because you might analyze risk wrong or are too casual about potential losses.
• If you are coming from a winning streak, traders also tend to feel too confident and, therefore, be less risk averse. This usually leads to excessive risk taking.
• On the flip side, coming from a losing streak can make you be too cautious and, therefore, make you miss potentially profitable trade.

To assess your current situation, observe how you react and interact with people and situations around you. The quoted passage from the beginning gives a few helpful tips how your actual behavior and perception of the world around you signal your current state of mind.

 If you feel not too well and you answer most of the questions above in a way that signals that you are not in the optimal state of mind, don’t trade! Take the time before lunch off, or even take the whole day off. You will always get another trade, but you can’t get back the money that you lost by making an unnecessary mistake. Another way of avoiding unnecessary mistakes when you don’t feel well is that you trade smaller positions. If you normally risk 2% per trade, go down to 1% or 0.5% until you are sure that you feel better. Trading is not a business where you get paid by the hour, but by your performance.