TRADING PSYCHOLOGY 
The Path Less Traded 
by Scott Brown

Good trading is as much a state of mind as it is a set of procedures.

Novice traders will find it hard to survive, let alone flourish, unless they learn to think and act in an appropriate manner. This means developing mental models and behavioral rules in a careful and deliberate fashion before entering the market. And it is this careful, deliberate planning and reflection that makes the difference between long-term profit and loss. It would be wise to develop an appreciation for trading fields that are less known to the public but far more profitable than the beaten path.

MENTAL MODELS

We perceive the world through our senses. We interact with what is out there through the use of mental constructs assembled from the many signals we receive through our senses. These underlying mental models, referred to as paradigms by psychologists (and mindtraps by Roland Barach), generate the thought processes that lead to our actions.

These actions can have good or bad consequences. When we are trying to create an outcome, such as profitable trading, we use our mental models to decide what actions to take to achieve that outcome. The alignment of our mental models with the reality of the market is a major determinant of our success or failure. When we trade, we are really dealing with two systems, one our psychology and the other the market. We cannot control the market and must therefore learn to control ourselves.

If you strive to recognize and correct your faulty mental models, your actions will be better in sync with the market. Professional specialists who have dedicated their lives to trading are your opponents in the market. Without sufficient introspection, planning and discipline, your odds of success against them will be poor. Without proper strategy, you will be up against your own "enemy within."

NEW TOOLS

Psychologists have found the human mind to be surprisingly limited in the number of variables it can process in decision-making. A study by clinical psychologists found that the participants commonly held the belief that they could process more complexity than they actually could. Researchers have found that it is more effective to resolve our inherent intellectual limitations by focusing on a handful of the most important components of a complex system.

In his book The Fifth Discipline, Peter Senge discusses the importance of systems thinking in corporate management. He describes two types of complexity: detail and dynamic. The first exists when there are a large number of components and interrelations in an organization. The latter exists when cause and effect are subtle. The greatest barrier to learning is dynamic complexity, wherein an action may take days or years to produce an effect.
 

Scott Brown is an off-floor futures trader and analyst. He is also completing his doctorate in finance in the area of money management and investments.

Excerpted from an article originally published in the September1998 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 1998, Technical Analysis, Inc.

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