Don't Rationalize Mistakes If You Want to Improve
Rationalizing Mistakes Is a Huge Hindrance to Progress
You see a perfect trade setup, but for a moment you hesitate and miss the opportunity. You tell yourself "Getting in late is better than never!" and so you jump into the trade, late. By jumping in late your risk may be bigger or different than what it would have been had you taken the original (valid) trade signal. If your risk is out of whack your position size may be too, and your target may not appropriately compensate for the risk.
A rash decision was made on impulse, in the moment. It started with a rationalization which made it seem okay to not follow your plan, and instead do something random. Rationalization comes in many forms. Here are some of the ways it tricks you into not following your strategy, which in turn leads to inconsistent performance.
Your Success Is Your Ability to Follow a Proven Method
Great traders are simply excellent system followers. Consistently profitable traders have found an edge and they exploit it repeatably. Not by doing random things, but by following a method they have practiced hundreds if not thousands of times in all sorts of market conditions. They follow their system no matter what pops into their head telling them to do otherwise.
One main rationalization traders make is that they don't need a system because they are great traders. They believe they can make money acting on impulse, on their wits, instead of following a proven plan. This may work for a time, but these traders don't last.
Only takes trades you have practiced hundreds of times getting into and out of. Don't take a trade because you tell yourself "I'm good, I can make some money here." You have no plan for how to handle this trade, and no data that indicates what you are about to do has a statistical edge.
Rationalizing to Trade More or Less
We just discussed not trading outside of your tested and practiced trading method. Market conditions will often make you want to deviate from this rule though. Assume it is a very active day, with lots of price movement and volume. Within a few minutes of trading, you've already taken several valid trades. This is more than normal, but the market is producing the signals (see How Often a Day Trader Should Trade).
You start to get into your own head and think "This could be a life changing day!" Depending on how you react to that statement you may take fewer trades going forward than you should because you are afraid of blowing it, or you take more trades attempting to make more money than the market (combined with your system) is allowing. Your focus has moved from trading to something else. You are no longer focused on just finding valid setups, now you are rationalizing taking more or less trades than you should. Your greed and/or fear is going to start shaping your trading decisions, instead of your system.
A boring day can also lead you to take a trade, when there isn't a valid one, simply out of boredom. You may tell yourself "I gotta make something!" and before you know it you're in a random trade, gambling to make a profit.
Keep focused on finding valid trades while trading. Let the market conditions and your trading system determine when you trade, not your greed, fear or rationalizations.
Rationalizing to Stay in a Trade or Get Out
Every trading strategy must have an exit point. If you don't know how to get out of your trades you have missed the most important step in creating a winning strategy. The exit is where profits and losses are taken, so when you take a trade you should know exactly how you will get out. Once this is established you may still fall into traps.
In a losing trade, traders will often come up with rationalizations for staying in it. You may tell yourself "I probably should have used have a larger stop loss based on the conditions" and so you feel justified in expanding your stop loss and taking on more risk. Or you may find some piece of evidence to warrant staying in the trade: "That indicator is at an extreme level so the price will likely move the other way soon." The problem is that you are changing your strategy mid-way through the trade. Why have a strategy at all if you can change it at will? If the strategy says to get out, get out, no matter what reasons to the contrary pop into your head.
Most new traders also have a problem with staying in winning trades. They feel compelled to take a profit as soon as it materializes and the mind is more than happy to come up with a rationalization for doing so. "Can't go broke taking profits" or "Conditions are tough so I best take what I can get." And just like that you are out of the trade with a tiny profit. That tiny profit will do nothing to cover any losses which will inevitably come along. You can go broke taking profits when your losses are bigger.
There is no escaping it. If you want to be successful you need to follow a plan with an edge. Stick to that plan, no matter what.
Dealing With Rationalizations
There is no easy way to overcome rationalizations. Rationalizations will try to sabotage you constantly while you are trading. The only way to handle them is to ignore them and focus on your plan. They won't go away though, they often just become more covert. Your primary defense is to practice following your plan, and executing it perfectly in spite of rationalizations to the contrary.
You may also find it helpful to write down all rationalizations that occur while trading. Go through the list and mentally rehearse what you will do when thoughts like that pop into your head. In this way, you are prepared, and rationalizations will have little power in swaying you away from your trading system and more consistent profits.