Trading Psychology: An Interview With Mark Douglas
The following is an edited transcript of a live TraderTalk conversation between Mark Douglas and TradingMarkets CEO Larry Connors on Thursday, August 8, 2002.
Larry Connors: With me today is Mark Douglas, author of “The Disciplined Trader,” a book that’s been around now for almost a decade and one of the most popular books available to traders, on the mental side of trading.
He also wrote the very popular, “Trading In The Zone,” and created a video course, “How To Think Your Way To Consistent Results.” Today, Mark and I are going to talk about how to improve your trading results. Mark, thank you for being with us.
Mark Douglas: Oh, thank you, Larry.
Connors: I hate to bring up almost a negative question to begin this, but I think it’s a very important starting point. Trading is obviously a very difficult game and it takes quite a while to succeed at it, but a number of people don’t end up succeeding. Can you give us some of the reasons you’ve seen in the past — why many of these people failed. Why did they fail?
Douglas: Well, Larry, you’re asking me a good question — I wrote two books on it. (Laughs) Anyway, I can answer that. I can sort of encapsulate it down to at least four primary issues that people have to look into and address.
First of all, you said that trading takes a long time to master. You did make that statement and interestingly enough, that is one of the reasons why people fail. It’s because they don’t recognize just how much time, how much effort, how much real sincere dedication they have to put into mastering these skills.
And one of the reasons people don’t generally do that and take for granted many of the things they have to learn, is because when you really get right down to it, and I think this is something that I even started out saying when I spoke at your conference last year, is that you need, a person, a particular trader needs absolutely no skills to put on a winning trade. You don’t need to know anything. In other words, you can put on a trade, find yourself in a winning trade, find yourself in a huge winning trade — and what did you need to know to do it? Nothing.
Connors: Yeah.
Douglas: And you can see, Larry, the thing is if you can put on one winning trade without any skills whatsoever, then you can put on two, and if you can put on two, you can put on three. But there’s a problem here. Because people can so easily find themselves with a pile of money after a few seconds or a few minutes or a few hours, it seduces them into believing or thinking that trading itself is easy.
In other words, here is the difference: You need no skills to put on a winning trade but if you want to create consistent results, if you want to master the skill of creating consistent results from your trading, then you’re looking at what could be a lifelong process of learning, because there are a number of different skill areas that have to be mastered. The problem with these skill areas that have to be mastered is that most of them are psychological in nature. In other words, I’m going to break it down into four major categories:
1. First, people have to learn how to read the market, meaning that they have to be able to discern when the market’s giving them an edge. I’m simply defining an edge as a higher probability of one thing happening over another. 2. The second thing, which is extremely difficult, is training their mind to think of probabilities. Now the problem here is that the market exists in a probabilistic environment, meaning that if technical analysis — if I am going to look at the market from a technical perspective, one of the things that technical analysis does for me is it identifies these patterns that continually repeat themselves. And this even goes to back to what I said about being seduced about how easy trading is. In other words, if I don’t have to know anything to put on a winning trade, I discover technical analysis which identifies all these patterns that repeat themselves over and over again, in every single time frame, then what that does is make the market like this never-ending stream of opportunity in which to enrich myself. But there is the big problem here — it’s that patterns imply consistency, but — and it is true, these patterns do repeat themselves — but the problem is that there is a kind of a paradox: The patterns repeat themselves but the outcomes to the patterns are not consistent, meaning there is a random distribution between wins and losses on any given set of variables that define an edge. And the big problem here is that our minds are specifically not designed to think that way. Meaning that I have to train my mind to think in probabilities, even though I may understand the nature of probability. I may understand the concept, but actually thinking in probabilities is another matter entirely — and people take that completely for granted.
Connors: Mark, let’s bring that out. I love what you’re saying here — it’s the truest thing. How do you get to that point of thinking in probabilities? I guess it has to stem from number one is that you have to know that you have an edge, because otherwise you’re not going to be able to withstand part two, which is thinking in probabilities — meaning that you are going to be wrong four, five, six times in a row, potentially, with your methodology.
Douglas: Sure. How do I get to that point? This is something that “Trading In The Zone,” really addresses in great depth and detail, as well as the tapes. As a matter of fact, the videotape program does it better than the book itself, but basically what it boils down to is making a commitment to use your trading as a means to acquire certain mental skills, as opposed to continually focusing on just making money. What the tapes and the books do, for example, is help you understand why it’s so imperative that you set up a regimen, an actual test… let me back track and say that one of the problems is that when you have acquired these mental skills I am talking about, like thinking in probabilities, a person is always going to be susceptible to making trading errors.
What’s a trading error? It’s like getting in too soon, getting in too late, not taking a signal when it presents itself, not putting a stop in, or moving your stop, or taking your stop out of the market. I mean, there’s any number of ways that people can screw this thing up and the problem is that even though it takes nothing, no skill at all, to find yourself in a winning trade, the problem with creating consistent results in many ways is an endeavor in eliminating your susceptibility to making all these different errors.
Because as long as you are susceptible to making one error, if you think about it, you are always just one trade away from disaster. So no matter how good the results that you may compile over any period of time, if you’re susceptible to any one error, you are always one trade away from financial and emotional disaster.
Connors: Mark, by one error, do you mean the one time that you just don’t… adhere to your stops…
Douglas: That’s right! It just takes one time, Larry, that’s all. All of us who have been trading for a long time, know that.
Connors: It’s certainly the worst thing that can happen to you. I think it’s almost worse to be rewarded for making that mistake — so you don’t put in your stops, the market ends up reversing itself and you end up being OK. It’s rewarding for breaking the rules. It’s the worst thing that can happen…
Douglas: Exactly. What you said is just huge, because many times what will happen is that people will break their rules, will in essence make what is considered from the perspective of “my desire is to create consistent results.” If you look at it from that perspective, you’re making a trading error, and then the market rewards you for making that error.
Connors: Yeah.
Douglas: Here is the essence of it, this is what I mean — I’m kind of connecting this with thinking in probabilities. The essence of thinking in probabilities is staying in the “now” moment, meaning that you have to understand that even though the market generates behavior patterns, that when we look at charts, what we see are lines, OK, and we see various ways of analyzing the lines, you know, mathematical or we can identify a certain pattern, but basically at the most fundamental level, the market exists on up and down ticks.
The up and down ticks form into patterns. Technical analysis identifies the pattern. The patterns repeat themselves, but here’s what people don’t really grasp: Under the patterns are people. The problem is that the people whose behavior generated the last pattern, are going to be different from the people who are generating the pattern that exists in this moment. The pattern itself may be exactly identical but the people are different.
Connors: That’s why the outcome is different.
Douglas: That’s why the outcome is different, e.g., if I really believe (now think about this), I really believe there is a random distribution between wins and losses on any different set of variables that define an edge, then how can I make any one of those trading errors that I mentioned previously?
You see, every error that we are susceptible to making in that category of not having mastered how to think in probabilities, every error is the result of thinking we know what’s going to happen next. Think about it: Every error that falls into the category of not having mastered how to think in probabilities is the result of “I think I know what’s going to happen next.“
Connors: So how do you overcome that?
| ‘Train your mind… to believe that every moment is unique.’ |
Douglas: By going through the process of learning how to think in probabilities. In other words, training your mind to believe, literally to believe, that every moment is unique. That’s what it means to stay in the “now” moment. That’s why it’s so difficult to master trading itself, because, as I said, no matter how good you get at technical analysis — and there are people out there who really, truly are masterful technicians, but as traders, they are the worst imaginable because they haven’t learned to think in probabilities. Because their mind set is so steeped in “I know what’s going to happen next.
Connors: Is it a need to be right?
Douglas: Oh sure, a lot of it is. Look at how we grow up — what it means to be wrong. It’s all based on pain of every single one of us. So what we have to do is take trading out of the “right or wrong” context. It doesn’t have anything to do with being right or wrong. This is the process of identifying edges. And doing exactly what you need to do, when you need to do it, without hesitation, without reservation, without mental, internal conflict.
Connors: Yeah… yeah. OK, what’s the next step here? You’ve listed two things here.
Douglas: Then the next big category is a big one (sighs).
3. The third thing is (even though you may have, let’s say mastered the first two) learning how to identify a good edge and learned to think in probabilities — you may still be susceptible to self-sabotaging beliefs. What do I mean by self-sabotaging beliefs? Well, think about it, all of us have a sense of self valuation, like a sense of net worth. What are we worth, as people? And the easiest way, although for the purposes of this conversation, probably not exactly the best way, but just to make it easy, as I said…
If we had a way of categorizing every positive experience that we’ve ever had in our lives, and listing them on one side of a ledger and categorizing every negative experience that we’ve had in our lives on the other side of the ledger — and let’s say not every negative experience contributes to let’s say, “I’m not a deserving person” but it has the possibility of doing that. Most of them do. And we could just balance it off — how much negative, how much positive — we would come up with a net sense of self valuation. It could be a net positive or a net negative — and it changes, too. It’s not a static figure, you might say.
| ‘People… will be susceptible to self-sabotaging kinds of errors… (to) rectify the internal imbalance…’ |
One of the problems is that once people acquire the skills necessary to create consistent results, it doesn’t necessarily mean that they have the sense of self valuation that allows them to accumulate vast sums of money — or the amount of money that they’d like to have. And so what will happen is that as their equity curve starts to rise, they will be susceptible to self-sabotaging kinds of errors. They end up maybe doing things, even unconsciously, things that they stopped doing maybe months or maybe even years ago for that matter, or just little things like putting in buys for sells, sells for buys — anything that will cause them to make an error that will in essence, you know, rectify the internal imbalance that’s the result of accumulating too much money — or more money than they believe they’re worth.
Connors: So if someone believes, for argument’s sake, they should not be a billionaire or millionaire…
Douglas: Exactly…
Connors: Ultimately as they start approaching that level, what happens?
Douglas: Unconscious things will happen. By “unconscious,” meaning that until they develop ways of monitoring their stream of thought so that they know when they’re thinking a distracting thought or that they know that they are susceptible to making an error — in essence they will sort of wake up and find themselves in a trading error.
Connors: I know this is very difficult in a 40-minute interview here, but give a couple of broader examples of how you overcome that.
Douglas: Becoming self aware and going through a process of self growth.
Connors: And how do you do that?
Douglas: Larry, there’s a lot of techniques. I mean, it’s not an easy thing to describe in just a few minutes, but let’s say in the workshop tapes and in my books — but most all the workshop tapes, there are many techniques that I give people on how the implications of things we’ve learned to believe and how to identify our beliefs. And then how to change them, how to neutralize some of these self-sabotaging beliefs. Specific techniques on how to do that — and then I give people a list of several beliefs that they can install that are, let’s say, consistent with their desire to be a millionaire. Just because one desires to be a millionaire — you can have an intense desire to be a millionaire — but like I said, if your beliefs are not consistent with your desire, then, you know, what’s going to happen is there is going to be an internal conflict. That internal conflict is going to result in devastating trading errors.
Connors: Does auto suggestion work?
Douglas: I don’t know exactly what you mean by “auto suggestion,” but if you’re talking about self hypnosis or hypnosis tapes, there are a lot of good techniques out there, but one of the best techniques as far as I’m concerned is just learning how to become self aware, meaning that there are certain mental techniques that you can practice on a daily basis — there’s like 10 or 15 meditations. You can call it a meditation — I call it a simple mental technique — where people learn how to become self aware. Just like great athletes. They have to stay focused. And that’s one of the characteristics that separates a great athlete from, you know, just like your mediocre athlete or someone who doesn’t make it into pros or make it into the higher echelons of achievement. They can stay focused. What does that mean — to stay focused? It means exactly that. Your mind — what you’re thinking — your body and your mind — and let’s say, your spirit — are all focused on accomplishing a certain task, whatever it is. Any thoughts that run through your consciousness that are conflicted with that desire is going to detract from your outcome, right? Well, it’s the same thing with trading.
Connors: It’s interesting that you say that because it reminded me of Jimmy Connors saying that there is no physical or ability characteristic differences between the guy who is ranked number 1 vs. the guy who is ranked number 20 in the world of professional tennis. Obviously from an earnings basis it was enormous but from their ability to perform and execute, there was no difference. I mean it was simply down to the difference in the mental process.
Douglas: Right. How well they can stay focused. How much they believed in their ability to win
Connors: Yeah, yeah. And that belief system became the difference between the guys that were ranked number 1, 2 and 3, vs. the guys that were ranked number 18, 19 and 20. And you say it’s the same thing with trading?
Douglas: It’s exactly the same thing. As a matter of fact, trading really is a vehicle that gives really anybody out there the opportunity to achieve at Michael Jordan levels. You don’t have to be born with a Michael Jordan body to be a Michael Jordan trader.
Connors: Most of us spend our time looking for edges within the patterns, etc. You’re saying that’s fine but where you should really be spending your time is working on the mental process.
Douglas: That’s right, because no matter how good you may become at defining edges, if you’re susceptible to making trading errors which is a result of not having learned to truly think in probabilities, what difference does it make? You’re going to create a nice equity curve and one error is going to take it down 50%, 75%, and you’re going to start the process all over again.
Connors: Now, you’re not going to know that you’re making these mistakes without — I know you’re a big believer in keeping a journal.
Douglas: Oh yeah, keeping a journal is really big. That’s part of the process of learning how to become more self aware. Connors: And that journal — what should be in a journal? What advice would you give to someone to keep in that journal?
Douglas: Well, one of the things I do for example, just dealing with my own trading, is I grade my trades. I grade my entries, I grade my exits on longs, I grade my profits, and I give myself “A,” “B,” “C,” “D” or “E” trades, you know.
Connors: Do you do that every day?
Douglas: I do that on every trade, not every day.
Connors: Wow. OK. And before you get there, do you have a checklist for yourself so you know exactly where you should be buying, where you should be…
Douglas: I have like a checklist that’s laminated as if I was an airline pilot. For example, no matter how many times they do it, no matter how many thousands of times or hours they might be in that cockpit, you know, all it takes is one little mistake. I remember several major plane crashes were the result of them forgetting to put the flaps up or down, or something like that. Some little thing they’ve done a thousand times and that’s why they have to read the checklist.
Connors: You use the checklist for every trade?
Douglas: Yeah… absolutely! Otherwise… see, the fact that I stop using the checklist, what is that telling me? I’m setting myself up for a trading error. That’s probably telling me that there’s some conflicting beliefs inside of me that’s causing me to want to give my money away.
Connors: So the reason why people don’t use checklists is in a sense it’s this conflicting behavior then, that they really just don’t want to be…
Douglas: They don’t want to confront it. There’s a good reason why. If you don’t have a way to put all of this in the appropriate context, Larry. If you don’t really understand the process, you really don’t understand this process, I mean a lot of it is scary and so you don’t really want to confront it. You don’t really want to be taking responsibility for all this because then it falls into the category of, “I must be a bad person,” or “There must be something wrong with me.” You know, and so you avoid the responsibility instead of in fact embracing it.
Connors: You know, a lot of us also pride ourselves — and I suspect that just about everybody who is listening to this has achieved some success or a lot of success in life — on our ability to be making decisions on the fly, and we try to use that same type of thinking, you know, good decisions on the fly — when you’re running a business, you’re making decisions constantly. Over time, you’ve successfully made good decisions. But with trading, that doesn’t work. You need to be doing the thinking ahead of time and then just executing off the check list. The pride should be in the fact that you put that checklist together and you have the ability to follow it.
Douglas: Exactly. You hit the nail right on the head.
Connors: OK, now you’ve listed the three things…
Douglas: The fourth one is — this one is really hard too. (Laughs) They just get harder as you go down the list: 4. Learning how to identify when you’ve crossed the threshold into euphoria.
Connors: Tell me what that means.
| ‘Everyone has a threshold where they go from normal confidence to a state of euphoria.’ |
Douglas: Well, as traders we need to be relaxed, basically carefree state of mind. Carefree in the sense that there are no internal conflicts that are preventing us from doing exactly what we need to do, when we need to do it. But at the same time, you know, like everyone has a threshold from when they go from normal confidence to a state of euphoria. And in a state of euphoria, the problem is when we’re interacting with the market in that kind of mental state of mind, it’s a state of mind in which we have completely lost our ability to perceive any risk at all. In other words, in a state of euphoria, nothing — absolutely nothing — that we don’t think is going to happen can happen.
Connors: You’ve been rewarded because you’re living in a world of probabilities — you’re going to be rewarded four, five, six, seven times in a row and it has nothing to do with just how smart you are — that’s just the probabilities.
Douglas: Yes, that’s right and you may have crossed that threshold and slipped into a state of euphoria and it is that next trade that’s coming down the pike that isn’t going to work. The problem when you are in a state of euphoria is that you are really susceptible to making huge catastrophic money management errors.
Connors: You increase size; you become sloppy in your decision-making processes? It all comes back to your checklist. If you’re just looking off the checklist, you can’t get into that state if you’ve checked everything off.
Douglas: Exactly! Right. In other words, you’ll know, “Oh, I know what’s happened here. I’ve kind of slipped into a state of euphoria because I want to break my rules.”
Connors: Yeah, yeah. I’ve told the story before of Sheldon Natenberg who wrote a wonderful book called Options Volatility And Pricing that I highly recommend — it’s been around now for about 15 years and it’s been in multiple editions. He told me the story once where he sees guys coming down to the floor and on day one, they are really impeccably disciplined. They trade one module and they make a little bit with one. They then trade twos and they go up to fives, and then tens. Then, all of a sudden, they go in and plunge into 50s or 100s. And the next time you see them, it’s usually when you’re out there hailing a taxicab and they’re driving the cab. And he says he’s seen this over and over again, after a couple of decades on the floor, where guys end up, because they had some wins there, they end up losing all their discipline and just blowing up.
Mark, of the four things you mention here that you listed: “1. Read The Market; 2. Train Your Mind To Think In Probabilities; 3. Stop The Self-Sabotaging Beliefs; and 4. Identify Crossing The Threshold Into Euphoria” — is “Stopping Self-Sabotaging Beliefs” the most important?
Douglas: No, I’d say thinking in probabilities is probably the most important. The most important one is training your mind to think in probabilities, because once you’ve done that, then everything else is pretty easy. Much easier, as a matter of fact — I’d say pretty easy. But a lot of things fall into place if you’ve gone through the process of training your mind to think in probabilities.
Connors: OK, let’s spend the last couple of minutes here talking about that since it is the most important. Is there a way to begin this training process?
Douglas: Well, again, Larry, in a few-minute interview, it’s kind of difficult but basically what I do is I tell people to decide on an edge. What they have to understand is that it doesn’t really matter how good the edge is, or — as a matter of fact I would say it’s optimum if the edge basically breaks even, you know, over a series of trades — and if it pays for commissions, that’s even better. But what’s important is that the edge has to be specific; the entry has to be non-subjective — in other words, the market is telling you this is an edge — and if the variables you use to define it aren’t there, then it is not an edge. And basically, pre-define your risk, pre-define your profit, and go through a series of trades and do the best you can to do exactly what you need to do, when you need to do it. And do it until you can do it with no mental conflict whatsoever. In other words, every time that you don’t do what you’re supposed to do when you’re supposed to do it, it’s going to be the result of thinking you know what’s going to happen. There is no other reason.
Connors: Mark, what just popped into my head — is it advantageous to have a coach with you, or for you? Where you buddy up with another trader or something and you go back and forth to make sure you’re just each watching each other?
Douglas: I would say that anything you do in that area, any idea that people come up with like that, about 1) see a coach, or 2) buddy up with somebody, you know, if there’s a positive synergy going on, then that’s great. That’s the real determining factor.
Connors: And it allows you to make sure that at least — it’s almost in a sense that you’re answering to someone else. I think many times, people do perform better when they’re forced — not forced — but in an environment where they’re accountable to someone else. That probably plays a great role in this thing.
Douglas: Sure. See, the thing that you want to do with this exercise, is you want to confront every, let’s say, conflicting belief that you may have about the nature of trading will come out when you have to do exactly what you need to do based on your system. In other words, you will be confronting every single one of these mental conflicts and what you do is do the best you can do. That’s why I grade myself on each trade. In other words, how many “A”s did I get on entry? How many “A”s did I get on exits with a profit? How many “A”s did I get on exits at a loss? And, you know, based on my grades, I put more effort and more focus in the areas that I am lacking.
Connors: Right. And ultimately if you have a checklist in front of you, though, you’re going “check, check, check, check,” there’s no wiggle room there. You should be getting “A”s on everything.
Douglas: Unless there’s a conflict, Larry. That’s the whole point. This is a process of changing your beliefs. You see, the thing that would cause someone not to follow their checklist or not to do exactly what they need to do when they need to do it, is something inside of them — some way that they define reality — is in conflict with what they need to do.
Connors: Yeah, yeah.
Douglas: So in essence, by doing this kind of an exercise, you are confronting these beliefs, so when you step through them, in other words when you are able to go ahead and do what you need to do anyway, what you’re doing — it’s like any habit that you want to acquire — you’re building a positive credit until there’s more positives than what was conflicting and then it just becomes who you are. Eventually, you’ll get to the point where you are able to do exactly what you need to do, when you need to do it, without any internal conflict.
Connors: But you’re basically warning us ahead of time that to do is like breaking any habit — whether it’s quitting smoking or whatever — there’s going to be some pain involved on the way to get to that point.
Douglas: Yes, some people might do it in one or two sample sizes of trade and other people might take a year. You know, it might take them 300 trades before they get to that point. But once they get to that point, everything changes. Everything.
Connors: And it changes for the positive.
Douglas: Oh yes.
Connors: And that’s when they can start…
Douglas: That’s when they can start making subjective decisions if they want about certain trades that they want to put on. Once they’ve developed these skills, you know, and they’ve neutralized all other conflicts, then they can trade as subjectively and intuitively as they want.
Connors: OK. This is great stuff and again, a lot of this information — or most of this information — can be found to some degree…
Douglas: Not most — all of it, plus 14 hours more —
Connors: In your video video course “How To Think Your Way To Consistent Results“ and some of it is also available in “Trading In The Zone.” This is great. Mark. Again, it’s been a pleasure. Thank you.