Tharp Think in Practice: Trading is 100% Psychology by Gabriel Grammatidis
The title of this article comes from Van’s legendary statement in the trading community. Van has been a renowned trading coach for many years and through my interest in capital markets and psychology, I found his work and met him for the first time about fifteen years ago. I came to know him personally and my experiences with his concepts led me to join the Super Trader program from which I graduated in 2010. From the beginning, I accepted Van’s belief about the importance of psychology, however, only since I have been trading full time and teaching other traders has the crucial impact of psychology on trading become more and more obvious to me.
Why is Psychology Such a Determining Factor in Trading?
There is a huge difference between understanding the idea that “trading is 100% psychology” and actually experiencing many varied nuances and implications of that idea in my own trading. That took some time but I have been able to witness this same progression with other traders who trade my systems after my workshops. Over the years, it has become clear to me that the more experience a trader acquires with a particular strategy or system, the more important effects psychology has on trading outcome.
Psychology indeed impacts many aspects of trading ranging from (1) system development, (2) fundamental trading beliefs to (3) trade execution and (4) reading price chart dynamics. Let’s focus on the first two areas in this article and see how psychology relates to them (discussion about the following two areas will be in the Part II article of this series).
System Development and Psychology
In the Super Trader program, I learned to build systems from scratch based on a set of beliefs. Most systems in the trading world out there do not explicitly state the beliefs behind their operation but actually, inherent beliefs form the basis for every system. Beliefs determine how individual system components will be elaborated including setup rules, entry rules, exit algorithms, position sizing strategies and the rest of the system components. As general advice, you should not trade a system if you do not know or understand the beliefs supporting that system. If you do try, you are likely to find that it won’t “work” very well for you if at all.
Once you determine the primary beliefs for a system, you can then identify individual market edges related to those beliefs. I have a strong opinion that the more edges you can aggregate in a meaningful way into a system (without eliminating too much opportunity), the better the system will perform.
This is a bit comparable to a cooking recipe: once you determine what matches your taste (the beliefs), you can find next the
right mix of ingredients (the
edges) and combine them in a particular way (e.g. the
rules and any indicator details). As with cooking, you might already have a strong sense of what ingredients fit well with each other. Cooking recipes have an exact order and timing that defines the
outcome and that applies to the
outcome of your trading system rules as well. Coming up with a final recipe is a process of trial & error coupled with experience, intuition, and discovery. For a more detailed description of the
process of system development starting with the beliefs, please click this link to an article I wrote for Traders’ Magazine ‘How to Develop your Trading System’ / Traders’ Magazine
Fundamental Trading Beliefs and Psychology
While each system has a specific set of beliefs, some fundamental beliefs define your trading as a whole. These are independent of any one system and they define who you are as a trader. As you add a new system to your trading repertoire, pay attention if it is congruent with your fundamental trading beliefs. This will allow you to flawlessly execute it without trading mistakes (i.e. at a high efficiency level).
Let’s have a look at how a set of Fundamental Trading Beliefs might look like. The list below defines who I am as a trader, what fits me and how I approach the markets:
Source: Overview of my Fundamental Trading Beliefs (from my workshop material)
How do these beliefs affect my trading? In every way but here are a few examples —
- I am a trader who believes in the power of the human mind so my trading style is rule-based discretionary in nature (combining the conscious and subconscious parts of the brain).
- I have a strong belief that prices trend which presents me with a strong edge (see Belief 1 above). Thus, I only trade systems that are trend-following in nature. Being a visual person, I found myself flogging towards the trading niche of visual chart pattern recognition (see Belief 6). The interaction and the relative strength of buyers and sellers can actually be determined by the “psychological footprints” that these market actors leave on the chart through imprints of certain price candle pattern formations.
- Being a visual person, analyzing charts is my passion and charts are all I need to trade — the less news I see or hear the better (see Belief 1). I believe in the strong edges that Leading Indicators and Higher Timeframes provide (see Beliefs 3 and 4). Most traders focus solely on the chart timeframe they trade while ignoring what is going on in the next higher timeframes. This basically means that they are leaving important edges on the table.
- Fundamental Belief (6) on price patterns comes especially from my experience trading the markets. Once in a while, I detect a repetitive price pattern about which I was unaware previously. When I find such a pattern, I try to develop a rule-set providing a clear entry and stop-loss level for low-risk trading. I then look for ways to capture profit consistently from that price pattern.
- My systems are developed so that they can be traded with the very same rule-set in any timeframe – from very short to very long periods of time (see Belief 7 on the fractal nature of markets).
- I am a big proponent of price consolidations on a horizontal line (see Belief 5) that develop after a momentum move in trend direction has occurred. Technically, this appears as a half-mast pennant and provides the opportunity to enter a trade during a consolidation phase (the so-called Trend Refresher). While the decreasing volatility during this period allows for a tight stop, a follow-through with good prospects of momentum enables a break-even trade very soon after entry. The trade target for this kind of strategy is the flag pole top of the pennant, a measured swing move, offering nice profits above 2:1 reward-to-risk when it works out.
Do any of these beliefs resonate with your beliefs? It may depend on what kind of systems you trade now — which indicate your Fundamental Trading Beliefs. As an example: a band trader trying to trade a trend-following system like mine may want to take profits too early as he strongly believes that price will come back to the previous price levels (as they tend to do with trading bands). In this way, however, he actually misses the biggest chunk of profits inherent in a complete swing move.
Your Fundamental Trading Beliefs
Have you thought before about your Fundamental Trading Beliefs? It might be a good opportunity to do so now. What do you believe about the markets and trading them that influences your trading? If you have a passion for system development, why don’t you start developing a system from scratch based on a set of beliefs as the foundation? In this way you can custom-build a system that perfectly fits you. If you prefer, you can research other trader’s systems that might fit you once you understand your Fundamental Trading Beliefs.
Part II to follow…
I hope to see or hear from you soon,
Note: The article in the Traders’ Magazine mentioned above details how I came to develop Forex System 1 — the Busted Breakout system. I simplified the system’s rules in the article to suit the needs of that publication’s large subscriber base. In my coming Forex workshop, however, I teach the specific system rules and present historic execution results (which are quite good) for the system.
PS from Gabriel — I teach three low-risk systems at the next Forex Trading Systems Workshop at the Van Tharp Institute in Cary, NC. Part of my personal mission is to help others, to provide information, and to transfer knowledge so that your path of trader development becomes as smooth as possible. As more experienced traders will tell you, everybody needs to transition through certain learning stages and I enjoy helping both new and experienced traders make those transitions. With every workshop, I too learn from you in how to be a better coach. I like to stay in touch with attendees once the workshop is over and I offer various degrees of mentoring support after each event.