Forex Trading Articles

PROTECTING YOUR MENTAL CAPITAL

By Dick Thompson for Forexmentor.com
©2007, Currex Investment Services Inc.

February 19, 2007

Last year, during a ForexMentor workshop, one of the attendees used the phrase “Mental Capital” in a class discussion. For some reason, bells started ringing in my mind and I jotted down a note to myself to give this some serious thought.

We, as traders, are taught from the very beginning to learn to preserve capital. When we first hear that, we immediately conclude that the capital being referred to is money - the money that we “can afford to lose”. We are taught about risk management, how to cut our losses, how to place stops and how to hedge. We are told that trading is a journey, and that if we want our journey to be a long one, we must have financial “staying power”. It is pointed out, through anecdotes without end, that many traders have a short journey.

Money, however, is not the only “capital” that we bring to the markets when we embark on our journey. We also bring Mental Capital. Just as our trading journey is finished when our financial capital is depleted, our journey is also over when we become mentally bankrupt. Mark Douglas makes the following point in his well respected book Trading In The Zone: “There’s a big difference between predicting that something will happen in the market and the reality of actually getting into and out of trades. I call this difference, and others like it, a “psychological gap” that can make trading one of the most difficult endeavors you could choose to undertake and certainly one of the most mysterious to master”. It is this psychological gap that can cause the drawdown on our Mental Capital. We also need mental “staying power”.

Most, if not all, financial educational forums, mentors, teachers, etc mention that psychology is very important in trading and that we must master our emotions to be successful. Chris Lori of ForexMentor has written an excellent treatise titled “Face The Trader Within” and Mark Douglas has published two books focusing on this issue. I suspect that there are others as well. But beyond these efforts and the cautions made in the various courses, workshops and seminars, techniques and strategies to manage our Mental Capital are rarely discussed.

If you accept that, as we trade, there is serious risk to our Mental Capital, then clearly it is imperative to manage this risk, just as we manage the risk to our money. The question is how? Guidance in this arena is sorely missing. While I do not consider myself qualified to provide that guidance, I have recognized the risk, and I want to share the approach I have taken to deal with it.

First, I assessed my trading skills. These consist of my background and experience in mutual funds, stocks, options, and Forex; the many books I have read; the workshops and seminars I have attended and CD courses I have watched, and all of the other media and Web-based sources of information that I frequent. Most importantly, it includes the retained knowledge from all of these sources and my hands-on experience. Then, I tried to evaluate the strengths and weaknesses of my personality, my emotional makeup, my ego, my need to be right. I also included the possibility that my trading (the London session) might cause family stress. Evaluating these psychological issues were probably the most difficult task because I, like most of us, am poorly trained to know how these characteristics affect our trading. The net sum total of this is my Mental Capital.

Next, I examined how I apply this skill base, or this capital, to my trading. Do I simply assume that at any point in time, I am the net sum total of all the above and for better or worse, just jump right into the market? Or do I try to capture the vast knowledge I have been exposed to and formalize these skills and methods that I have learned into a rigid trading methodology and follow it religiously? Or do I continue to try to build on this base and continue learning? Or do I set this base aside and search further for the “holy grail”?

Then I composed a list of specific risks to my Mental Capital. I initially wrote down everything that I could think of, more or less a brain storming session of one person. Then over the period of a couple of weeks, I added to this list as thoughts presented themselves. This was a process of trying to evaluate objectively the way I apply my skill base as either “good” or “bad” and from there, label anything that could prevent good trading results, a risk. These risks fell into two basic categories. There was the list from personal introspection: compulsive behavior, seeing only what I want to see, lack of confidence, focus on profit/loss rather than execution, lack of self-forgiveness, trading when emotionally upset, angry, stressed or frustrated. Then there was the list from the skill base itself: poor integration of my knowledge base, lack of a cohesive trading plan, lack of method of retaining or refreshing my knowledge, no discrimination between applicable knowledge and that which I would not use.

Perhaps one example will help to clarify these ideas: I have frequently felt the desire to be in the market, to make a trade. This “compulsive behavior” causes me to “see” technical signals in the charts that I want to see, that support a trade setup, and ignore what the charts are actually showing, that may not support the trade. Has anyone else ever been there? It is clear to me that any risk abatement procedure that will alert me that I am behaving in this way has to be a good thing.

The final step is deciding what to do. How can I formulate a risk abatement program or a set of rules to eliminate or at least minimize the impact of these risks on my trading? I understand the goals are to minimize the draw down to my Mental Capital and to prevent mental bankruptcy, which could lead to loss of trading capital. But what will this program look like? How will it be applied? This is difficult and is now an ongoing activity.

I am pursuing a variety of ideas. I am re-reading couple books on successful traders identifying their characteristics for cold, calculated and unemotional trading that I can adopt. I am developing a checklist to follow prior to and during trading sessions. I am reevaluating my personal trading goals and how to achieve them.

In summary, this article is not a “knowledge based” discussion where I, the author, presume to have facts or information to provide you, the reader. Rather, it is a sharing of ideas that I hope will be thought provoking and will lead you to recognize the existence of your Mental Capital and the need to preserve it. Perhaps, through the ForexMentor member discussion forum, this will lead to a sharing of ideas that we can all benefit from.

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