12 Trading Psychology Lessons From “Art of War”
What Is Sun Tzu’s The Art of War?
The Art of War is a literary and philosophical classic for good reason.
It contains many gems of wisdom for all walks of life – from ancient soldiers to modern-day traders.
In today’s article I want to address my personal favorite quotes from Sun Tzu’s The Art of War – and I want to draw your attention to the parallels between the wisdom of war and the wisdom of trading.
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Human beings are combative creatures. We are militaristic in nature, and always have been. Strangely, not a single one of us disagrees that war is horrific and terrible.
Yet when our most sacred values or beliefs are challenged to enough of an extent, most people not only accept war, but cry for it.
Luckily for me I’m a better trader than I am a philosopher, so I won’t go into much detail about what I personally think about this. All I know for certain is that it’s a fact of human existence and smarter people than me have tried to make sense of it and failed.
But like a phoenix from the ashes, in that horror of war often emerges a crystallized form of intense human wisdom. When human beings are pushed to their mortal boundaries, they often have epiphanies that ordinary life experiences typically fail to conjure.
Sun Tzu’s Art of War is a literary masterpiece that captures the essence of this phenomenon.
It is essentially a manual for classical war commanders and soldiers on how to conduct themselves both on and off the battlefield in order to optimize their chances of consistent victory in warfare.
I don’t think I need to go to great lengths to inspire your imagination to see the parallels between warfare and trading. Of course you can’t compare them literally, but as you will soon see, figuratively and allegorically, they share a lot of the same connotations.
Trading Lessons From Art of War
“If you know the enemy, and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.”Sun Tzu
This is my favorite quote from Sun Tzu. It holds wisdom that can be applied to all walks of life, not just combat and warfare.
I like to substitute the word “enemy” with “markets” when reading The Art of War. So I read this quote as saying:
If you know the markets, and you know yourself, you need not fear the result of a hundred trades.
But if you don’t know the markets, then it doesn’t matter how good your trading psychology is. You can’t have an edge if you don’t know the markets, and if you have no edge, then knowing yourself is not going to help your trading results.
Therefore it is important to have a firm grasp on both yourself and the markets if you wish to achieve greatness as a trader.
“The art of war teaches us to rely not on the likelihood of the enemy’s not coming, but on our own readiness to receive him. Not on the chance of his not attacking, but rather on the fact that we have made our position unassailable.”Sun Tzu
This refers to the importance of preparation.
If you are properly prepared in advance for any potential risks or danger, then the probability of that risk or danger having a catastrophic effect on you is significantly diminished.
For example, we never know when a losing trade is going to occur. Therefore, in light of that known and accepted risk, we should prepare in advance to mitigate the damage of that inevitable threat.
The way we do this is by employing stop-losses. As consistently profitable traders, we use stop-losses – always – under all circumstances. Even our biggest winning trades should have started out with a protective stop-loss.
By preparing our defenses in advance of the threat, we essentially neutralize the threat, and then we can act offensively. When we cap the damage of our failures, then by correlation, we uncap our potential for victory.
Or in other words – we take small losses when necessary and let our winners run to make up for them, and that’s how we remain victorious over the markets in the long run.
“Whoever is first in the field and awaits the coming of the enemy will be fresh for the fight. Whoever is second in the field and has to hasten to battle will arrive exhausted.”Sun Tzu
This quote refers to preparedness as well, but also focus.
The wisdom of this advice is obvious on a battlefield. If the enemy wakes up before you do, mobilizes before you do, and is prepared for battle long before you are, then it is expected that they might have a significant mental and tactical advantage in combat.
As traders, this can be compared to our morning process. All traders, no matter what timeframe they trade, ought to have a morning routine in which they spend some time analyzing the markets and how they have changed since the previous day.
Unless you trade a weekly-chart strategy, then you should be performing top-down analysis on your Daily chart each and every single day across all of the instruments you plan to trade – at least once. And the earlier you can do that during your trading day, the better. Personally I prefer to do it after breakfast, when I have a fresh burst of mental energy and clarity.
Everyone has a different schedule, and the beauty of trading is that you can typically pick your own working hours, so it will be different for everyone. But whatever you do, and whatever time you decide to do it – ensure that you make your top-down analysis process a routine part of your day before you begin trading.
Make sure you’re first on the field and fresh for the fight.
“In war, the victorious strategist only seeks battle after the victory has been won. Whereas he who is destined to defeat first fights, then afterwards looks for victory.”Sun Tzu
Impulsive decisions fare no better in a war zone than they do in your trading account. The war strategist who doesn’t plan his fights before he engages the enemy puts himself in a very disadvantageous position.
Likewise, the trader who doesn’t plan their trade before they enter their market orders puts themselves in a very disadvantageous position.
I know I’m not the only one who can relate to this mistake. There were many times in my early trading days where I found myself involved in a losing position, making stressful decisions to manage my way out of some mess I’d gotten into, without even remembering why I’d ever gotten into the trade in the first place.
I don’t recall this ever working out well for me.
But ever since I began trading a rules-based strategy with a strict plan for how to attack the markets, my trading results have made a 180-degree turn and I’ve gone from a terrible trader who consistently blew accounts to a consistently profitable trader who now breaks-even at worst.
So plan your trade, trade your plan, and you’re starting out in the correct winner’s mindset. Only good things can come of that kind of consistency over time as you improve and adapt.
Trade your edge. Not your fears or expectations.
“He will win who, prepared himself, waits to take the enemy unprepared.”Sun Tzu
This one isn’t advice so much as it is an objective observation of reality.
The trader who does their homework and puts in the time to know themselves and their strategy intimately will always have a lethal advantage over the trader who slacks off, doesn’t care to develop self-awareness or self-discipline, and doesn’t act consistently.
When you win a trade, the profit either came from another consistently profitable trader who took a small loss on his strategy and lives to fight another day – or it came from an unprofitable trader who doesn’t have an edge and doesn’t stand a chance until he puts in the same work you did to develop one.
So have no mercy with your trading. You deserve the money that your trading process generates! You earn it through a fair fight with other traders. And the traders who are prepared never lose; they just take minor setbacks.
The traders who are unprepared always lose, and if they don’t make the effort to get their act together quickly, then the market eventually spits them out – broke and discouraged.
It’s rough, but none of us are exempt from this harsh reality. So in the end, it makes it a fair playing field, and those who put in the work will always get ahead of those who don’t.
“What the ancients called a clever fighter is one who not only wins, but excels in winning with ease. Hence his victories bring him neither reputation for wisdom, nor credit for courage. He wins his battles by making no mistakes.”Sun Tzu
I love this quote. It is one of my favorite excerpts from The Art of War.
What we would call an elite trader is one who not only wins, but excels in winning with ease. Think someone like Paul Tudor Jones, Peter Brandt, Steve Burns, Buzzy Schwartz, or even Warren Buffet. These types of market heroes make winning look a lot easier than it is. How is that?
It’s because they win gracefully. They are humble in the face of the markets, but confident in their process. They know their limitations and they know their strengths, and they’ve found a way to exploit their strengths while minimizing their weaknesses on a consistent basis.
When you have both an extremely effective trading process and an extreme level of confidence in it, then the money comes easy. Of course you have to have both, and both are hard to come by. But once you have them, the winning is a natural side-effect of the efficacy of your trading process, and the achievements you make as a trader are a natural side-effect of your unwavering faith in what you’re doing.
I’ve experienced this feeling in my own trading at times, and it’s what I believe Mark Douglas would refer to as “trading in the zone“. When my trading is going extremely well, I can’t help but feel like taking total credit – but it would be misleading.
The truth is, all I did was follow my plan. Sure, I came up with the plan – but to think that I had any part to play in the trade winning is a dangerous act of hubris. I give myself no credit for that individual victory, but I do give myself credit for having the discipline to stick to my plan and making no mistakes.
And that is why I also cannot give myself credit for courage. Because before I placed those winning trades, there was never any fear of them losing. I never had to exercise any courage. All I did was have faith in my strategy, which I got from backtesting it over historical data for thousands of trades, and the strategy did what I expected it to do – it won some trades.
It loses some, too, and when the losing starts then I typically lose that feeling of “trading in the zone”. But it comes and goes, ebbs and flows, like all things in life – and so long as I continue to make no mistakes, then success will come in due course.
“The consummate leader cultivates the moral law, and strictly adheres to method and discipline. Thus it is in his power to control success.”Sun Tzu
This piece of advice is actually deeply personal and has nothing to do with “the enemy”, or in our case, the markets.
What Sun Tzu means here is that if you take the time and put in the effort to orient yourself properly in the world – physically, intellectually and spiritually – according to your own moral law or highest values, then you have infinitely greater control over your life.
When you have established an inner foundation of mental fortitude and a positive mental attitude towards life and challenge (they’re the same thing), then life stops happening to you and you begin to create your life deliberately.
With proper self-awareness, proper orientation towards your own highest good, and proper discipline and consistent effort at acting out your beliefs (instead of just thinking them like most of us do), you stack the odds of success dramatically in your favor no matter what it is you’re trying to achieve.
For traders who are seeking to become financially independent through trading, this boils down to thoroughly thinking through what it is you specifically want to achieve from your trading, and then being honest with yourself about what you need to change in order to realize that necessary reality.
That’s half the battle – the remaining half is doing what needs to be done to make those changes, which is why method and discipline are also important to success in trading.
“The clever combatant imposes his will on the enemy, but does not allow the enemy’s will to be imposed on him.”Sun Tzu
This is an easy one to relate to trading.
Most of us have felt like the market has imposed its will on us at one point or another in our trading careers. In fact, it’s common to feel this way. And it’s a normal feeling to have as a trader, especially during a nasty losing streak.
But the best traders, the “clever combatants”, they don’t feel this way. They are completely open-minded about the markets and open to all possibilities both positive and negative, and they prepare for both without emotional attachment one way or the other.
They don’t judge the market’s behaviors as subjective or personal – all they see is repetitive objective patterns and opportunities to act on them. They impose their will on the markets; not the other way around.
When an elite trader has a strong edge in the markets then their experience of the markets shifts from feeling like the market is often against them, to feeling like they are in synchronicity with each other. An elite trader doesn’t feel any animosity towards their charts or even their P&L.
All they focus on is the next trade – and making no mistakes.
“To refrain from intercepting an enemy whose banners are in perfect order, to refrain from attacking an army drawn up in calm and confident array – this is the art of studying circumstances.”Sun Tzu
This is a fair warning about fighting against the underlying conditions.
You don’t get far sailing your boat against the wind. Likewise, you don’t get far by being stubborn and acting before the time is right to act.
And so it is with trading. There are many sayings that capture this sentiment – such as the trend is your friend (until it ends), don’t try to catch a falling knife, losers average losers, etc.
These catchy sayings allude to an underlying meta truth, which is that trying to trade against what the market is more likely to do is suicidal. For example, if a market is obviously trending, don’t try to trade against it! If a market is consolidating, don’t try to capture trend-continuation swings!
It seems obvious in writing, but it takes many traders a long time to learn this in practice.
To know what the underlying trend is, to know the current context of the markets and the optimal way to act on them – or when to stand aside – this is the art of studying market conditions as a trader.
“He will win who knows how to handle both superior and inferior forces.”Sun Tzu
The soldier who underestimates his opponent risks being taken advantage of, and the soldier who overestimates his opponent puts himself in a state of lacking confidence.
Likewise, the trader who overestimates their abilities risks blowing up, while the trader who underestimates their abilities will lack assertiveness and focus.
You need a balance between method and confidence. If your methods don’t work, then any degree of confidence is futile. If your methods work well, yet you are overconfident in them, then you will experience unsatisfying results which will lead to poor decisions. And if you are under-confident in your trading methods, then you will lack the discipline to execute properly which will also lead to poor decisions.
It’s important to know your strategy intimately – and then have faith in yourself and your ability to know when to use it and when to stand aside. Good trading psychology is comprised of a healthy balance of these two aspects.
“The experienced soldier, once in motion, is never bewildered. Once he has broken camp, he is never at a loss.”Sun Tzu
Any soldier who gets bewildered on the battlefield when it matters the most doesn’t last very long.
And that’s true in trading, too.
It’s normal to be bewildered when you first begin trading. But by the time you are putting any significant amount of money at risk, you should know what you’re doing and you should be confident in your process.
That doesn’t mean there won’t be times when you feel challenged or overwhelmed. But those moments should be few and far between, and you should have a predetermined plan for dealing with them when they arise.
Experienced traders have a finger on the markets and their process at all times. They don’t necessarily stare at charts and P&L all day, but they are always aware of everything that’s relevant for them to do what they need to do.
Whether that be through a consistent routine (ie. performing top-down analysis and checking for trading opportunities at the same times each day) or automation (ie. broker alerts, customized scripts, etc).
Make sure you have processes in place for your trading that ensure you never feel bewildered or at a loss once your money is at risk. All factors that could stress you out or confuse you ought to be considered long before you place the trade.
“If it is to your advantage, make a forward move. If not, stay where you are.”Sun Tzu
This final quote is integral to our success as traders.
The soldier or army who moves unnecessarily when they have a known disadvantage in doing so puts themselves at increased risk of demise, which is obviously a stupid thing to do.
Likewise, the trader who acts on the market when they know it is not to their advantage to do so sets themselves up for a world of unnecessary pain, which is also a pretty stupid thing to do.
Any time you make a trading decision that is not based out of a process that objectively increases your odds of success (ie. an edge), you are essentially gambling your money away like in any other form of betting game.
This is the main difference between gambling and trading, and something most novice traders and outsiders have a difficult time understanding. At the casino, the player who bets is always at a disadvantage no matter what they do. So we call it gambling.
But in the markets, traders not only get to choose when they play based on when the odds are most in their favor, but they also get to choose how much to bet with no table rules designed to limit their profit potential, unlike a casino.
Of course, how accurately they determine when the odds are in their favor has a large role to play in a trader’s success.
But it’s an almost opposite dynamic. In the case of gambling, the casino has the edge, so it is in the casino’s best interest to keep playing the game, and in the players’ worst interests to keep betting. The longer they play, the more likely they are to lose.
On the other hand, when a trader has the edge, it is in their best interest to keep executing their edge over the long term for a guaranteed positive expectancy – just like a casino does! The longer they play, the more likely they are to win.
So we call it speculation, not gambling – and there’s a distinct difference that only consistently profitable traders understand.
I hope you found this analysis of The Art of War interesting and relevant to your own trading. I believe it’s important to look for trading wisdom in all areas of life because sometimes we learn certain things better from example than from experience.
There is no substitute for experience, but there is also no substitute for the value that can be found in having an open mind and drawing parallels between ideas when reading books, or watching movies, or even watching sport. There’s no limit to the amount of profound trading analogies you can find from other performance-based disciplines if you look for them.
Trading is an art as much as it is a science, and you can learn how to become a better trader from anything that can help you to become a better person. As far as I’m concerned, they are one and the same.
Anything that makes you a better person will make you a better trader, and most things that make you a better trader will make you a better person.
Good luck with your trading journey, and I look forward to continuing this dialogue next time!