The Psychology of Money Management

In this Wiki, we will explore some common issues and solutions to the Psychology of Money Management.

The Psychology of Money Management

The Basics of Mental Money

The psychology of money management can be an extremely daunting subject. Instead of forcing a master’s degree in psychology on you, it might be better to give you a few of the basic forms of mental issues that traders tend to fall into. After that, we will discuss some steps that you to take to make sure that you do not fall into these same traps.

Focusing on the amount of money being made or lost while in a trade is a trap that leads you down a road filled with stress and anxiety that will eventually lead to failure. Allowing yourself to let a loss go further from your intended stop loss or grabbing at very small profits quickly will only encourage these types of losing habits in future trades. Once you get into these kinds of bad habits they start to warp your thinking on the next trade, then the next trade, and the next...

Before you enter a trade you should have already formed a very good Fundamental Analysis or Sentiment Analysis reason and planned out the entire trade from entry to exit for both stop loss and profit objectives. This allows you to have confidence in that you have a plan that will dictate exactly what to do and how to react no matter what the market throws at you.

Once a trade is entered you should have completely accepted the possibility of the maximum monetary loss that may occur as a result of your well-placed and planned stop loss order. If you cannot accept the maximum loss before you enter the trade then it’s only going to make the situation worse if you get into the trade anyways. If you do find yourself in a situation like this you should decrease your position size or try not taking the trade at all.

If you find that you cannot accept the maximum loss after you get into a position, and it’s not working out the way that you had intended, then it may be wise to cut the position size in half. Doing this should help you focus better but if it doesn’t then it is best to close the position entirely. Remember, you can always get back in.

Every trader will eventually have to accept that losses are and always will be a part of the trading business. However, trading losses should never get out of control and wipe out your account. Every loss a trader takes should be controlled and manageable by having a predefined plan before the trade entry. Always place your stop loss orders at a level that the market should not go to if you are correct about market direction.

The only thing the trader needs to focus on after entering a trade is any changes in the sentiment of the market environment. As new information presents itself you should adjust your bias accordingly. Nothing else should get in the way of your thinking not even what the profit or loss blotter says. All emotion should be removed from trading so that you can remain as focused as you were before you entered the trade. Don’t let what your profit and loss says twist your thinking. Focusing your attention on profit and losses will take away your focus from what’s happening in the market and can lead you down a slippery road to ruin.

You will need to learn how to gain the confidence to follow your well thought out trading plan through discipline and results tracking. After all, the only reason a trader would change the plan in the middle of a trade is that he doubts his plan (or simply doesn’t have one) and lacks the discipline to follow it. However, if the trader had seen results from the trading plan then he would have had more confidence to stick to the plan.

Dollar Counting

Don’t count the money until you ring the cash register and book your trade. It should not matter how much profit you see while in the trade, the only thing that should matter is what is happening to the market environment in real-time.

If you find yourself staring at the profit and loss blotter instead of monitoring the news flows it might be a good idea for you to minimize or hide the blotter. If you find yourself peeking at it then close it all together and focus your attention on the price action and sentiment.

If you focus your attention on how much money is being made or lost on your screen and thinking about it in terms of rent or car payment you are going to have a hard time focusing on more important things such as managing your position in accordance with your trading plan. You should never be trading with scared money that you can’t afford to lose. This puts a lot of pressure on the trader to perform and if you are a new trader it’s unreasonable for you to think that you can come to trading and instantly start generating a great income from day one.

Counting your money and mentally spending it on whatever you’re thinking about while in the trade will cause you to make irrational trading decisions that are based on things other than what is genuinely important such as price action, real-time news flow and sentiment.

Reasons you May be Thinking about the Money While in a Trade

Trading with "scared dollars" is a major reason people think about money while in a trade. If you are trading with your rent money then that is probably not a very good or safe idea. Your emotions will overrun your rational mind with thoughts of "what if" or "what will I do if I lose this money?" Never trade with money you can’t afford to lose because most traders will lose money while they are learning how to trade.

Many traders think about the money because they lack complete conviction probably because don't understand their trading strategies or trading plan (or they don’t have a plan). This is very common and can lead to many other trading problems that are not habits a trader wants to get into if he wishes to become consistently successful. Without a trading plan, the trader is lost and stacks the odds of success against him.

Many traders fall into the trap of not trusting that they will do the right thing that they know they should be doing. This usually occurs after they have broken their own trading rules or didn't follow their trading plan so many times that it has become a habit. Developing this bad behaviour can be a very costly habit. Examples would be not taking your stop losses because you can’t admit you are wrong or taking your profits way too early out of fear that the market might take back that profit. If you break your rules once it becomes easy to continue breaking your rules so make a plan and stick to it.

Some traders get over-excited and trade too large a position for the size of their account. This really makes them think about the money because they are about to murder their account on one trade if it goes wrong. More importantly, trading too large a position too early in a trading career can be a crippling experience. It doesn’t make sense to go from a default trading size of 1 micro lot to trading 10 standard lots on the next trade. The size of trader’s positions should be increased incrementally over time as more experience and profits build up in the account. Also, the trader should be consistent with how much capital they risk per trade. Lot sizing of a position should be based on how much money you are willing to risk per trade. 1-2% risk per trade is a good general idea.

Overcoming Temptation

Do not place a trade out of fear of missing out on the trade. Getting a bad case of FOMO ( Fear Of Missing Out) can cost you a lot of money. You will need to gain all the necessary information to make a good trading decision before you place a trade in the markets. Don’t worry about a missed trade because there will always be another trade right around the corner.

Missed money is always better than losing money and not having the appropriate amount of information before placing a trade is a surefire way to lose money. Each trader will need to gain control over these types of impulse trades. They cost you commissions, potential capital losses and create bad habits that are hard to get rid of.

Don’t sell your position out of fear that prices will move against you and you might lose out on one penny of profit. If you want to take a larger gain you will have to sit in pullbacks against your positions while the market corrects and prepares for its next move. Concentrate on understanding the forces of supply and demand taking place in the market in real-time. Always have at least two scenarios of what might happen while you are in the trade, no matter how bullish or bearish you might be. This will keep you open to possibilities of profit or loss in any position. Remember that anything can and will happen in these volatile markets that we find ourselves in today.

There are no guarantees in the markets or in trading. It would be a benefit to any trader to consider other possibilities other than what the chart suggests. Patterns fail all the time and you need to be prepared when they do fail to save your capital and potentially profit from the failed pattern itself. This is why monitoring real-time news feeds are so essential to stay in tune with the market sentiment.

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