PINNACLE POINTERS
Risk Management and Trading Psychology: How Over-Position Sizing Leads to Trading Errors
In trading, risk management and psychology are deeply intertwined. One of the most common psychological pitfalls is over-position sizing, where traders risk too much capital on a single trade. This mistake doesn’t just impact your account balance—it also triggers emotional decision-making that can derail even the most sound trading strategies.
To understand why this happens, it’s important to recognize how our brains work, particularly in the context of servo mechanisms.
What is a Servo Mechanism?
A servo mechanism is a system designed to automatically reach a goal by constantly making adjustments based on feedback. It’s like a missile guidance system: it constantly corrects its path to ensure it hits its target. Our brains function in much the same way, making subconscious adjustments to help us achieve our desired outcomes based on the instructions (or beliefs) we give it.
If you feed your brain the wrong instructions—such as taking excessive risk on a trade—your brain will try to “correct” by pushing you toward behaviors aimed at minimizing losses or perceived threats. However, these actions often manifest as fear, anxiety, and emotional reactions, leading to erratic decision-making.
The Impact of Over-Position Sizing on Trading Decisions
When traders over-size their positions, they are essentially programming their brains to focus on the fear of loss. The brain, acting like a servo mechanism, enters a state of stress and tries to protect itself by making irrational decisions: exiting trades too early, holding onto losing positions in hopes of recovery, or engaging in revenge trading to win back losses.
This cycle of emotional decision-making often snowballs, leading to further losses and poor performance. Over-position sizing overwhelms the brain’s natural ability to remain calm and calculated, turning trading into an emotional rollercoaster rather than a disciplined process.
How to Program Your Brain for Successful Trading
To avoid emotional errors in trading, you must train your brain to stay focused on your strategy rather than being distracted by the emotions triggered by high risk. The key is to treat your brain like the servo mechanism it is: give it the right instructions, and it will guide you correctly.
Here’s how to do that:
1. Practice Disciplined Risk Management: Keep position sizes small and manageable. Risk no more than 1-2% of your total capital on any single trade. This keeps your brain calm, allowing you to focus on executing your strategy without the fear of major losses.
2. Use Stop-Losses Consistently: Setting clear exit points reduces emotional involvement. When your stop-loss is hit, you exit automatically, removing the need for emotionally driven decisions.
3. Think in Probabilities: Understand that trading success is a result of a series of trades, not individual wins or losses. The outcome of a single trade is irrelevant in the bigger picture, which helps you stay emotionally detached.
4. Track Performance Over Time: By reviewing your trading performance in terms of win rates, risk-reward ratios, and maximum drawdown, you reinforce a data-driven approach rather than focusing on short-term emotional responses.
Action Steps to Train Your Trader Self-Image
1. Develop a Clear Trading Plan: Your brain needs structure to avoid confusion. Create a well-defined trading plan, including risk limits, entry and exit strategies, and rules for managing trades. Follow this plan consistently to build confidence.
2. Visualize Success: Take time to visualize yourself following your trading plan, sticking to your risk management rules, and calmly executing trades. This helps your brain become accustomed to the behaviors of a successful trader.
3. Affirm Positive Behaviors: Reinforce positive qualities by repeating affirmations like “I am a disciplined trader,” “I stick to my risk limits,” or “I execute trades based on logic, not emotion.” These affirmations program your subconscious to adopt these qualities over time.
4. Review Mistakes Without Emotion: When reviewing past trades, avoid judging yourself. Look at each mistake as a learning opportunity, and focus on how you can improve. This helps rewire your brain to view losses as part of the learning process rather than personal failures.
Positive Qualities for a Successful Trader Self-Image
To cultivate a winning trader self-image, here are key qualities to aspire to:
• Discipline: The ability to stick to your trading plan and risk management rules no matter what emotions arise.
• Patience: Waiting for the right setups and not rushing trades, even when it’s tempting to jump into the market.
• Emotional Control: The ability to keep calm during both winning and losing trades, knowing that each trade is part of a larger series.
• Objectivity: Making decisions based on data and analysis rather than gut feelings or emotional reactions.
• Consistency: Repeating the same process every day without being swayed by individual outcomes or market noise.
Applying This to The Pinnacle Method
For Pinnacle Institute members, understanding how psychology impacts trading decisions is crucial when using the supply and demand methodology. By maintaining disciplined position sizing, traders can avoid emotionally driven decisions like abandoning trades too early or holding on too long. When traders stick to the predefined supply and demand zones, using stop-losses and limiting risk per trade, they reinforce a logical, structured approach. This keeps their “servo mechanism” focused on the strategy, rather than reacting emotionally to market volatility or losses.
In supply and demand trading, it’s essential to think in probabilities—knowing that not every trade will succeed but that over time, following the rules will lead to consistent success. Embracing the right trader self-image—discipline, emotional control, and objectivity—allows Pinnacle traders to execute trades calmly and confidently, minimizing errors. By training their brains to trust the system and maintain small, calculated risks, Pinnacle members can use the psychological principles discussed to strengthen their performance and remain aligned with the core strategy.
Conclusion
In trading, over-position sizing is one of the biggest threats to success because it disrupts the brain’s natural ability to stay calm and focused. By treating your brain as a servo mechanism, you can program it with the right “inputs”—small risks, disciplined behavior, and a probabilistic mindset—to ensure consistent performance.
Developing a strong trader self-image through visualization, positive affirmations, and consistent practice will help you maintain emotional balance and avoid the psychological traps that lead to trading errors. With the right mindset and risk management practices, you can trade with confidence, discipline, and success.
Tax Benefits of Options vs Stocks
It has often been said there are two guarantees in life, death & taxes. While death seems to be a given, and unfortunately final, what about taxes? It seems that Uncle Sam will always come calling for his share of our gains, however, how we’re taxed and what we may owe has a lot more flexibility than many traders realize.
Now when it comes to taxes, the best recommendation is usually to… pay them!
Now while it’s important for us to pay our fair share, nobody wants to pay more in taxes than they have to. We want to keep as much of our profits as we can, legally! There are certain options strategies designed to do just that. To have our profits taxed at a lower rate.
In general, traders and investors pay one of two tax rates:
- Long term capital gains tax rates
- Short term capital gains tax rates
Long term capital gains are approximately 20%, while short term capital gains taxes are 40%. A long-term capital gain is any trade held for over 12 months, while short term trades are trades held for less than 12 months.
While long term investors will not be dealing with this issue often, shorter term traders usually will, as most short-term day traders or even slightly longer-term swing traders will not be in a trade anywhere near 12 months and their profits would be subjected to short term capital gains.
Let’s look at taxes. Futures traders are familiar with the long term/short term capital gains tax distinction. When trading any futures contracts, all profits are taxed at a 60%/40% long term/short term capital gains rate regardless of how long they were in the trade. Even someone day trading /ES futures contracts would be taxed at the long term 20% rate on 60% of their profits, while only 40% of their profits would be taxed at the short term 40% rate, even if they were only in the trade for a week, a day, an hour, or even ten minutes.
Why is this? Because it is. If we’re paying taxes, it means we made a profit. And that’s a good thing. While options have many unique aspects to them separate from stocks, one of the benefits is how certain options trades are taxed.
Some options trades are taxed just like futures contracts. Meaning you can significantly reduce your tax bite, not just by trading options, as opposed to stocks but by which options you trade.
While the Dow Jones, SPX, Nasdaq and Russell indexes are not tradable, they are option able. And when we trade index options, as opposed to stock/ETF options, those index options are taxed like futures contracts with the 60/40% long term/short term tax benefits. If someone were trading options on AAPL or TSLA, those are equity options, and would be taxed like stocks, based on the length of the trade.
So, let’s say trader #1 entered a bullish ETF trade on the SPY, at the same time a bullish options trader entered a long call option on the SPX. Same entry, stop and target on both trades, which would be doable as both the SPY and SPX options are tracking the same index. They entered and exited the trades at the same price points on the SPX chart. If the position is sized accordingly, their profits would be the same.
While their gross profits would be the same, the net takeaway would be different. I’m going to use a $10,000 profit to make the math easy.
Let’s take a look:
That’s an extra 20% gain, on the same profit and on the same movement of the SPX. An extra $1,200 profit in your pocket, by trading the index option vs the index ETF.
And you used leverage without having to pay to buy the ETF. At today’s close the SPY closed at $518/share, that’s over $51,000 for 100 shares, while an in the money call option could have only cost as little as $2,200 to $3,000.
Needless to say, there are significant differences between Stocks/ETFs and options. Strike prices, expiration dates, time decay and volatility, to name a few. But once a trader learns how to overlay index options over supply and demand…the leverage and tax benefits could increase dramatically.
Of course there are no guaranteed profits, and any trade, regardless of asset, can suffer significant loss, up to and including 100% of the principle invested. Please have a trade plan with rules for entry and exit and follow them.
*This article is an overview and for informational purposes only. Always check with your tax professional regarding your specific tax obligations.
Focusing on the Big Picture
Trading is an endeavor that requires exceptional patience and perspective. Especially when it comes to measuring one’s efficacy.
Too often, traders miss the forest for the trees by obsessing over the outcome of an individual trade rather than evaluating their performance statistically in the aggregate. To really prosper at this, it is important to zoom out and prioritize overall probability over short term outcomes.
That is not easy. Which is understandable, because on a singular basis, trades simply appear as random wins and losses. One zone might result in a windfall, the next might stop you out for a loss.
This is difficult to cope with because both zones may look exactly the same. They are the same pattern in appearance, but diametrically opposed in terms of outcome. Our brains are wired to seek patterns that predict reliable outcomes, which is a great thing. However, in trading this can trip us up.
When reality matches our expectations, we feel satisfied, pleasure. When reality is incongruent with our expectations, we tend to feel pain, dissatisfaction.
The foundation of your expectations stem from beliefs. If you truly believe, on any level, that every zone is supposed to work, you are more likely to feel pain when stopped out.
Why?
Because your expectation of the “pattern” of a Supply or Demand zone is that it’s supposed to work all the time. And while the pattern of supply and demand occur all the time, and work a good degree of the time, it does not guarantee that every trade will be a winner. The Pinnacle Method is not about guaranteeing any one particular outcome. It’s about probability – improved odds.
The inherent uncertainty in markets is what makes trading psychologically challenging. Traders must accept that they cannot control or force outcomes, despite wishing to be right or make money on every trade. Attempting to do so is fruitless and harmful. Instead, lean on probability. That requires prioritizing the forest over the trees.
Reliable positive expectancy emerges through consistency applied across many trades. By executing your plan flawlessly over 20, 50 or 100 trades, probabilities have time to clearly reveal themselves. What appears chaotic on the micro level exhibits statistical order when zooming out. It takes composure and perseverance on your part as the trader to cope with the inherent randomness of the markets.
Once you see the results over a large sample size, and truly install the belief that you DON’T know what is going to happen next regardless of how perfect a zone appears, the faster you will be able to trade with a sense of ease and effortlessness.
At that point, trading is no longer about doing everything you can do to be “right”, it becomes about pure execution without thinking. (Assuming you’ve become adept at the method and created a clear rule-based plan.)
Keep your eyes on the aggregate forest rather than getting lost staring at individual trees. Trading outcomes cannot be predicted, only optimized probabilistically. Execute properly, embrace uncertainty, and have faith that your efforts will bear fruit in due time across a sufficient sample of trades. And until your results prove out successful performance, keep risk to a minimum.