Psychological Smoothing

Every Tuesday Chuck releases a new Trader Tip video on YouTube. In this episode you will discover how to use psychological smoothing in decision-making so that the stress is reduced around any single trading decision. This is a key when to trading options. Trading decisions are hard and can induce stress. You have to learn how to make the right trading decision day in and day out if you want to be a successful trader.

You can read the episode transcript below or watch the video that follows.
If you have any questions, please reach out to us. We look forward to being a continued part of your trading education!

Welcome to Trader Tip Tuesday, and today we are going to talk about the topic of psychological smoothing. Now, psychological smoothing is a trading topic that is rarely discussed but is incredibly important in our performance as traders.

So what is psychological smoothing?
Psychological smoothing is the smoothing of your trading psychology as it relates to decision-making. Now, binary decisions, yes, no, I’m all in all out. Binary decisions introduce stress. It’s all or nothing thinking. And it creates the thinking of damned if I do damned if I don’t.

Data exhaustion.
Now the average person holds about seven bits of information at any given time, in their conscious mind, usually plus or minus two. This is a reason why phone numbers are usually seven digits because you can remember without integrating it in your subconscious mind. However, under stress, our ability to remember data in a conscious mind shrinks. The more stress we’re under, the less things we can remember. That’s why if you’ve ever been really, really stressed, let’s say you had a big fight with your spouse, all you can think about is your fight with your spouse. That’s all you can think about. Nothing else exists, because you’re just focused on this one thing that’s causing you stress.

This happens in trading: is we get more and more stressed about our positions, all we could do is focus on our position. And what’s going through our mind when we’re really stressed is should I hold it? Or should I get out? Should I hold it? Or should I get out? And sometimes we’re like, yep, if the market just rallies a little bit, I’m going to get out. And sure enough, market rallies a little bit. And they’re like, No, I’m gonna hold it. No, no, I should get out. All right, I’ll hold it. And we drive ourselves crazy around a single decision.

Move away from a single decision point.
So psychological smoothing, is the concept of moving away from a single decision point, and taking our decisions and spreading it over multiple decision points. This reduces the stress around any single decision. So for example, if you’ve ever been long one contract in the market, there can be a lot of stress about one contract, even though it could be a very, very small position. So you’re in a situation where the market rallies, it rallies into resistance, you know, it’s resistance. So then your mind you’re like, should I sell it? It’s resistance, I should sell it, my rule says sell it. But what if it keeps going up? And you put yourself in this position where you can be damned if you do damned if you don’t. So it rallies up there and you sell it, and sure enough, the market keeps going, I knew it. I knew I should’ve hold. Or it rallies up to resistance and you convinced yourself, you know what, this is my shot, I’m going to let it go. And then the market sells off. I should have followed my rules. I didn’t follow my rules, the market sold off. If you get into this position, no matter what happens, you think you did the wrong thing. That is the stress of psychological binary decisions.

So if you think about it, you have this stress around selling one contract. If we had the same situation, we rallied up to resistance, and we were along 100 contracts. And I said to you, do you want to sell one? Right? Sure. No problem. I’ll sell one. Why? Because you’re not worried about it. In your mind, you’ve created a construct where you can be right no matter what, if the market rallies, you still long 99 of them. And if the market sells off, you’re like, Well, I’m glad I sold one. So you create an environment, a framework of decisions that affirms what you’re doing. That’s what psychological smoothing does.

The more we smoother way in and the more we smoother way out, the less stress we have.
That’s why if you actually watch professional traders, professional traders scale into their position and they scale out of their position, they try and avoid getting in the entire position, or getting out of the entire position in one shot. Why? Because they don’t want to feel like they’re wrong. So by having multiple scale ends, and multiple scale outs, they distribute the stress.

Options.
Another aspect of this too, is options. Options are another way of psychological smoothing, because even if you only have one contract, you can hedge. So for example, if I’m long one contract of s&p e-mini futures, and I rally the resistance, I could sell a 30 Delta call against my position as a hedge. This allows me to maintain 70% of my long e-mini in case we keep rallying. And if we were all over, my call will make money. And I will hedge 30% of my exposure. So options can be really useful this way as well.

Review, Reflect & Improve.
So one of the things I encourage you to do with this information is go look at your trading plans and see, do you engage in binary decisions? If you do, then take this concept of psychological smoothing and see how you can implement it to smooth your psychology, you’re going to find out, it can make a massive difference in feeling better about your trades. If you already do this, then I encourage you to go back and look at it and see if there are aspects of it that you could use to improve it. Having more ways that you smooth both on the way in on the way out. Just consider all of that. So take psychological smoothing and see how you can integrate that into your trading. And come back here next Tuesday for the next Trader Tip Tuesday. This will be going on every Tuesday. And I will continue to teach you different ways like today’s concept of psychological smoothing that are just different than what you see in the mainstream, and you can use these tips I’m trading with you to take your performance to the elite level.

I will see you next Tuesday. Bye!
– Chuck Whitman