Trading on the Edge: Balancing Overconfidence and Underconfidence in the Markets
The Cycle
It is 2017, I was confident in my abilities, and with every successful trade, my confidence grew stronger. I had the magic touch and nothing could go wrong.
As the markets fluctuated my ability was put to the test. I took bigger risks, got lucky which I saw as a sure sign that I was doing the right things. Warning signs became a more of a challenge to beat rather than a call to safety, I was convinced I was one step ahead of the game.
It was not long until I lost 25%+ of my account on one trade.
I got to taste the bitter taste of reality. Feeling defeated I had to reevaluate my approach once more and to the contrary of the recent period, the emotional issues reversed!
I had no confidence in my trades, I felt paralyzed in the face of risk. I took illogical stop outs to protect from what I felt was a sure losing position anyways.
I was caught in a cycle of absolute extremes for months and years on end, either overconfident enough to blow up a majority of my account or so scared that logic became overwhelmed by my irrational fears.
Confidence is non-negotiable and remains one of the most integral parts of my success, trading is a game where 1% of the 1% make it to the top. If you do not have 100% confidence in your ability to be that designated person, you will never be.
Managing confidence and channeling it into energy to propel yourself forward in a safe manner is what this blog post will try to tackle.
“Our lack of confidence is not the result of difficulty. The difficulty comes from our lack of confidence.“
― Seneca the Younger
The cost of Overconfidence
The higher your overconfidence the higher the damage.
We all know the famous ‘There is no way this heads higher‘ or the feeling of being right for 2 weeks straight and as if we had a gift to trade perfectly.
The cost is not purely monetary as it involves a hidden cost of decreased cognitive work, future sizing ability as well as a decreased ability to track progress.
Try to picture a high performance athletes like a football player, running the fastest he can to score a touchdown one week and the next one stays in his corner scared to get hit. In order to truly be able to work on his abilities, the athlete needs to keep a centered mentality to allow consistency as the norm.
That centered mindset and emotional balance allows him to evolve and work on what truly needs work rather than doubting and living in constant emotional extremes.
My biggest losses come right after my biggest wins.
I become overconfident, I drop my guard and I get punished for it.
Structuring mental fortitude
A shift in confidence level can be retraced to one of these main emotions:
fear, greed, and excitement.
Structuring the emotional process will help you make rational and disciplined decisions, even in high-pressure situations. We will focus on 3 main parts to achieve this goal.
The Before, The While, The After
In Trading, you have the privilege to have the same timeframe to trade with each day. The market opens at 9:30am and closes at 4pm(ETZ), which allows us to build a mindful process to avoid confidence traps. The three man categories are characterized by the time before, while and after the trading session.
Before we jump into the three pillars I will briefly go over the number 1 and most important point of all which you keep on hearing from me.
The Precursor: Data
Data gives the expectation, expectation grounds your emotions. Before working on anything else I need you to understand no effort will help you if you have no expectancy. If you trade randomly you have no expectation and if that is the case, how could you possibly know if you are behaving based on emotions or based on a positive skew?
Thus the first step is to categorize your setups and prepare based on a historical pattern. This allows you to build a norm and gives you the ability to notice divergences both in terms of price action as well as in your own emotions and how you deviated from trading the expectancy of the historical precedent.
The Introspection Cycle
The Before:
Practice mindfulness:
Incorporate mindfulness practices, such as meditation or deep breathing, into your daily routine.
→ I want to create a routine to get me back to centered. Just like I wear a suit to work to get my mind in a ‘crush‘ and work mindset, I want you to find a 5-10min routine at the start of the day that allows you to ignore everything around you and allows you to ask yourself: ‘How am I feeling today ?‘
Set realistic expectations:
Just like the precursor paragraph, understand the expectancy.
If you deviate from the plan you will have 2 possibilities as to why it happened. You could either have deviated due to emotions or an external and surprising event could have changed the plan.
Work on instinctively asking these questions every time you press a button, is it because I trade a positive skew or because I am being emotional?(You will get better over time)
Seek the advice of a financial advisor or mentor to help you set realistic goals.
Sometimes, you will not know what enough is, what you should expect, what you can achieve and how fast. A mentor or the right exposure to more advanced traders can help you achieve clarity and thus more stability in your view.Review your goals regularly and adjust them as needed based on market conditions and your own abilities.
While the main long term goals should remain fairly stagnant, mid term goals have the ability to steer us in the wrong direction if you do not listen to the markets. Trying to hit your best year ever during a market crash might not be realistic and so you sitting back during a 2020 market.Adapt and be pragmatic doing so.
Develop emotional regulation techniques:
Research various techniques such as cognitive-behavioral therapy, visualization, or stress management practices
→ We already talked about creating structure before chaos!Start out the day with a checklist like excel table from 0 to 10 where I want you to rank these things:
How did I sleep (I use the Oura ring)?
Was I emotional yesterday?
Have I prepared for today?
Do I have time to trade today?
Am I annoyed at something or someone today?
Seek the guidance of a therapist, coach or pod.
Having someone or a group to talk to can help you formulate your own questions better. Their job is to open up your mind to yourself and try to understand why you might be over or under confident.
The While:
Monitor your emotional state:
Be aware of your emotional responses during trades.
Use a journal or excel to log in emotional responses and work on it during the review at the end of the day. At the end of the week I want you to review the most prevalent emotional responses and formulate a plan to eradicate them.
Take a break if necessary to manage strong emotions or stress.
Your physical state is deeply entrenched with your mind. Just like having cloth for work, an office, a routine and more help with having a healthy and balanced life, taking a breather and getting out of your trading environment can help you gain a different perspective over your actions.
Often the best thing to do when emotional is just to stop and leave the screens.
Use rooms, pods, fintwit and other social environment to get a thermometer like idea of the mental state of other players. Sometimes you will see all fighting a stock or all avoiding another. Notice these patterns and link them to your own emotions as well as stock performance.
Emotional behavior is very much connected to the social aspect. If you see all winning, you might feel down and underconfident. If you won and all lost the opposite could happen. Monitor the noise and how it affects you.
Use a trading journal:
Write down your emotional state and the events that triggered it during each trade.
Reflect on your emotional responses and consider how they affected your decisions.
Identify patterns and make more informed decisions in the future based on your journal entries.
A journal has three main purposes:
Heighten your introspection skills
Reviewing the performance based on the prepared plan
new ideas and brainstorm
Engage in mindfulness and visualization practices:
Mindfulness: Breathe, Take a minute, relax your muscles starting from your neck and down to your legs. Realize you are tense.
Use visualization techniques to stay focused and centered during high-pressure situations.
figure out the most likely scenarios: how would you react on a stop out, on unexpected news, on a cover or sell opportunity. Do so closing your eyes like in a dream or daydreaming. You will get better at this practice and it will help you when the situation arise.
The same can be done for bigger goals as well. High level athletes work hard on visualization to improve their reaction time and preparedness.
Visualization is daydreaming with a purpose
The After:
Review your journal:
Reflect on your emotional responses and their impact on your decisions.
Seek the advice of a therapist, coach or pod to help you understand any underlying emotional or psychological factors affecting your trading if needed.
Incorporate any insights and learning from the review process into your ongoing practice as soon as the next prep.
Seek support:
Be open and honest about your emotional state and any challenges you are facing if seeking support.
In general to not bottle up emotions, find people you can trust and be open to them. My pod knows exactly how I think emotionally at all times. I manifest my emotions and tell them: This is not who I am as a trader, I feel XYZ way and it is detrimental to my performance.
They saw me leave my desk for the day/s after I used them as a sounding board.
Incorporate insights and learning:
Reflect on your progress and any insights you have gained from the process.
Update your emotional regulation techniques as needed based on your learning.
Enjoy the process of getting better, it never ends. Appreciate your dedication to being better every day as it is the actual goal.
By following this "Before, While, After" process, you can cultivate the mental fortitude and emotional resilience needed to stay leveled and avoid overconfidence or underconfidence in your trading.
Many of these points can be used for other purposes as well as most of all, this complete process is one of progress and introspection, which can be used in any part of the development process.
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Great post, thanks!
One question that comes to mind is how can I balance sizing up during good times with overconfidence? I feel like it is a challenge to size up without bumping my confidence with it.
Also, would love to see a post of your thoughts on soft data (looking at charts, keeping mental/physical notes about it etc) vs hard data (actual data tracking, percentage calcs etc)
Probably the best trading article I read this year. Absolutely feel that and have been working a lot on stabilizing the confidence to avoid the downfalls the last 6 months. Great job and thank you