Psychology of Risk Taking – Foundational Concepts

Mar 4, 2007: 12:42 PM CST

A key book that helped me address my own fears of trading and risk-taking was a book by trading psychiratrist Ari Kiev: The Psychology of Risk Taking.

Kiev worked with many traders through his career, and found the number one problem facing professional traders was that they did not take on enough risk in their trades – they held back when they should be pressing aggressively. When I speak of “fear,” I don’t just mean “fear of entering a trade”; rather, I speak of fear across the spectrum of trading which also applies to those who have traded for years but aren’t making the phenomenal results they expected or hear that others are achieving.

Notes from the Opening Chapter

“The Very Essence of Trading inherently involves taking risk – how you manage risk determines your success or failure”

“Taking risk means:

  • Being willing to create a vision from which to trade
  • Increasing your capacity to interact with the realities of the market
  • Freedom from constraints of prior rationalizations or self-justification”

“In trading, this means making realistic assessments of the market and being willing to face the truth about your positions and opinions without being caught in rationalization and denial that are easily triggered by market events and outcomes.”

You expand your reality by giving up beliefs and limitations from the past (both in your trading life and personal/developmental life) and engage the world in a more open (to possibilities) and vulnerable way (almost like a child with wonder and awe).

Kiev further describes risk-taking behavior as

  • Willingness to live life as the risk it is, not in terms of limiting notions of your own self-doubt
  • Engaging in new activites (new methods/trading) spontaneously and naturally (Dr. Brett Steenbarger echoes this)
  • Willingness to commit to your Vision and create numerous goals related specifically to the vision
  • Ability to Work Backwards from your vision and develop a strategy consistent with achieving those goals
  • Focus on the present moment on implementation of the goal without obsessive concern with reaching the goal
  • Allowing room for mistakes, errors, and set-backs related to achieving your goal

Finally, “Risk taking means letting go of the past habits and values that lock you into a fixed way of relating to the world so as to trade with a NEW concept of what is possible. Successful risk taking requires you to commit to a specific result instead of ‘merely taking what the market gives you.’ It requires action and strategy in position sizing, measuring upside and downside probabilities, getting out when things go against you and ADDING size when things go in your favor.”

From my perspective, I echo these sentiments and can show real life examples of how these concepts can not only increase trading profitability, but broaden your psychological perspective and mental state as you approach your next trades. You need to spend time and actively create a vision of where you want to be and work backwards of how you can get there and then take the risks inherent in moving you across the ‘chasm’ between where you are and where you want to be. Living in the chasm means being uncertain, but the alternative is a continuation of the status quo and possible “life lived in quiet desperation (Thoreau).”

You will live in uncertainty as a trader and you must take steps to address this psychological reality. You will never know the outcome of your next trade but you never need to know, either. Comfort arises from lessening the burden you place on yourself when you stress over the ‘next trade’ or add personal contraints on yourself.

Plan your goal, and add in your plan the reality of losing trades, bad weeks/months, mistakes, unforced errors – if you anticipate them, then their psychological impact is reduced when they occur. If you are blindsided by loss or errors (or this recent swift market decline), then you increase your stress and odds of quitting ‘the trading game’ because it appears too scary or risky.

Never compare yourself with others, don’t compare yourself with the market (“the Dow was up 100 points today and I lost money trading!”), and continue living life and trading consistent with your plan and future vision.

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Comments
  • When it comes to decision making you must analyze the consequences and benefits before taking that huge decision in life.

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