Discipline in Derivatives Trading

Of the biggest mistakes in derivatives trading, a lack of discipline is the most difficult mistake to avoid. You can lay out every step of your trading program down to the last detail. But then you must pull the trigger. That is when this mistake comes into play. As a result, the opportunities to make this mistake are limitless. A lack of discipline occurs while you are in the line of fire.

Picture a new soldier who goes to military school, boot camp and engages in other extensive training. Then suddenly he finds himself in live combat for the first time with somebody shooting real bullets at him. Now consider an individual new to derivatives trading. He has planned everything and knows exactly what needs to be done in order to ensure his long term survival. Then he suddenly finds himself in a difficult situation, with real money—his money—on the line. How people react in difficult situations cannot be known until that time arrives. Hopefully their planning and preparation will allow them to overcome any psychological obstacles. But you never know for sure how they will react until the moment of truth arrives.

A lack of discipline in trading is almost always the result of one or more of the three great obstacles to trading success:

• Fear
• Greed
• Ego

Every time a trader makes a decision regarding any element of his trading he is subject to the effects of fear, greed and ego. This does not imply that we all need hours of serious therapy. It is simply human nature taking over. We all want to make money (thus we feel greed) and we don’t want to lose money (thus we feel fear). Cutting a loss is extremely tough on the ego.

Once you cut a loss on a trade there is no chance to recoup that loss without

entering into an entirely new trade. This explains why cutting a loss is often such a difficult thing to do. How many people enjoy going around and voluntarily admitting mistakes, especially ones that cost them money? Not very many. It simply goes against human nature. Yet when trading derivatives, it is often exactly the right thing to do.

These emotions are at times so powerful that they can cause you to do all kinds of foolish things:

• You bail out of a trade prematurely with a small loss simply because you don’t want to risk a bigger loss (fear/ego).
• You stop trading altogether during a drawdown—right before things turn around (fear).
• You take a profit prematurely because you don’t want to give it back, thereby missing a big profit (greed).
• You double up or increase your position size in an effort to get back to break-even or in an effort to “make a killing” (greed).

This list goes on and on ad infinitum.

How to Avoid This?

Just telling yourself to put fear and greed and ego aside won’t do the trick. You must identify the points within your own trading plan where you will most likely confront these obstacles and make plans to avoid their negative effects. For example, if your approach requires you to interpret chart patterns, you need to define your rules very carefully to remove as much subjectivity as possible. If you do not, you may find yourself interpreting the same pattern differently at times. If your trading has not been going well lately it may be easy to find some perfectly justifiable reason not to take the next trade. Likewise, if you are planning to use mental stops you must prepare yourself to always follow through and to place orders as needed. If

you fail to do so, then one bad trade can do you in.

Happy Trading!!!

Cheers.