A Trader’s Most Valuable Asset – Mental Capital

The trading journey is tough. All of us know the industry legend that says 95% of traders will fail. What most people do not know is a big majority of the 95% who fail in trading fail due to reasons that could have been prevented. If I asked you why most traders fail, what would your answer be? Perhaps you would say things like discipline, risk management, poor strategies. These are all good answers, but none of them are the right answer. The number one reason why traders fail is a severe depletion of mental capital.

Mental capital is a traders most valuable asset. Let me explain why. Most, if not all, traders lose money when they begin Forex trading. That’s how this profession works. When a new trader loses money, he has 2 options. He can keep very tight risk management in place, which will allow him to survive the learning curve with capital in his account, or he can use poor risk management, blow up his account, and then have to re-fund his account with new capital. However, you can see from this example that poor risk management is not why a trader fails and quits trading. If he wants, a trader can always work, save up, and fund a new trading account. That cycle can go on indefinitely.

The reason traders fail and quit trading is because they lose their mental capital. Mental capital is a traders confidence and psychological fortitude. This is a trader’s greatest asset. When mental capital is drained a trader will quit the journey. Nothing else will actually cause a trader to give up on trading. Thus, all traders should make the preservation and growth of mental capital a primary focus in their trading journey.

Mental capital is much like account capital—it can increase and it can decrease. When you make poor trading decisions and lose money, your mental capital will begin to decrease. Fear and lack of confidence will begin to overtake you. Now you are trying to trade from a psychological framework that is not conducive to good trading. Thus, oftentimes the cycle continues with more bad trading decisions and more losses, and mental capital decreases even more.

When you plan a trade and execute your plan and a trade makes you money, then your confidence grows. Your mental capital increases. In the beginning stages of trading your mental capital tends to increase and decrease as your account equity does. Thus, one of the greatest ways to preserve and strengthen your mental capital as a new traders is to trade very conservatively. It is wise to not risk more than .5% per trade as a new trader. This will enable a new trader to remain emotionally detached from each trade, since the amount being risked is so small.

This emotional detachment from a trade will allow a trader to trade with a clear mind and better trading decisions will result, and mental capital will increase as a result. Eventually a trader will progress to the point where his mental capital will grow uncorrelated to his account equity. Let me give you an example. When you plan out a trade and then execute the trade according to plan, and it does not work out, that is still a good trade!! As a maturing trader you will know that, and those losses will actually increase your mental capital because you will know that you are executing your plan perfectly, and this is one of the greatest keys to long-term trading success.

 
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