Trading Psychology and Emotions

Trading Psychology and emotions play the biggest role in your daily trading. Let me elaborate on this more in this article.

Dr. Van Tharp, a leading psychologist, is very well known for breaking down the trading process into three categories that affect traders. He categorises them by importance as follows:

  • Trading strategy (10%)
  • Money management (30%)
  • Psychology (60%)

The fact that trading strategy is the least important factor in Dr. Van Tharp’s trading process above, this suggests that regardless of how successful your trading strategy is, your psychology is the key to being successful in trading.

In one of my previous articles we looked at Fear of Missing Out (FOMO) and how it can affect your trading. Fear & Greed are the two emotions that have a negative impact on your trading journey. Experienced traders know that the greed makes you to try to take too much profit (when it is not there) and you end up with less profit or loss. Similarly, fear causes you to cut your positions quickly in loss or less profit where you could make much more.

Another important psychological factor is the ‘Ego’. We all have an Ego. We all want to be right. A trader highly influenced by his own ego will never admit that he/she is wrong. This means that, he will never be able to learn from his/her mistakes as he is unable to see those mistakes in the first place. This will ultimately result on more losses and get him/her out of the game all together.

Another aspect of emotional trading can be summarised as ‘revenge trading’. In revenge trading, the focus of the trading shifts from finding the best trading setups (according to trader’s own strategy) to fastest way of recouping losses. The trader focuses on winning the losses back (very similar to a loser gambler attitude) and ends up losing more money.

The final aspect of emotional trading is over trading. This mainly happens after big wins and the trader greed kicks in for more profits. The whole situation ends up with losing the previous gains or accumulating big losses in the process. This is a Greed based human behaviour that can be seen in experienced and inexperienced traders. Difficult to control but not impossible.

So how can we cope with our own Psychology and Emotions? You heard the trading term: “be like a robot” that comes to mind. Easier said than done! The trading algos are much more profitable than humans (when they are using a profitable strategy) for one reason only, they cut out the emotion from the equation!

As a human trader, your only weapon is discipline. You might know about what to do but applying discipline to your trading will require time and experience. As good old Warren Buffet says: “You can’t make a baby in a month by getting 9 women pregnant”.

My personal advice is as follows:

  1. The start point should be working on your ego. When you are wrong, admit that you are wrong. This will be difficult at first, but in time you will see the benefits of doing so. You will be able to see your mistakes. What went right and what went wrong with that particular trade.
  2. Have a trading diary. We are humans, we forget! My suggestion to especially new traders is having an excel sheet and note down every single REAL trade that they have done (not interested in paper trades as they do not reflect the emotion of losing real money). Make sure to have a separate column for your notes, note down everything why you entered in that trade, why you exit? did you follow your initial plan (this is very important), if not why not? Take as much notes as possible so you can go back and see what happened to your trade. What went well and what went wrong. The pattern will start to emerge when you have at least 100 or more trades, you will be able to see the bigger picture. I Cannot stress this enough, HAVE A TRADING DIARY (even if you are an experienced trader).
  3. Be DISCIPLINED! Once you have a working strategy, follow it to the letter! It is not always easy to do so, but you will get better in time if you apply discipline. Also make sure to have some trading goals (my article on setting goals can be found here)
  4. Set your expectation accordingly! Trading is not easy, do not expect easy money. Know that you will have to work for your money. A lot of hard work needed to be a successful trader.
  5. Find out what works for you. Be honest with yourself. If you are overtrading, what is the best thing to do? Some people can control themselves in front of the PC, some simply cannot. After a successful trading session, I often take a coffee break to clean up my mind and more importantly my emotions. If it is a particularly good trading day, I go for a drive in my car. Whatever works for you. Perhaps go dip in the water, have a coffe, drive, call a friend, etc.
  6. Enjoy what you do! Yes, trading is hard work but there is nothing more satisfying then knowing your strategy works, you were disciplined and executed that trade according to the plan (or avoided that big loss successfully).

I hope it helps. Have a great weekend.





Introduction to Options Trading – Part 2 – Options Strategies: Butterfly Strategy

In the last Options Trading blogpost (Introduction to Options Trading), we looked at the basics of options trading: what does options trading mean and I’ve explained a few examples how you can trade options. If you are new to options, please start from part 1 here.

In the next few weeks, I will cover some of the best options strategies that works for me.

In this post, we will specifically look at Butterfly Options Trading Strategy. Please note that this is by no means a complete strategy guide for options or butterfly type of trades, just the strategies that I utilise when trading options. Again, this doesn’t mean that these are the best strategies in options, just take them as new tools in your trading toolset.

Butterfly Options Strategy

This is an advanced ‘neutral’ options strategy that requires you to find stocks that trades in a very tight price range. When I utilise this strategy, I look for stocks with a change of 5% for the last 3 months and shows similar type of price change in the last 12-18 months. You also need to make sure there are no major news or results are expected before the expiration date (so there is no big change in the price of the underlying stock).

A typical butterfly trade, consists of at least 3 options trades to be done at once. Just like statistical arbitrage trades, this means that you will lose in two options trades and win in one option trade. As you rightly guessed, your winnings should be higher than your two losses to make money on this strategy. Also note that, both your risk and reward are limited in this type of strategy.

Let’s look at an example, as below.

LONG Call Butterfly Options Trade Example

MonacoTrader (MT) finds a good candidate stock (XXX) for a Long Call Butterfly.

Stock XXX – Today’s (DEC) stock price: $100

MT enters a Long Call Butterfly by purchasing a JAN 95 CALL for $11 per share and sell x2 JAN 100 call for $4.50 per share, and buys JAN 105 call for $0.80 per share. (you will remember from part 1, there are 100 shares in 1 option contract).

So just to summarise:

when I buy 1 Contract JAN 95 CALL, I pay $11 x 100 = $1,100 (needs to be paid immediately to the broker to cover the purchase)

When I sell 2 Contracts JAN 100 CALL, I pay $4.50 x 200 = $900 (will get paid immediately to your brokerage account as you sold them)

When I buy 1 Contract JAN 105 CALL, I pay $0.80 x 100 = $80 (needs to be paid immediately to the broker to cover the purchase)

MT’s Gross Cost:  $1,100 – $900 + $80 = +$280

Now I know that my maximum possible total gross loss in this trade will always be $280. The trade will be a loss only if the market price of XXX was above or below the max loss point at the JAN Expiration date.

In other words, the net premium paid at open is the maximum possible profit that the investor can gain from this strategy, and the difference between the net loss reaped between the long and short calls or puts minus the initial premium paid is the maximum possible loss that the investor can incur as shown in the example above.

The maximum profit on a Butterfly Spread is at our Short Strike, in the example above, it is the 100 Strike. In some Butterfly Spreads, the maximum profit at expiration can reach over 250% (waiting for this comes with its own risks!) but I generally only hold Butterfly trades for 15 to 21 days, and then exit. If all goes well, expect to exit with a handsome profit of 10% to 20%. Of course if you wish to hold it to the expiration date, you can. But any news or major event can change the price of the stock dramatically and it can turn into a loss!

Another way of looking how to profit on a Butterfly Options trade is through the reduction of Time Premium of our Short positions during the 15 to 21 days period. Since one of our Long positions is ‘In The Money’, almost all of the cost of that Option will be ‘Intrinsic value’. However, the amount that the position is In The Money, the value of our Short Positions, will be almost all Time Value. As we get closer to Expiration, we will be able to sell our Long positions for about what we paid for them. However, it will cost us less to buy back our Short positions, and we end up with a profit. In essence, we buy the Butterfly at a low price, and then sell to close it later at a higher price.

For those of you using Interactive Brokers (IB), they have a quite a good (but not excellent) Options Strategy Builder comes with their TWS. It is relatively easy to use tool where you can create spreads and analyse potential profit, exit, break even points. You can also create multi-legs for even more complex options strategies. I suggest you try and see yourself.

My Ultimate Trade Setup for Butterfly Option Trades:

Time to enter the trade: 35 days until 25 days prior to expiration

News: There are no major news or expected, no earnings news, no mergers or acquisitions, no major sector movement for the chosen stock.

Time in Trade: 15-21 days. You can hold it until expiration if you wanted to (perhaps waiting for expiration and not take the profits when available is riskier strategy)

Stock Price: At least $60 or above – If the price is underlying is too low then the price of the options will be too low. Hence the potential profits will be low.

Summary QA

Q: When should I use this strategy
A: When you think the price of the underlying stock will be stagnant or will change very little before the option expiration date.

Q: What are the advantages of Butterfly Options Strategy?
A: 1) Good profit potential with low cost entry 2) Risk and Reward parameters are set before entering in the trade 3) Quite a large number of underlying stocks can be found to utilise this strategy.

Q: What are the disadvantages of using Butterfly Options Strategy?
A: 1) Depending on your broker, larger commissions might be applicable to these type of trades 2)This strategy is more appropriate for experienced traders who can watch the markets during trading hours and thoroughly understand the potential risks and rewards involved.

I hope this helps. Let me know your comments or questions on twitter (@MonacoTrader).

Have a nice weekend.


Roulette and the simple way of maximising your chance of success (Martingale Betting System)

I hope you are all having a great weekend. A blogpost about something different today. Let’s look at Martingale Betting System and its use in Roulette, the table game.

Let’s make one thing very clear, I DO NOT gamble unless it is for a social occasion. I have nothing against people gambling for having some good time (more for socialising purposes) but I have zero respect for people who can’t control themselves and lose a lot of money unnecessarily to the casinos.

Living in Monaco comes with its perks. After all, Monte Carlo is the place where it all began. The funny thing about Monaco is Monaco citizens (note not residents – means two different things) are not allowed to gamble. This is almost ironic, basically giving the message that Monaco will entertain you the max, take your money and then will send you home where your bank manager is waiting to have a word… (a bit like Vegas – perhaps a bit more classy way of taking your money). And that is exactly what happens in the Monte Carlo Casino.

I socialise and go to the casino quite frequently. My wife and I are members of number of societies in Monaco where after a great meal in Hotel de Paris, the night generally ends in the Casino. The only game I would ever play to socialise with the crowd in the casino is Roulette. There are number of reasons for this, which I will explain below.

Now let’s go back in time, all the way to 18th Century. We are now in rural France. You are looking at a house lit with oil lamps and a man is working hard on advanced probability theory. This is the Martingale Betting System. It is originated with the betting on heads or tails using a coin. In classic Martingale system you double up the next bet after each loss and as soon as you win you reduce your bet the initial amount after each win.

You will never leave the casino penniless with this system – the winnings will cover all your net losses of the previous bets (all IN THEORY!!!).

Let us use an example to understand how it works. Let’s say you are playing classic or European roulette (so we have RED, BLACK and only one GREEN colour on the roulette). This means, as a player, you can bet to the colour RED or BLACK. If you win you will get win double your bet.  Let’s say you always bet to RED colour. To win you need RED colour (any other colours such as BLACK or GREEN means that you will loose the bet).  By the way you can bet to RED or BLACK this doesn’t make any difference. The probability for both are exactly the same.

Let’s say, You bet 1 dollars to RED and lose the bet, the next time you now have to bet 2 dollars (this is how Martingale System works, you need to double your loos). If you happen to lose your 2 dollars, you must bet 4 dollars the next spin. If you lose again, do not give up! Bet the increased amount of 8 dollars! When you win (Let’s say at $8 bet – now you have won $16) you should reduce your next roulette bet to the starting amount of 1 dollars. As a result, you will always have a minimal gain. In our example it is 1 dollar minimal gain: $16 – ($1+$2+$4+$8)=$1. Well, using Martingale system, in theory, you can’t loose. Sooner or later you will get the colour of your choice and you will at least win the minimal bet amount.

Let’s have a look at your probability of losing under Martingale System, here is a chart:


If it sounds too good to be true, it generally is!

As the old sayings go, in the long run the casino will always win. Because they have an advantage, the GREEN (0) to their advantage. The catch is you’ll get red *less than* half of the time (as seen above), since there are black and green spaces on the wheel. You can keep doubling your bet and eventually you’ll win a whole $5, or eventually you won’t have enough money to double your previous bet and you’re screwed. Or you will hit the table maximum. Most online casino do not let you to bet more than $1000 on a roulette table. Some do but they will always have a maximum limit to stop you winning. This means that if I bet on RED and if I start with $1, I will only have 10 chances to get RED ($1, $2, $4, $8, $16, $32, $64, $128, $256, $528, $1016). It sounds like 10 BLACKS and/or GREENS in a row looks like a small chance, it happens all the time. The more you play, the more likely you will get this in a row. Trust me, it WILL happen!

Once I first discovered Martingale Betting system years ago, I straight away wrote a software programme to automate Martingale and make a million! It worked successfully and bet exactly how I wanted but at the end of the day (was trying demo accounts only of course), I was always the one who was losing at the end of the day. It is simple mathematics.

In the short term, the system will very likely to work. So if you want to impress your friends or family, it is a great trick in the casino. Take your winnings and never play again that day. That’s what I do.  One thing is for sure, trying Martingale in a demo account is so much fun. You want to test it? Follow the link and have some weekend fun (DON’T LOOSE ANY MONEY!): (choose European Roulette)

If you like the article, let me know on twitter.

Have a nice weekend.