THE PSYCHOLOGY OF A SUCCESSFUL TRADER

Presented before a group of would-be futures traders,
Chicago, Illinois,
October 10, 1970.

Living as a pit trader day-after-day teaches one many things about the people who inhabit the pits. One learns to distinguish the good traders from the bad, the successful techniques from the unsuccessful, and the good habits from the faulty. One also learns to distinguish the lovers from the fighters, the winners from losers, the serious from the frivolous, the cerebral from the superficial, and the friend from the foe. But above all, one learns that the psychological make-up of the trader is the single most critical element of success.

"Do you think I can become a successful futures trader?"

I have been asked this question countless of times. It is a difficult question with no certain answer. Obviously, the question is not whether someone can make an occasional profitable transaction, mere chance alone will cause that to happen.  The question is whether one is likely to be consistently successful over the long term. My usual response is a bit of a hedge: "Only you and you alone are best qualified to ascertain the answer."

It would be wonderful if there were such a test to determine the issue. Alas none exists. Seemingly well-qualified people fail at trading while the least likely sometimes succeed.  Clearly, many traders make money speculating in futures--sometimes big money—yet many others are losers.  What makes the difference? Unfortunately, the only real test of trading potential is the market itself. It is extremely difficult to evaluate a prospective trader's potential until after observing his or her actions and reactions to real market situations.

What are the requirements for success in futures trading? There are at least four important requisites that come to mind that materially influence one's ultimate success as a futures trader—whether on or off the trading floor. The first three I will simply enumerate without further discussion, the fourth is cardinal and requires thorough comprehension:

(1) Approach futures trading as a business enterprise, applying orthodox business rules, judgment, and money management.  Futures trading is not a game nor a gamble toward which one can apply rules of chance or probabilities. Futures markets are governed by the fundamental rules of economics.

(2) Adopt a predetermined trading plan; a set of rules and established guidelines that are known to be valid and have withstood the test of time. If your philosophy is based on a technical approach to the market, know your rules and religiously adhere to them. If your philosophy is based on a fundamental approach to the market, know the components that will affect supply and demand and honor their dictates.

(3) Utilize only risk capital—money that, if lost, would not materially alter your standard of living.

However, while the foregoing are very important, it is the fourth requisite that divides the winners from the losers in futures trading. It concerns one's psychological make-up. The type of person you are—the way you react under pressure, your ability to make quick decisions, to think logically, the strength of your character, the emotional quotient of your personality, your philosophical approach toward money—will determine your probable chances of success or failure in trading. In futures trading, more so than perhaps in any other field of endeavor, one's psychological make-up is critical.

After you have established a position in the market, will your judgment be influenced by emotion? Will you be unbiased in your interpretations of facts and market action? Are you likely to mistake an emotional decision for a logical one? Will you be foolishly swayed by the actions of others? Conversely, will you stubbornly refuse to listen to good advice? If you find you are wrong, can you admit error in the face of defeat? Remember, ultimately you will have to openly face the truth—your broker will always know, your family and friends will eventually learn, and floor traders usually know how other traders have fared.

Will you have the strength to remain in the market at a loss when you are certain your calculations are correct? Conversely, when you know you are wrong, will you have the courage to quickly liquidate your losing position to minimize the loss? The old saw about "running away to fight some other day" is nowhere more applicable than to futures. Will your trading be dictated by cold factual interpretation of statistics, instincts, and experience, and not by ego, fear or stubbornness? Or will inertia, fear to act, or hope for a favorable turn take over?

Do you have the temperament to allow profits to pyramid when you are right, irrespective of their impressive sums? Conversely, will you know to take your profit quickly, even though the market may do better if you wait? Will you know when to do one and not the other? Will you learn from your mistakes, or are you prone to repeating them time and again? Can you take defeat after defeat without succumbing to a defeatist attitude? Will you have the patience necessary to learn the different types of markets, market situations, and how to react to each of them? Are you one who can, after a heavy loss, face the market the following day without looking back on yesterday? Or, are you more likely to brood about a previous trade and allow it to affect your next attempt.

These questions relate to personality and character. The answers to them spell the difference between a successful futures trader and a loser. But this should come as no surprise.  Isn't one's psychological make-up equally important to success or failure in most fields of endeavor?  Of course it is.  But there is a difference. 

In futures trading, your personality and emotions are stripped of the customary buffers that offer comfort and assistance in most other areas of life. Moreover, in trading, emotional problems are enormously magnified because you are dealing with money—your own money!  Here, your personality, your emotions, and your character are tested as nowhere else.  The normal tranquilizers we consciously or unconsciously lean on in other fields of endeavor are not available in this field.  Here, you cannot adjourn the meeting to think things over; you cannot temporarily turn to a different subject; you cannot postpone a decision to consult with an expert or friend; nor can you take time out to relax. The market continues on with or without you; the moment of decision cannot wait. Your emotions and your psychological make-up must not interfere with your ability to make a prudent decision the instant it must be made.

I am reminded of one of the ads written by the Chicago Mercantile Exchange's advertising agency to profile the typical trader: "Was Toulouse- Lautrec too short to trade commodities? No. Too temperamental. Lautrec was a highly-emotional man given to impulsive changes of opinion.  Such a personality is ill-suited to futures trading." Truer words were never spoken.

Thus, in answer to the original question posed, there is much to being a successful futures trader. There are many rules to be applied and many lessons to be learned. There must be a willingness and ability to learn, to comprehend fundamentals and statistics, to grasp technical applications, to develop an inner trading sense, to accept defeat and live with victory and much more. But most of all, there must be present a multitude of inborn characteristics relating to the trader's personality, psychology, emotional equilibrium, courage and patience.

Reprinted by permission. Excerpted from Melamed on the Markets, by Leo Melamed. John Wiley & Sons, 1993

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