Irrefutable Law of Trading Success #9: Money Manage Your Psychology

What does it mean to money manage your psychology? This is an aspect of trading that many traders just never even think about. What we mean by money managing our psychology is that we can actually have money management rules that actually reflect our psychology of trading. Most people are unaware of this and as a result, what most traders try and do is they try and manage their psychology through their trading rules and there typically is a big problem with this because typically, one of the biggest emotions that are managed is fear, particularly fear of loss of profits, fear of giving the money back. 

A lot of traders, what they do is to manage their fear of giving their profits back, what they do, is they use their trading rules to try and protect them. A great example of this is they might tighten their stop, they might have a trailing stop, they might have something like this so if the market turns over, they won't give all their profits back. But the problem is, is that when you use rules like this, you strangle your trade and what ends up happening is you just get out and then the market takes off without you. You might have a trade that has three R and profit in it, and you get out at two R and for the moment, you're happy, like oh, I made two R, yay and then you watch it go 10 R higher, and you're not in. 

See, life is filled with all these paradoxes, the thing you want to try and avoid is the thing you get. You want to try and avoid giving your profits back. Well guess what, you'll be out, you'll get exactly what you want, you'll be out and you'll miss the move. What we need to understand as traders is we don't want to manage our psychology through our trading rules, we want to manage our psychology through our money management rules. We start to have rules where we look at, we're only going to have a certain amount of exposure at any given time and if our risk gets too high, rather than tighten our stop, we start clipping the position, we start taking it off.

A lot of trade management rules have us buy high and sell low, we might enter on a breakout and buy high, then we might have a trailing stop and so low on a trailing stop. This was one of the rules we talked about prior with positive reversion. Okay, we don't want to have negative reversion, which that's what those types of trades are when a positive reversion where we buy low sell high. Well, we set our money management rules and we have a risk framework in mind, when our risk gets to be too big, well we sell and at the moment that our risk is too big, in that moment, we're selling high or we're buying low. Money management rules typically have a selling high and buying low, selling high and buying low and this works really well.

The other thing is, money management rules are independent of the market. It doesn't know anything about the market and it doesn't care. They're just there to manage your equity curve. Your equity curve is different than the market. Your trading rules should revolve around what's going on in the market. Your trading rules should get you in when there's an edge in the setup and get you out when you're wrong or get you out when the trade is over. Anything outside of that oftentimes gets in the way and ruins the trades. But if you use money management rules, where you sell high and buy low and everything is based off your equity curve, not about the market, you'll find that you can get exactly what you want.

You want to have an upward sloping equity curve from the lower left to the upper right. Great. You can totally do that if you set your money management rules the right way. You want to go for big wins. You want to do pyramiding, you want to be a shooter, great. You do this through your money management rules. 

Your money management rules are where you frame and express your psychology. I spent a lot of time studying under the late great Dr. Van Tharp. I'm so grateful to him for so many things that he taught me and Van really understood this concept at such a high level that many people who studied under him, read the position sizing manual. They didn't get what he was actually saying. What he was saying was brilliant. Your position sizing rules, your money management rules are how you frame your psychology, not the trading system, not the trading method.

For you, are you even aware of this? What are the money management rules that you have in place? Are you trying to smooth your equity curve to have a very smooth curve or are you trying to amplify it and going for really, really big wins? It's so interesting, everybody looks to the trading system as the trading system is going to get them rich. A great trading system, no doubt helps. But if you want to get really rich, you deal with your money management rules.

Money management rules framed around a good trading system can make you really rich. But the thing is, is the maximum amount of profit is right next to bankruptcy. Can you handle that? So many traders I talked to when we start talking about pyramiding, start talking about campaign trading things like this, they get so excited. They're like, yes and I laugh because in my experience, 95 to 99% of the traders can't handle profits. They just can't, they start freaking out when they make money. That's the biggest problem I see with traders, their inability to stay with a profitable trade. Now the same people that can't hold the three R profit are gonna pyramid in? Give me a fucking break, not happening. That's great they have this excitement, but in practice, they can't pull it off.

You have to get really honest with yourself about what is your psychology. What is your risk tolerance, and then you frame your money management rules accordingly. This is the path to getting what you want and this is why this is rule number nine of the 10 Irrefutable Laws of trading success. This is Trader Tip Tuesday where I come to you every week with a tip like today that helps you take your performance to an elite level. Hopefully you liked this, I will see you next Tuesday.