It certainly is a fascinating time in the financial markets at the moment. We’ve seen a healthy rally from the “PIIGS” induced mini-crash in April and May to put the ASX 200 firmly back up around the 4600 level. (For those of you who are not familiar with the lingo, the PIIGS are Portugal, Italy, Ireland, Greece and Spain, and world markets tumbled in April and May due to sovereign debt concerns within these countries.)
Many novice traders I meet at my free seminars tell me that they’re still nervous about the markets, even after the recent rally, and are struggling to make confident decisions for their portfolios. Many are even questioning whether they should be in the market at all. My response is generally the same: When were you last confident in making decisions on how to invest your money in the markets?
Their answer is just as consistent: Well, really not since the middle of last year (2009), or before the GFC began in 2007. These were of course the easiest times to make money in the markets, when prices were trending steadily higher and both good and bad trading practices were rewarded.
It appears that these traders were only confident in their trading approach in forgiving bull markets. The confidence occurs solely due to market conditions, rather than from any in-built confidence in the trader’s own ability to make the right decisions. These traders are doomed to experience short term success in friendly markets and to then flounder when market conditions change.
In contrast, I look at the markets right now with great confidence. Not necessarily in the market’s ability to appreciate over the near or long term, this is actually of little relevance to me as I have no preference over rising or falling markets, but rather in my own ability to make good decisions in any sort of market condition. I’ve have had this confidence, and unwaveringly so, for many years since I learned the secret of confidence in one’s trading. The secret is self-efficacy.
What is self-efficacy? It’s the trait we all wish we possessed – and often do – but often misplace due to emotion, perceived bad luck, and a few other factors. Self-efficacy is the belief that we can perform in a certain manner to achieve specific goals. It is the ability to produce the desired result.
Not surprisingly, as suggested above, many traders have high degrees of self-efficacy during steady bull markets but less so when markets become choppy, or worse, turn into protracted bear markets. In order to be a successful trader, self-efficacy must be constant.
This is very hard to maintain when you’re feeling nervous, despondent, greedy, or otherwise negatively influenced.
Fail to plan and plan to fail
The basis for self-efficacy in trading comes from two areas. The first is having a structured approach, otherwise known as a trading plan. A trading plan in its most basic sense consists of a number of rules under which the trader will enter the market, how much they will risk when they do so, and how they will exit the market. Far from being a random assortment of rules, an effective trading plan is one which has been tested and proven to be successful under all manner of market conditions.
Hopefully it is clear that by possessing such a plan, this will give the professional trader great confidence in their approach and help them to be far more decisive – even in difficult markets. The possession of a robust and proven profitable trading plan greatly reduces self doubt and therefore improves self-efficacy.
The second area which fosters self-efficacy is the setting of clear goals within one’s structured approach. Goals keep you from straying into negative emotional regions, and goal-setting energizes your trading efforts. The thing is, there are goals, and then there are goals.
One big mistake traders make is setting a big, general goal. Say, for example, a trader decides: “I want to make $5000 this week”. This goal is highly unrealistic. Why? The goal is general in nature, involves no logical steps, and involves no solid plans for achievement.
To improve self-efficacy, goals must involve small, immediate and achievable steps. Such goals should involve day-to-day trading, not expansive, idealistic dreams. An example of a productive goal would be to follow one’s trading plan to the tee for the coming week – no matter what the temptation to stray. Note that this goal has nothing to do with making money, simply following one’s trading plan. A trader who is confident in their plan knows that by following it consistently, this will in turn produce the desired monetary results.
The reasons why smaller goals are helpful are not only because they are achievable, but because they are most likely to generate feedback and the opportunity to review that information. This information spread over a number of achieved goals allows the trader to learn, which is important in making successful future trades.
A lot of traders are able to set goals, but they forget how important it is to structure their work involving these goals (trading plan). Self-efficacy involves self-improvement, so in order to keep your efficacy level high you must be determined to research, be open to new ideas, but at the same time keep your eye on the goal at hand.
Keeping your self-efficacy on track
Renowned psychologist Dr. Albert Bandura noted that there are a few sources of self-efficacy, with the most important being “mastery experience”. Research shows that those who believe they can perform well are more likely to view difficult tasks as a positive challenge rather than a trial. Now, this may sound a bit trite – but it is important to believe in your own ability and remain positive to achieve positive results.
Self-efficacy, and the confidence which inevitably helps achieve it, comes from having seeing a correctly executed plan produce the desired results. Nothing gives us more confidence in a plan than seeing it work over and over again in all market conditions. When faced with what might seem to most as a tough trading decision, the confident trader is comforted by the notion that if the plan works, why would one ever have the desire to stray from it?
The great problem for all-too-many traders is that they don’t have a proven profitable trading plan in the first place. This causes them to fall prey to self-doubt and emotion and therefore achieve inferior results.
As long as you stick to improving your self-efficacy and believe in your trading plan, you can avoid setting yourself up to fail. Initiate plans, and keep your trading goals small, specific and achievable.