In the world of trading, where every decision can make or break your strategy, the ability to make quick, effective choices is paramount. But how do top traders consistently make sound decisions under pressure? The answer often lies in the mental shortcuts they use—known as heuristics. If you’re unfamiliar with the term, don’t worry; I’m here to explain.
What Are Heuristics?
Heuristics are simple rules of thumb or mental shortcuts that help people make decisions quickly, particularly in uncertain situations. This concept was popularized by the legendary behavioral psychologist, Daniel Kahneman, in his book Thinking, Fast and Slow. Kahneman’s work explores how the human brain relies on these shortcuts to navigate complex and often ambiguous environments, like the financial markets.
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While heuristics are not foolproof, they are incredibly useful in areas like trading, where speed and timing often outweigh the need for perfect accuracy. Over the years, I’ve come to realize that many elite traders—those who consistently outperform the market—use a set of common heuristics to guide their decision-making.
Universal Heuristics Among Top Traders
After networking with some of the best traders in the world, I’ve found that many share similar rules of thumb that help them identify profitable setups and avoid costly mistakes. These heuristics, in my experience, are universally acknowledged by elite traders:
Your Best Trades Immediately Go in Your Favor
One of the most common sayings among traders is that if a trade isn’t moving in your favor almost instantly, it’s probably not the right setup. A strong trade often shows clear signs of success from the moment it’s executed. If it doesn’t, you might want to reconsider your position.The Biggest Trades Are Obvious
You’ve probably heard the saying, “If you have to convince yourself it’s a good trade, it probably isn’t.” The best opportunities in the market tend to stand out—they practically smack you in the face. If a trade requires excessive justification, it’s often better to stay away. Trading is not about forcing opportunities; it’s about recognizing those that are crystal clear.The Best Trades Don’t Look Back
Strong, profitable trades move with confidence in one direction. They don’t waste time with excessive pullbacks or hesitation. A trade that shows immediate strength is often a sign of a high-probability setup that will keep moving in your favor without looking back.
These heuristics act as mental filters, helping traders quickly sift through numerous potential trades and focus on the ones that are most likely to be profitable.
Personal and Collaborative Heuristics: Lessons Learned from Experience
While many heuristics are shared by traders, some are unique to individuals or the teams they collaborate with. Over the years, I’ve developed several of my own that have been shaped by experience and working closely with other traders.
One such heuristic that I coined is the 20% Heuristic, which I developed through years of refining my strategies. The core idea is that if a trade doesn’t show a certain level of movement within a set period—usually around 20% of the expected move—it’s likely not worth pursuing. This helps me focus on high-probability setups rather than getting bogged down by trades that are too sluggish to provide real opportunities.
Another valuable heuristic came from working with Shark, one of SMB Capital’s top traders. We both struggled with fighting steady market moves—those that were too strong to fade. To solve this, we created a simple rule of thumb: “You don’t fight stocks above/below VWAP unless they capitulate.”
VWAP, or the Volume Weighted Average Price, is often used by traders to determine market direction. This heuristic helped us avoid making the mistake of trying to fade trends that were already in motion, saving us from unnecessary losses.
Perhaps the most critical personal heuristic I’ve developed is: “If you’re ever drawing down big, you’re wrong.”
This is a particularly crucial principle in trading because, unlike fundamental investing or hedge fund strategies, where larger drawdowns may be acceptable, trading is all about precision. A significant drawdown is usually a signal that something is off, whether it’s the idea behind the trade, the timing, or the way the position is structured.
The Ever-Evolving Nature of Trading Heuristics
While I’ve shared some of the heuristics that have worked for me, it’s important to note that trading is an ever-evolving practice. The best traders are those who are constantly learning and refining their strategies. In this dynamic environment, new rules of thumb emerge all the time, and successful traders adapt by integrating them into their own decision-making processes.
You’ve probably heard some classic trading axioms, such as “The trend is your friend” or “The chart never lies.” These simple yet effective rules help traders stay focused on the bigger picture and avoid getting distracted by short-term noise. But what’s even more fascinating is the potential for personal heuristics—those that you develop through experience and experimentation. Maybe you have a unique trading principle that has helped you navigate the markets. If so, I encourage you to share it. Who knows, it might become the next widely-recognized rule in the trading community!
Trading Is a Journey of Continuous Learning
At the end of the day, trading isn’t about following a rigid set of rules—it’s about developing a system that works for you and continuously refining it. Heuristics are a powerful tool in this process, helping traders make quick, informed decisions that lead to consistent profitability.
So, if you’re a trader looking to improve your results, pay attention to the heuristics that work for you. Test new ideas, learn from your mistakes, and keep evolving. And if you’ve developed a heuristic that’s been particularly helpful in your own trading journey, don’t be afraid to share it with others. The more we learn from each other, the stronger the entire trading community becomes.
Trading is a journey, and it’s one that’s shaped by constant growth and adaptation. Keep sharpening your mental shortcuts, and remember that the best traders are always learning, evolving, and, most importantly, adapting their heuristics to the ever-changing market conditions.
