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2024/07
Jensen Effect: What do you need to know?
Many people excel in simulated trading but frequently lose in live trading. This phenomenon is similar to what is known in psychology as the “Jensen Effect.”
What is the "Jensen Effect" in Trading?
The “Jensen Effect” describes a situation where an individual performs well in practice but fails in real situations due to poor psychological resilience. This effect is common in trading, especially during the early stages of a trader’s career.
Causes of the "Jensen Effect" in Trading
Different traders experience the Jensen Effect for various reasons, but generally, the causes can be summarized into four main points:
1. Poor Psychological Resilience
The Jensen Effect is fundamentally a psychological issue. Traders with poor psychological resilience are prone to experiencing this effect. Psychological resilience in trading can determine a trader’s success or failure. For instance, whether a trader can decisively open a position, remain rational during decision-making, hold onto a position during a drawdown, or have the courage to close a losing position without affecting future trades depends on psychological resilience.
2. Overemphasis on Money
Trading aims to make money, but overemphasizing money can lead to the Jensen Effect. This overemphasis causes exaggerated emotional swings with profit or loss, leading to significant tension and pressure. This explains why many traders perform well in simulations (where there’s no financial risk) but fail in live trading due to the pressure of real money gains and losses.
3. Overemphasis on Trading Outcomes
Focusing too much on trading results can cause excessive tension. This can be seen in two scenarios:
- Traders rely solely on trading profits for living expenses or debt repayment, linking their life quality directly to trading outcomes.
- Traders who equate their value with trading success experience significant psychological pressure when they fail to meet their expectations.
4. Heavy Position Sizing
Trading with positions larger than one’s comfort level can induce tremendous psychological pressure. Heavy positions stem from greed and lead to fear, resulting in distorted decision-making, such as fearing losses or missed opportunities.
How to Overcome the "Jensen Effect" in Trading
To break through this psychological barrier and become a mature trader, consider the following methods:
1. Focus on the Process, Not Just the Outcome
While trading results are essential, they are inherently uncertain. The trading process can be controlled. By concentrating on what you can control—such as planning, execution, and risk management—and leaving the rest to the market, you can significantly reduce psychological pressure.
2. Trade with Smaller Positions
Opt for lighter positions to manage risk and gradually build up profits. This reduces psychological pressure and helps maintain a stable mindset.
3. Use Idle Funds for Trading
Ensure that your trading capital comes from surplus funds that do not affect your daily life. This way, your lifestyle remains unaffected even if you lose all your trading funds. This reduces the emotional impact of profit and loss, allowing you to focus on the trading process rather than the money.
By understanding and addressing these factors, traders can mitigate the Jensen Effect and improve their performance in live trading.
