Mastering the Head Game of Trading

Everyone has seen it happen. Something snaps and knowledgeable traders start falling apart and blowing it in the heat of trading. You probably have experienced it personally more than once. Retail traders and professional traders usually have different routes to the failure of their highly trained minds. But on the P&L statement of both – it shows up red.

The retail trader usually comes to the game of trading with a lack of tolerance for risking capital (expressed as a need for control over outcome) and believes ardently that superior knowledge is all he needs to win. Meanwhile, the professional trader sooner or later gets ambushed by euphoric over-confidence (irrational exuberance) and mismanages risk till it bites him hard. Euphoria smashed by serious threatening consequences, the memory of those losses then begins to foreshadow his calculation of entries. It’s hard to shake once the trauma of losses become real. Either way, both the retail and the professional traders end up with compromised minds at the very moment they need their A-game to perform.

This cycle is the never ending story of both Main Street traders and Wall Street traders. At least until the trader begins to wise up to the “head game” aspect of trading. It is this inner game of trading that separates the wheat from the chaff. Mere knowledge versus performance-tested knowledge – being able to act coolly under pressure. And not being seduced either by fear’s irrational pessimism or by euphoria’s over-confidence and irrational exuberance.

This need for emotional state management is what we examined in last month’s article, The Emotions of Money and Loss. There the necessity of calming (regulating) emotions was addressed before they could compromise your trading mind. Once the mind has been hijacked by emotions – it’s too late. The damage is done. But let’s say that you have learned to regulate emotions so that you are not being sucked into the vortex of either irrational pessimism or irrational exuberance (the two horsemen of the trading apocalypse) – what happens then?

The Mind in Conflict You Never Thought You Had

Let’s say you have succeeded in calming your emotions. What does that get you? It gets you to the door of the mind. It is here where you need to step back for a moment and ask the question, “What is the mind, anyway?” Most likely your perception is that the mind is where “your” thoughts take place. Just “you” and “your” thoughts. How could it be more complicated than that?

Let’s re-think mind so that you have a different, and more effective, way of understanding of what, exactly, is going on in your head as you trade, when you get out of your comfort zone. Have you ever really noticed your thoughts while you are trading? Have you noticed that a heated and spirited debate often breaks out in your head when making a trading decision? Suddenly, “you” are of two minds, or more. It’s like a tug of war going on inside your head. There are at least two sides (actually a good bit more as you will come to learn) in competition to win the argument. So now “your” thoughts are divided into two armed camps (or more) trying to control the direction of decision making – of what you are going to do.

This is where the trader gets in trouble. Often, the voice of reason gets pushed aside during the conflict going on inside your head. Imagine, here you are in the thick of the moment, and reason (what you need most to trade effectively) is no longer heard over the cacophony ramping up to an emotional meltdown. Reason, drowned out by louder voices, results in reactive emotional thinking taking over the mind.