Mechanical Trading Systems: Pairing Trader Psychology with Technical Analysis

PSYCHOLOGICAL PROFILE OF AN INTERMEDIATE-TERM MEAN REVERSION TRADER

Iron-Willed Discipline

Gain the Discipline to Fade the Crowd To succeed as mean reversion traders, traders have to overcome many psychological obstacles: crowd psychology, media hype, and the direction of recent price action. All of these particular demons can be boiled down to one basic personality prerequisite: discipline. Without the discipline (and courage) to fade recent price action, we will forever remain paralyzed with fear, unable to initiate the trades generated by our systems.

As a particular trading opportunity disappears and the market reverts to its mean, paralysis often turns into regret and determination to act the next time that a similar opportunity arises. Of course our next opportunity is accompanied by the same media hype, and bearish or bullish news, making it almost as difficult to overcome the paralysis as our previous attempts.

Oftentimes the next phase of our maturation as a mean reversion trader results in the manifestation of a form of the perfect trader syndrome. We now have the experience to recognize that these strategies do succeed, but we still lack the courage, discipline, and maturity to take the signals generated by our systems. Instead we attempt to outthink the system by placing entry orders at a point, which (if filled) would entail lower risk and higher reward.

In reality, this fine-tuning of our system is a modified version of the same trader paralysis that prevented us ...