by Brian DeChesare Comments (46)

Trading Psychology: How to Think Like a Trader

trading emotionsTrading – it’s all about using your brain to analyze the options and then make the best decisions, right?

You might hear that from a trader at a cocktail party when he’s trying to impress people, but most traders know that psychology plays a huge role.

Some traders would go as far as saying that psychology and emotions are 80% of the battle.

Do not overestimate your ability to be unaffected by emotion.

Real Life vs. the Trading Floor

Even if you’ve been a calm, analytical guy or gal most of your life, don’t assume that you’ll be able to stay relaxed on the trading floor.

The pressure and stress you’ll face will be far greater than anything you’ve ever experienced – especially if you’ve only been a student before.

When I first started trading, I was confident of my math and analytical skills – so I thought I could base all my trading decisions purely on analysis, unaffected by emotion.

Nothing could be further from the truth – to see why, let’s walk through the emotions of a trade.

Trading Highs and Lows

This example is actually a short series of trades that spans one trading day – but similar emotions can occur over weeks or even months.

9:30 AM: You watch as the market opens. You are looking for a good buy entry point into Microsoft [MSFT] because they are going to announce earnings shortly after the market close today, and based on your analysis you think that they’re going to beat analyst expectations and that institutional buyers will load up on the stock throughout the day.

10:30 AM: MSFT inches upward for an hour, and then takes a small dip. You think, “Great chance to buy on the dip!”  Originally you were planning to buy 20K shares, 10K for intra-day trading and 10K for holding until after the earnings announcement.

20K shares? That means even if you successfully catch a $1 stock price move, you only make a measly $20K? Better double that.

You buy 40K shares of MSFT at $28.50 (Emotion: greed), contrary to your initial plan and risk guidelines. Based on your technical analysis, you plan to take profits on half of your shares at $28.80 and cut losses at $28.20.

11:00 AM: The broader market (that is, the S&P 500 index) zooms upward based on bullish comments by one of the regional Fed governors. MSFT zooms upwards along with the broader market. $28.60.. $28.70.. $28.80.. you’ve reached your profit-taking point!

But wait! You don’t take profits yet (Emotion: greed) The rally isn’t over. $28.90..$29.00..$29.10.. sweet! This is awesome! (Emotion: elation) You’re not sure why it’s going up this far, but who cares?

You’re making money. You pat yourself on the back. Maybe you’ll buy yourself an expensive lunch to celebrate.

11:15 AM: MSFT’s rally starts to weaken.. then it starts to move sideways.  C’mon, this rally has got to have another leg up, right? (Emotion: hope)

Then MSFT starts to fall slowly… $29.00… $28.90… Well, that doesn’t mean the rally is over, right?

Your technical indicators tell you a falling trend has began, but your heart tells you that this could be just a slightly oversized downward correction and that the rally hasn’t ended yet (Emotion: denial).

11:30 AM: MSFT starts to trend down further. $28.50… $28.30… You want to bash your head against your keyboard. Why didn’t you sell earlier? Why is this dropping so much anyway?

Some %^$^*%@# hedge fund must be short-selling huge amounts to manipulate the price. It’s not fair that hedge funds are bigger than I am. (Emotions: anger, frustration).

$28.20… $28.10… you’ve hit your stop loss point but you fail to hit the sell button. After all, MSFT was having a great day. Surely the price will bounce back up eventually? (Emotion: hope)

11:45AM: $27.60…$27.50… the selling spree is not relenting. You minimize the window that shows your losses because it is too painful to watch. Why didn’t you sell earlier?

You’ve just erased everything you’ve made from weeks of trading. How are you going to ever make this money back? (Emotion: despair)

You stop caring about how much MSFT drops (Emotion: resignation). It’s already a huge loss anyway… what’s a couple more thousand matter anyway?

1:00 PM: $26.80… your technical analysis indicators show that right now may be a good buy entry point.

You know that you already have 40K shares and you can’t afford to take any more risk. But you are mad at MSFT and you want to get revenge.

Your boss is probably going to yell at your later anyway, so you might as well go all out. You double down and buy another 40K shares, bringing your total share count to 80K (Emotion: desperation).

1:30 PM: MSFT starts to nosedive. Wait, what!? MSFT dropped 20 cents in 10 seconds!? $26.20… $26.10… What is going on? What are you going to do? (Emotions: panic, fear)

You cringe as you submit a market order to sell all of your 80K shares at $26.10. Almost immediately after you sell, MSFT stops nosediving and recovers slightly.

You sold your shares at the worst possible price; if you weren’t so panicked, you could have divided your order into chunks and used limit orders and achieved better price execution. You want to cry. You are a failure. (Emotion: depression)

4:15 PM: You spend the rest of the trading day wallowing in misery without making trades. Shortly after the market close, MSFT announces blowout earnings and it shoots up to over $30.00.

You stare in disbelief… but there is nothing you can do now – if only you had followed your initial plan… (Emotions: helplessness, regret).

If You Could Do It All Over…

What would an experienced trader have done in the above situation?

Actually, even experienced traders are affected by emotion – I’ve seen a white-haired trader at a bulge bracket investment bank turning red, swearing his head off, and pounding at his keyboard – but I’ve also met a trader in his early 30’s who never once lost his cool.

So the question should be, “What should this trader have done in the ideal scenario?

In this example, the trader should have followed his own plan and rules strictly – he should have stayed within his risk limits, sold the stock when the price hit the pre-determined stop-loss level, and he should have taken his profits when the stock reached the pre-determined profit-taking level.

In short, he should have sold immediately when the stock hit $28.80 – yes, that’s “only” a profit of $12,000, but it’s way better than losing $124,000 as this trader did.

Experienced traders know when to break their own rules because they have the discipline to not break the rules too often and to keep the risk-taking from getting out of hand.

Traders without such discipline such stick to strictly to their rules to protect themselves. As the saying goes, “plan your trades, and trade your plan.”

And if all else fails, you can just get your own trading stress bracelet.

M&I - Brian

About the Author

Brian DeChesare is the Founder of Mergers & Inquisitions and Breaking Into Wall Street. In his spare time, he enjoys memorizing obscure Excel functions, editing resumes, obsessing over TV shows, traveling like a drug dealer, and defeating Sauron.

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  1. Good write-up Jerry. Just a small error in your analysis. If the trader had followed his plans and rules strictly, he would have only bought 20K shares instead of 40K and therefore profited $6000 instead of $12000. I know this is not the moral of your story and I perfectly understand the hard-to-execute concept of not letting emotion tamper your trading.

  2. Brian, Readers:

    These days I’m a bit lazy to study for my final exam so I spent some time reading around your site and this ingenious idea came to my mind that I might very well ask you about…

    I’d like to become a professional forex trader. I started a live account beginning this year and it’s really a time consuming activity with all the research, wiggle-watching and hard nosed thinking…Most companies ditch my resume for anything finance related since I did more of a general management and technology track…And then now there is a potential offer from a small consulting boutique to do my just-out-of-the-grad-school internship there in business process modeling which is more in line with my previous experiences…If I take it I won’t have time to further improve my trading skills and build my track record and besides it will ruin my plans for the vacation I booked for the next month since they’re asking to start asap (not kidding)…But how prudent is to refuse it and just hope I’ll manage to make some profits from my (rather small) account to at least sustain everyday living costs?!

    Guys, what would you do?

    1. Avatar
      M&I - Nicole

      Is this role something you’re interested in? On the more conservative side, yes you may want to take it and try your best to find time to trade so you can sustain yourself. This experience may also build on your previous experience so it will help you if you want to progress your career on that path. On the other hand, if you are confident that you can make money trading and really want to take your vacation (and you really don’t care for the job & the path too much), I may not take the role though it can be risky.

      1. Thanks for the answer Nicole!
        Yes in fact it’s a rather risky move to ignore offers and focus on daytrading from home. If I stop doing internships even for a while I won’t be able to get anywhere, not even into a small consultancy. I heard stories about fresh graduates wandering around depressed and unemployed for years.

        But still the fact I’ll be doing some rather boring process modeling and smart-ass “strategic thinking” rather than something finance related (ideally trading) pisses me off.
        There is also thesis to finish and it’s going to be a big stretch while working, let alone trading on the side.
        Either I am working for living and getting further from breaking into finance,
        either I am risking big time to do it “my own way”. Third possibility would be to ditch the thesis and face hefty university fines :shocked:

        1. Avatar
          M&I - Nicole

          If you think of it on the bright side, you have an offer (many don’t.) And you also have the opportunity to trade given your previous experience. If you don’t take the offer, you will then have to make sure you make money trading. I wouldn’t worry about what others are doing.

  3. I have a question for the author of this article. I don’t know if you made up the numbers or not but where are you working where you are a discretionary trader making $1.2mm trades. I don’t know of any prop traders that trade with that kind of size and I thought all bank trading was executionary now since bank prop trading is getting shut down…

    1. He was just giving arbitrary examples to illustrate the concepts.

  4. Regarding to the Mental Math part, i have some questions.

    So basically it is “only” numbers with like 37*15, as mentioned in above answer. In what cases it is important for a trader?
    Isnt all the important things like, i dont know .., stock prices * amount i want to buy displayed on the monitor? I just want to see some examples.

    Second is, can it be improved? (mental math)

    1. Avatar
      M&I - Nicole

      They may have other brain teaser questions. Please refer to:

      Yes, such skills can be improved with practice.

      1. Thank you very much, this is exactly what i looking for!

        1. Avatar
          M&I - Nicole


  5. This is very true… I’m a junior trader at a prop firm and trade interest rate derivatives and although the mechanics of monitoring the position are different, the emotions are same.

    Anger is a another one for me which I had to learn to control – I was hitting a series of bad trades and being pissed off, wouldn’t follow my plan and double downed plenty of times hoping for a hail mary! All things considered, poor money management due to emotions will f*ck you out of a job and career as a trader. It puts things in perspective if you think of your profit as “only” (greed) but once the market goes against you, and the ego takes over, it becomes a matter of being right, getting revenge, proving others wrong or whatever and the losses are so much more worse… Anyway, this post discusses a fundamental part of trading/investing very concisely and it has become my go-to post to center myself, believe it not.

  6. Hey!
    I have a rather difficult question for Jerry, but I would love to hear the input of Brian as well, and of anybody who has an opinion on this:

    Let’s say you are just about to start your career, had the proper financial background and eventually wanted to manage your own money and advise friends/family, or even manage their money too. Which job experiences would give me the knowledge and expertise to do so in a competent way?

    So if you put salary, prestige, exit strategy etc. aside and would make it just about preparing yourself to be a good portfolio manager, what kind of career would you choose? What kind of employer? Big institutional fund? Hedge fund? Buy side analyst? Prop Trading? Private wealth management?… All of them? In which order?

    Can’t wait for your answers!

    1. Avatar
      M&I - Nicole

      I think having a track record managing money will assist you in raising funds from F&F and others to help them manage their money. Jobs on the buy side (long, hedge and private equity funds) can help. Which one suits you most depends on your traits and skills. And I think having the CFA will help you too. If you’re interested in the public markets and not doing deals – whether you want to be in asset management or work at a hedge fund – then the CFA is almost a requirement.

      The best way to prep yourself to be a good PM is to find the best PMs on the Street and work for them! Look at their track records and their style of investing. If their style resonates with you and you have a chemistry with them, ask them if they’d be interesting in taking you on.

      ER is a good way for you to build your “basic knowledge” too.

      Big institutional fund/HF/ER are all great avenues to learn investing.

      1. Thanks for the reply!

        I really liked what you said about looking for successful PMs and their strategies and the “chemistry” and then just try hard to work for them. I guess really getting exactly the job you want is difficult, but it’s worth a try and a great motivation.

        Two follow up questions:
        1) I am German native speaker. CFA is not the thing to have here. Can I get into a US hedge fund or mutual fund after working as asset manager in Germany without CFA?

        2) You suggested ER to start off. What about Investment Research in a fund, instead? I understand that ER will help you to get in depth knowledge of how to analyze companies, but you are focused on very few stocks. If I understand correctly, as investment researcher you will look at a broader field and will be closer to the actual investment being made. If you are asked, you can tell the PM your recommendations. What do you think of that? Is that correct or do I have a wrong idea?

        So for you, Nicole, it would be first ER and getting the CFA and then get into long/hedge/private equity funds, depending what you are interested in. I would love to hear more opinions on that! Who agrees/disagrees?

        Thanks guys, you are awesome!

        1. Avatar
          M&I - Nicole

          1. Yes though it would be good to have the certification regardless
          2. Yes I think you are correct.
          3. No I don’t believe there’s a particular path. While what you mentioned is a good path and provides you a solid training ground, I have met people who joined funds straightaway while taking CFA on the side. I think the key is finding the right firm, team, culture & fit for you.

          1. Thanks for the answer!

            Do you have any thoughts on how to find the “right path” for oneself or is it really just trial and error? Or let me be more precise: do you have any tips on how I can find out whether a job will help me learn a lot and get closer to my goal of being a good PM before I work there?

          2. Avatar
            M&I - Nicole

            Network with people in the industry and see if you are interested in what they are doing. Speak with them.

            I’d also suggest you to figure out your strengths and weaknesses and what you’re truly passionate about. Great PMs are truly passionate about the markets.

          3. Good point! So I guess after reading a lot of “on the job” articles on your site, I will get into the “networking” part now. Thank you, Nicole, for all the answers!

            If somebody else has an opinion on the original question of “how to become the best PM you can”, I would be very interested in hearing it!

            Obviously this is a question with many different possible answers, but this is what makes it so interesting I think!

            Maybe this could even be an idea for an article on the page?

  7. Is it true that no matter what you are or who you are , if you make lot of money for your trading firm you will be an instant hit

    1. Avatar
      M&I - Nicole

      I think instant hit is too strong of a word but yes you will get attention

  8. Money elicits major emotional reactions from all of us, mostly because its pretty hard to make so when a chance to make some shows up you want to maximise and when its going down you want to minimize. It would be easier if you could control the market but you don’t, there are thousands like you out there trying to outdo you and turn your losses into profits for themselves.
    Thanks for a great article.

  9. Avatar

    In your example wouldn’t the trader be fired for making a loss of $124k in one day? Or is it only if you make a $10million dollar loss (or some other gigantic sum)?

    Thanks so much!!

    1. Depends on the size of the bank / firm and how your group works… all traders have days where they lose money so it’s not the end of the world unless it’s a truly massive lost.

  10. Profound analysis of the emotions that traders go through. I’ve been retired and out of the industry for 11 years now, but I must say this is a very good post for anyone who wants to trade anything, be it professionally on the street or in your 401k. These are the sort of lessons you read about but never fully appreciate until you are trading for real. Everyone assumes they are as cool headed as Jessie Livermore until they actually give it a try (don’t forget, he wound up shooting himself).

    Also of note is that the mental math in trading has gotten far easier since the decimalization of share prices. Back in the 80s when I moved into trading at Salomon Brothers, it was the mark of a true trader to be able to multiply with fractions without batting an eye.

    1. Interesting, thanks for sharing.

  11. I answered that in about 2.5 seconds, not quite rainman but does that mean i can be a trader? I think so

    1. Get it down to 0.5

      1. LOL… some of these questions are.. WOW

      2. I don’t agree with this at all. Sure, in highly quantitative firms does this mental math speed become relevant. But, I’ve worked in trading successfully for 5 years in boutique prop shops and this was never a requirement. How you manage risk is what is important. The number crunching is handled by computers nowadays and it frees your mind up to focus on on trade itself.

        You’re not “boxed out” of trading if you take 5 seconds to answer a mental math question. You’re boxed out if you can’t handle stress and justify the risk.

  12. What kind of mental math are we talking about here?

  13. If I can’t do mental math super quickly am I basically boxed out of trading?

  14. Dear M&I,

    This really isn’t a question, but I just wanted to say THANK YOU. This website is absolutely awesome, I just got an offer to be a summer intern at a merchant bank to do M&A stuff for PE companies just about 5 minutes ago. I’ve been avidly reading your site for months now and it really does work.

    Oh and I only applied for the job about a week ago and I’m currently a freshman in college with no prior finance experience. I’m not trying to show off or anything don’t get me wrong, but I posted this publicly for two reasons. 1) because you’d probably get read this sooner, and 2) more so that I wanted people to know that your site WORKS and that even now, IT’S STILL POSSIBLE TO GET SUMMER INTERNSHIPS. And you’re right, CONSIDER ALL ANGLES, had to go through about 50 different local boutiques to land this so keep working all. Again, THANK YOU!!!!

    1. Congrats on the offer, well done.

  15. This is completely unrelated to this topic, but what is the difference between investment banks and merchant banks? It feels like an MB is an IB with PE capabilities but I’m really unsure.

    1. Yes, merchant banks = investment banks + PE firms. They advise companies and also invest in companies.

      1. If I want to eventually move over to private equity, do you think I have an advantage if I start at a boutique merchant bank rather than a boutique IB?

        1. Helps somewhat but not much

  16. Keep on with the Securities/Trading posts !

  17. Is S&T easier to get into than Ibanking ? Also I read around that traders require a programming language is that true ?

  18. Avatar
    wannabe banker

    very well written. i agree, with money in the game its hard to have the restraint and to not lose cool.

  19. Avatar
    john galt

    got any tips for breaking into equity research? i’ve got 2.5 years experience in corp. dev. lookin to make the move. i’ve spoken to a few banker alumns who like my cv and experience.
    I’m about to start cold emailing, but looking for other avenues

    1. Other than the usual tips – solid story, extensive networking – no, not really. Breaking into anything in finance is a grind, all I can offer are tips on certain aspects of it.

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