The biggest leap forward in my trading came when I began to think like a trader. This important realization was a result of training my brain to think in terms of probabilities. The best book hands down (for me at least) that helped me think this way was Trading in the Zone by Mark Douglas.
Thinking in probabilities did a lot more for me than just help analyze my trades. It allowed me to trade with more confidence because I knew the likely statistical outcome of a series of trades.
I’d like to pull from some of Mark Douglas’ work in this post to help you better understand how to think like a trader.
Think in Sample Sizes
Looking at the markets in terms of probabilities is extremely important, both to help you understand your edge and to calm your emotions from trade to trade. I like to think in sample sizes of 20 trades. I am not looking at my profit/loss for the day or week – rather I am monitoring my P & L for the last 20 trades.
Each trade you make is simply one of thousands of trades that you will make over the course of your trading. If you keep this in mind and limit your risk on every trade then mentally there is no need to fret over one or two losing trades, or even a string of losing trades.
Monitor your last 20 trades. What is your worst string of 20 trades? What is your best string of 20 trades? The numbers may surprise you.
Eliminate the Emotional Risk
Thinking in terms of probabilities also helps remove the emotional risk of trading.
Mark Douglas talks about the 5 Fundamental Truths, they are as follows…
1. Anything can happen
2. You don’t need to know what is going to happen next in order to make money
3. There is a random distribution between wins and losses for any given set of variables that define an edge
4. An edge is nothing more than an indication of a higher probability of one thing happening over another
5. Every moment in the market is unique
When you train your mind to think in this way, the emotional stress and fear of pulling the trigger diminish. You become less concerned with the outcome of each individual trade and more concerned with how it fits into the larger statistical set.
Become an Observer
Think about how objective we are when observing the markets with no money on the line. This is the state of mind we are looking to create throughout the entire trade.
Win, lose, or scratch!
One exercise I find useful is to visualize yourself standing just behind yourself, watching over your shoulder as you trade.
Does this trade meet your trade plan entry criteria? Is this a trade taken out of boredom? Are you sure you want to break your rules? These are some questions the observing self would ask your conscious self. Once you’ve identified your edge, practice executing your trades the same way, each and every time. Use this observer exercise to help keep you in check and remain disciplined.
The 7 Principles of Consistency
Mark Douglas talks about 7 principles which help beginning traders develop into consistent winners over time. The following are his list of guiding principles…
1. I objectively identify my edges
2. I predefine the risk of every trade
3. I completely accept the risk or I am willing to let go of the trade
4. I act on my edges without reservation or hesitation
5. I pay myself as the market makes money available to me
6. I continually monitor my susceptibility for making errors
7. I understand the absolute necessity of these principles. I never violate them.
So to think like a trader means to think in terms of probabilities, identify your edge, execute your trades the same way each and every time taking every setup that first your trade plans and then analyze your trades not individually, but in sample sizes. Doing these things (over time), can help develop a level of consistency trading the markets.