The mental approach

Reading time: 17-23 minutes (4.421 words)

 Key Concepts in this chapter:

  • Investing and trading is all about making a plan and sticking to this plan.
  • The fear of missing out is a prime example of people getting caught by their emotions.
  • If you already know that 90% of all people lose money on the stock market in the long term, you should do the exact opposite of what 90% of the people are doing.
  • Don’t be greedy.
  • It is impossible to time the market.
  • It's almost impossible to beat the market.
  • Diversify your portfolio.
  • Don’t forget you have to pay taxes and other fees.
  • Always do your own research.
  • Automate your investments or trading to rule out your emotions.

Trading and investing is all about making a plan and sticking to this plan. You don’t have to be smart to become a successful trader or investor. But you have to make a very important change in your mindset. You need to emotionally detach yourself from the money you invest. This seems almost impossible when looking at the way we live. Because money controls our lives basically from the moment we are born till the moment we die.

Quest: Emotional detachment
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You have to emotionally detach yourself from your investment or trading money because:

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You have to emotionally detach yourself from your investment money because:

  • You can’t stick to your plan when you need the money for other things
  • You will make wrong decisions when you are emotionally attached
  • You will always lose a trade at some point. More often than not. You need to accept this without regret. 

For example, if you want to invest in the stock market, your money's gone for the next ten years. You can't take this money out or use it. That’s the mindset you need to have. You need to make that decision before you start investing. If you need to take money out you can never stick to your plan. And if you don’t follow your plan, you are an emotional investor. It’s no secret that almost no one makes money in the stock market in the long term. 

That’s why the “pay yourself first” principle is very important. If you have money for emergencies then you never need to touch your investing account. So you basically are guarding your treasure (your stock account) from losses by insuring yourself you have money for emergencies. Meaning, you don’t need to pull out money or (even worse) sell your position if you get into financial trouble.

Not everyone can become a successful trader. If you can’t emotionally detach yourself from money then trading/investing is not for you. Because someday you will encounter that one moment where you are getting emotional and click the wrong button. But there is no way back. You have to become that robot that has no emotions and can blindly rely on his plan. Many people are scared of losing money. Others are overconfident. Millions of people have lost money because they were emotionally attached to their trade. You can't enter the stock or crypto market and expect to get a profitable investment without a plan and sticking to it. You should be mentally prepared before you step into any investing strategy, industry or product. It is inevitable that you will lose money at some point. But that is not a bad thing at all. Trading and investing is all about mastering your emotional reaction to a winning or losing trade or unexpected movements in the market.  

The following examples will prepare you for what emotions you might encounter and how you can react to them. 

8.1 The fear of missing out

FOMO is a very interesting subject. The fear of missing out is a prime example of people getting caught by their emotions. Most of the time resulting in bad decisions. The fear of missing out is always related to the sentiment of the market. You can basically have three types of markets:

  • Bear markets (when the market goes down for a period of time)
  • Bull markets (when the market goes up for a period of time)
  • Sideway markets (when the market is moving in neither a bear or bull market)

FOMO is always related to a bear or bull market (or sudden price spikes). The fear of missing out kicks in when people miss the first part of the bull run and fear to miss out on the profits the bull run might give. An example we used before:

FOMO bitcoin chart

Bitcoin chart, timeframe in days starting 15 sept. 2017 till 27 march 2018. Source: Tradingview

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What does a standard candlestick represent on a daily chart?

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In 2017, bitcoin wasn’t that mainstream yet. Most people had no clue what bitcoin was and what you could do with it. But the price for one bitcoin was rising hard in a few weeks, news sites started to pick it up once again. People started to notice. These are people that had no clue how to invest or make the right trading decisions. These people started to flood the market, driving up the price even further. Let’s assume someone missed all the news or was hesitant to buy bitcoin because they had no clue how bitcoin or trading works. But after many news messages about reaching all time highs (the highest trading price the asset has ever reached) one starts to think:

  • “This thing is going up like crazy, I need to get in!”
  • “This thing has been going up for weeks now. I want in!”
  • “I don’t want to miss this, everyone is making money except me!”

Now imagine you buy bitcoin at the mark of the arrow. At that point in time, you will only see the following chart:

FOMO bitcoin chart

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Would it be a wise idea to buy in at the all time high?

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You don’t know what will happen the next week. Actually, nobody knows. But you can clearly see that the strong bull run has already going strong for many weeks (each candle represents one day of trading). People who are getting in late having a bigger chance of buying in at the wrong moments and have a higher chance of losing all their money. Because one who has the fear of missing out also has the fear of losing money and will probably sell their positions at the wrong time.

If you take a few steps back and you know you have absolutely no clue about trading or even the industry you are trading in, would it be a wise idea to buy in at the all time high? Most people not familiar with trading would say:

Penke

“Yea, this thing has been going up for weeks now! It will go up even more, I'm 100% sure about it!” 

The reality is, buying in at an all time high is never a smart move without a plan. You need to have a plan to minimize your risks. You need to know at the fundamental level why prices are going up. Buying in at an all time high in a bull market of an industry you don’t know might be a very bad idea. But people don’t care because they only see this thing going up for weeks and fear they will miss out on future profits. They only care about making money. What most people did:

  • Novice traders started to notice the rising price of bitcoin because it became a hot news topic (FOMO)
  • People that had zero experience with trading were buying bitcoin with their savings (putting way to much money in something they don't know)
  • These people did not have a plan at all. They just poured in their money. Because this can only go up, right?

Not soon after, the whales started to sell.

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What are whales in the context of trading or investing?

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Although it's not 100% sure, the bitcoin pump in 2017 was actually caused by just one person owning a lot of bitcoins according to some articles found on the internet. So always try to find the reason why something is skyrocketing. Just like the stock from Gamestop got short squeezed in 2020 but there was no fundamental reason for this. In crypto you might get stuck in pump and dump schemes.

Quest: Pump and dump
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What are pump & dump schemes?

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Groups of people buying up coins to raise the price so other people think "This thing is going up, I need to get in!" (FOMO). Once enough people joined, the pump group sells all their coins leaving the FOMO people with worthless coins they bought at way to high prices.

Maybe you remember your uncle, brother in law or neighbour talking about bitcoin while they never had any experience with trading . This should be (and from now on, you will know) a very alarming signal. Basically, when one of your family members starts rambling about buying stocks or bitcoin while you know they have no clue what they are doing you should be thinking:

Penke

“Ok, I need to get out of this right now!”

Fear of missing out also works the other way around. When you are in a trade and things start to go south, most people fear losing more so they will abandon their positions. They buy in at the wrong time but also sell at the wrong time resulting in heavy losses. You should never buy or sell something without a decent investment plan. 

Mental tips:

  • Don’t fear missing out. The stock and crypto market will be here for probably hundreds of years. There will be so many opportunities. Detach yourself from missed opportunities. Go on and find the next one.
  • When people start to talk about stocks or crypto while they have no clue what they are talking about you should be cautious. 
  • Never invest in an industry or asset you know nothing about
  • Don’t immediately react to markets that are rising quickly. If you are stepping in a rising market you might already be too late for the party. And if you do, make a proper plan and determine where you set your stop loss.

8.2 What's everyone else doing?

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In general, would it be better to do what most people are doing or the exact opposite when trading or investing?

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Trading psychology works exactly the opposite of what you might think most of the time. And that is very easy to explain:

Penke

If you already know that 90% of all people lose money on the stock market in the long term, you should do the exact opposite of what 90% of the people are doing!

  • If prices go up and everyone is buying you could start considering selling
  • If prices go down and everyone is selling you could start considering buying

If you see patterns where the masses are buying or selling, you should take some time and try to find news and fundamentals about why people are buying or selling. Recently, in 2021 Elon Musk announced that Tesla bought 1.5 billion worth of bitcoin in the last few months. And, Tesla accepted bitcoin as a payment. You can imagine what happened with the price when you read this in the news:

Since the announcement of Tesla buying and accepting Bitcoin, it has been huge news. Everybody jumped in. Should you jump in? That totally depends on when you have read the news. If you heard about it a few weeks later and start to fear missing out, you should definitely not jump in blind. But the news is quite big, should you jump in if you did not read the news in time? Yes, you can. But stepping in late requires you to minimize your risks by using a plan/strategy. The risk of losing money when stepping in late becomes bigger and bigger the later you step in.

Hardly a few months later, Tesla announced it sold some BTC (taking profits) and does not accept Bitcoin as payment anymore. The market plummeted. If you did step in near or at the all time high of $65k you are now looking at very big losses. The market plummeted from $65k to around $30k. If you did not expect this and took no precautions you are stuck in a bad trade. Especially if you have put all your money in this one trade. But now let's presume you did not read any news about Tesla and are just looking at the chart. It looks like everyone is jumping on board. It's easy to become emotionally attached by thinking that everyone is jumping in but you are still waiting. 

Exactly the same thing happened in 2020. A global pandemic (Covid-19) was the cause of a very big drop in stock and crypto markets. For example, VWRL (vanguard, all world ETF) dropped from €90 to €64 in a matter of days/weeks:

VWRL Covid-19 dip

Vanguard all World ETF in Euro, source: Google.com

People (the news) were panicking about Covid-19. A perfect moment for an investor to look at the fundamentals. Many people started selling and caused a huge dip. But now suddenly you could buy this ETF for €64 instead of €90. That seems like a bargain. Just a few months later the price went even higher like nothing happened. Imagine you just bought this ETF at €80, prices started to plummet to low €70 and you decided to get out. You did not only lose money, you also missed the opportunity of buying in even cheaper. That's why you should always do you own research, be patient and never follow other people. Most people panic because they have no clue what they are doing so they sell when things go south. Don't be emotionally attached to charts. In big events like the internet bubble (2000), financial crisis (2008) and the Covid pandemic (2020) you would have made more money if you just bought some more when everyone was selling.

There is no single chart that only goes up or down. But in the history of the total stock market, prices always ended up higher than before. That is no guarantee for the future but it does give you some fundamentals to work with. And most of the time, the masses have it wrong. 

Mental tips:

  • If you were trading/investing in 2000 (internet bubble), 2008 (financial crisis) and 2021 (Covid pandemic) and lost money you are panic selling based on emotions 
  • Never blindly follow the masses, they are probably wrong
  • Do your own research and find out why something is moving up or down

8.3 Piece of the pie

Most traders want the whole pie for themselves. They are overconfident and are almost 100% sure what will happen next. The fact is, no one will know what will happen in the future. 

You can certainly try to predict as most traders do but you will always fail. Rather than taking the whole pie, it’s much better to take a piece of the pie. Meaning, taking profits even though the asset might reach even higher prices. Basically every trader wants to buy at the absolute bottom and sell at the top. This is impossible. Don’t get overconfident when you are in a winning trade. Take your profits. And don’t get emotional when you are in a losing trade. Get out before things get out of hand. Don’t be greedy. But taking profits can be hard if you are not trading with a plan. Because how do you know where and when to take profits? We will discuss some strategies later on.

Whatever you do, cut off your “what if” thoughts as soon as possible. Don’t get stuck in the past. It’s very easy to look at a chart in the past. 

Penke

"Why did I sell my bitcoins at that time, I would now have millions…"

It’s a very logical way of thinking. But it only makes sense because you can look into the past and already know what will happen. If you could predict the future, you would be rich. But no one can predict the future. You’ll never know where the chart will end up a few weeks from now. You have to make your decisions based on the knowledge you have right now. For example:

If you bought bitcoin in 2012 for $8, would you sell it for $1000 in 2013? Ofcourse! But would you sell for $1000 if you knew bitcoin would be worth $60.000 in 2021? Of course not! You would even buy more. But this way of thinking makes no sense at all. Just take your piece of the pie.

8.4 Is it possible to time the market?

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Can you time the market?

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Many traders are waiting for that perfect moment to buy. The fact is, the right moment will never come. Because you don’t know when the market will hit the top or the bottom. Let’s have a look at the following example:

VWRL dip

Vanguard all World ETF in Euro, source: Google.com

It’s very easy to determine that in this case, you should buy at the lowest dip in 2020 (the black arrow). The only reason for this is because you can see what will happen next. If you were looking at the same graph in 2020 you would see this:

VWRL dip 2020

What would you do at that moment? Most traders would think:

  • “This thing is going down fast, I’m not buying this”
  • “I don’t think it’s at the bottom yet, I’ll wait a bit more”
  • "Everyone is selling so I'm not buying..."

Imagine you bought this ETF just a few months earlier:

What would you do? You bought it for around €80 but now it dropped to €64, that's quite a big loss! People start to panic:

  • “It’s already dropped to €64… I need to sell and take my losses”
  • “It might go down even further, I'm going to sell!”

If you look at this graph, what do you see if you take a mental approach? You were willing to buy this ETF a few months ago for €80 and now you want to sell it for €64? Does that make any sense? If you are willing to buy this ETF for €80, you certainly want to buy this ETF for €64 right?

Many traders are making the mistake of thinking when things go down that everything goes to hell. Don’t confuse the global stock market with single stocks of companies. Although the global stock market only goes up if you zoom out, companies can rise and fall. The global market is just the average of all companies and stocks combined. That does not mean companies can’t go bankrupt and stocks can become useless. 

8.5 It's almost impossible to beat the market

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What does beating the market means?

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"The market" represents a global market or industry. For example, the S&P 500 can be considered as “The Market”. Beating the market means that you make more profits by not following the S&P 500 index but building your own portfolio of stocks from different markets and industries. The S&P 500 had a return of around 16% in 2020. If you had bought an ETF that simply followed the S&P 500 and invested €100 you now have €116 (minus fee’s). In this case, the market had a return of 16%. If your handpicked stocks and other securities made a return of 20% in 2020 you would have defeated the market by 4%.

Most traders can’t keep their emotions under control and make bad trading decisions. You can potentially beat the market. But the only way to achieve this is to do a lot of research and know exactly what you're doing. For 99% of all investors, this is impossible. People have no time (or don’t want to spend that much time) figuring out what stocks they want to buy. And even if you do have the time, 99% will fail to beat the market. They will not only fail, but also make less profits. And the sole reason for this is emotional attachment. Since most investors are emotional, they will buy and sell stocks too many times ending up with less profits. Even the best traders in the world are still emotionally attached at some point. 

This also works the other way around. Everyone that tries to beat the market not only makes less profits but also loses more when a bear market hits. Only if you want to spend hundreds or even thousands of hours understanding technicals, indicators, reading markets, creating trading scripts and fully understanding industries can you beat the market. But as you can imagine, this will take much determination, time and will cost you money in the short term because you will make mistakes.

Actually, Warren Buffet (the world's most succesful investor of all time) dared the smartest people in the investing industry betting 1 million dollars that a passive investment (like an low cost S&P 500 ETF) would outperform any handpicked stock portfolio managed by Hedge Funds over a 10 year period. Ted Seides, CEO of a very big Hedge Fund, accepted the challenge. At the end of the bet, ending in 2017, Warren Buffet’s ETF gained 7.1% annually and the handpicked portfolio of Ted only gained 2.2%.

The biggest message here is that you should not expect bigger than average gains in the stock market. That's not what most people want to hear so they either try it anyway or try their luck in much riskier and volatile markets like crypto. 

8.6 Not diversifying

Diversifying simply means dividing your risk between different assets. If you put all your money in one stock and this stock goes down or becomes worthless you lose all your money. The best thing would be a healthy balance between stocks, crypto and cash. And if you look in detail there should be a balance in passive and aggressive stocks/crypto based on your age and your goal.

8.7 Don't forget you have to pay taxes, fees and inflation

An emotional trader will mostly look at their profits and losses but forget they also have to pay taxes and trading fees. That’s why it’s very important to first get familiar with your own finances as mentioned in “The basic principles of money management”. Most people have no clue where they spend their hard earned money and end up with an empty bank account each month wondering where the money went... 

As a trader, you will encounter additional costs. If you want to buy stocks you might have to pay a fee each time you make a transaction. When you buy an ETF, you have to pay a management fee. If you are making profits you need to pay taxes. Don’t calculate yourself rich by just looking at your profits. You will always start with a loss when you are buying your first stock. Brokers cost you money. If you hire someone to handle your account you also have to pay them. It's crucial to find the best broker / exchange that offers the lowest amount of costs. 

You don't really have to pay inflation. But inflation gives your hard earned cash less value. $10.000 now might be $7000 in ten years. This process never stops. Money is always inflated in the long term. There is an endless money pit created by the FED and central banks. Money can be "printed" indefinitely. The more money there is in the system, the less value it will receive. For example:

If you start trading with $10.000 and make $1000 profits in one year you did not actually make $1000 in profits because in a year from now you can buy less with $1000 versus today. You have to adjust your profits with inflation. Although in some cases there is no inflation or even deflation. If you look at the inflation rate of the US in the last 25 years, you quickly notice that inflation is very likely. 

8.8 Always do your own research

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What would be the best thing to ask anyone who is advising you to buy stocks or other assets?

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A common mistake among traders is listening to other “experts”. Don’t even trust anything you’ll find on this website. How do you know this is the truth? In trading, you should always listen but verify. Listening to other “experts” can be a good idea but you can't blindly follow anyone's advice unless you want to lose money. If someone else is telling you to buy a certain stock you should never buy it. Even someone from the bank who is managing your portfolio can give bad advice. And they mostly do. Because they simply have thousands of customers and they probably give the exact same advice to other clients. There is a simple rule to check if the people who are telling you to buy something are legit. Just ask them the following question:

Penke

“Did you buy this asset and for what price?”

You can eliminate 100% of false advice with this simple question. If the person who is investing in the same asset and telling you to do the same bought it for a much cheaper price then you know they are tricking you to buy for self benefit. You can even ask the same question to the financial adviser of your bank telling you to buy a stock for x price. If it truly is a bargain or good moment to buy, then the adviser would definitely buy this stock for themselves on their personal account. Most of the time people advising you to buy stocks are wrong. They have other intentions. Why would someone else make you rich without benefiting from it? Does not make any sense, right?

The only thing people or banks care about is their own money. Not some stranger on the internet or a random client. They have thousands, or sometimes millions of clients. They don’t really care if you lose some money or not maximising your profits. In the end, you are the only one who really cares. 

8.9 Automate your investments

If possible, you can automate your investments. Scripts or automatic setups always run emotionlessly. As emotions are the biggest culprit when investing you should look for ways to automate your investment. Many brokers offer options to invest on a monthly basis automatically. A good strategy that can accomplish this is buying an ETF every month for the next 20-30 years. 

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What is the biggest advantage from automating your trading and investing:

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Never buy a trading script. 99% of all trading scripts or technical indicators for that matter do not work. And even if they do, it’s probably only in the short term. Markets can change. Things that worked ten years ago do not work today.

Conclusion

The best way to remember the mental approach:

  • You are not trading against others
  • You are not trading against the market
  • You are trading against yourself

Your emotions are the biggest enemy when investing or trading. Never blindly trust any information from other people. Always verify by doing your own research. You have to ask yourself the following question when you push the buy or sell button:

Penke

"Do I know exactly what I'm doing?"



Chapters: Trading and Investing Guide for Beginners

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