03.07.2024
Piotr Skowroński
66
03.07.2024
Piotr Skowroński
66
Trading psychology may seem like a made-up term, but it's a very real thing. Financial markets don't have emotions, but we humans do. In order to have a long-term career as a trader, it's important to cultivate a mindset that will keep you calm while trading and not give in to emotional reactions. In this article, we will look at what trading psychology is and share tips on how to improve your trading mentality.
Trading psychology refers to the state of mind and emotions that influence our trading decisions. It has a big impact on our success or failure as traders. When a trader fails to be a winner, it's usually not because they can't follow their charts correctly. There could be several reasons, and one of the most likely ones is problems with psychological factors. Below are some examples of psychology-induced mistakes we make in trading. Improving the psychological aspect of trading is of great importance as it helps us make better trading decisions.
Overcoming emotional barriers is one of the first challenges faced by people who are beginning to master trading. Traders who control their emotions and egos have a big advantage over those who do not. The reason is that their trading decisions are based on objective market realities rather than subjective emotions. The way a person deals with emotions has a huge impact on whether or not they become a successful trader. Reacting to any emotion can make us make decisions automatically and simplify the reasoning process we have to do. Below, we will go into more detail about which emotions are most common when trading and their impact on decision making.
Fear is one of the strongest emotions in trading. It is based on the idea that fear is a natural reaction to what we perceive as a threat, and in this case it is about losing money or missing out on potential profits. Fear in trading manifests itself in many different ways and is the cause of many of the mistakes we make. For example, fear of loss can make us postpone selling a losing trade, which often leads to further losses.
Greed leads to many impulsive decisions that should be avoided at all costs. Traders under the influence of this destructive emotion often disregard sound principles of risk control and financial management. Greed also fosters a "gambling" mindset, where we trade without clearly defined rules, making hasty decisions and seeking quick and significant profits. Ultimately, this can lead to serious financial losses and negatively impact long-term performance.
Disappointment is an emotion that occurs after making a number of mistakes caused by the aforementioned emotions. When we fail to cut losses on a trade in time, we break the established rules and take excessive risk, eventually losing more money than we should have. This leads to a feeling of deep disappointment. Frustration reinforces all the negative behaviours that the trader is trying to combat and exacerbates existing problems. In a state of frustration, the trader may make even more rash decisions, leading to further losses and emotional exhaustion.
Optimism is generally a positive trait that promotes confidence and motivation. However, a problem arises when optimism becomes excessive, especially after a series of winning trades. In such a situation, overconfidence can lead traders to take more trades than they should and take excessive risk, relying on luck instead of analysis. This over-optimism can hinder objective market evaluation and lead to significant financial losses, upsetting the balance between confidence and prudent trading.
Hope can have a significant impact on trading decisions. When we enter a losing trade and feel a sense of hope, we tend to delay taking a loss in the hope that the position will recover. As a result, we may give the losing trade more time and space, which often results in even more losses. Hope, in this case, becomes a dangerous emotion that prevents us from objectively assessing the situation and making timely and informed decisions.
Ideally, traders should trade like a computer, based on facts and data, not on emotions. Mastering psychological factors takes time, as this aspect needs to be worked on specifically. Therefore, we will share with you a few tips that will help you reduce the influence of emotions as you improve your mentality.
If you are constantly opening trades in a hurry, going about your daily business, you are likely to approach trading with a nervous and hurried mood. Try to prepare for each trading session (be it daily, weekly, etc.) in advance, and when you trade, do so in as calm and clear a state of mind as possible. It's impossible to take emotion out of the equation, but it can help you reduce the potential damage when you find yourself making rash decisions.
Having a solid foundation of trading knowledge will indirectly improve your psychology. There is always something new to learn, whether it's technical analysis, learning new markets, risk management or finding the best trading indicators for your strategy. For one thing, it will help you make better decisions while trading, which is a positive factor in itself. Also, having a deep understanding of how trading works can make it easier for you to deal with losing trades or losing streaks over a long period of time.
One way to strengthen your mental state is to make a trading plan and stick to it. A trading plan is like a roadmap where you prescribe your trades in advance, it will help you determine entry, exit, position size and more. If you take the time to make a plan, you are more likely to stick to it, plus it prepares you in advance for different situations that may arise.
The first step to mastering emotions is to become aware of them. When we trade and show emotions such as fear or greed, they give clues from the start that can be recognised. This can be difficult at first, so we have to be aware of our thoughts and analyse them. On the one hand, we need to be aware of what emotions arise when trading and then see if we are influenced by them.
For example, if we have a trade open and the price reverses towards the stop loss, you have to be alert and avoid persistent thoughts such as "let's see if I get lucky and the price reverses in my favour" or "I will extend the stop loss to see if this gives time for the price to react". This leads to the conclusion about the dominance of the fear of losing a trade and the hope that the market will do everything for us. The idea is to start being aware of emotions so that we can correct them in the future.
If you notice that you are under the influence of emotions, which leads to impulsive trading, deviation from the trading plan and excessive risk taking, there are two possible approaches. One is to stop trading for a period of time to calm your mind and regain control. The length of this break depends on the specific situation and the trader's personality. The other option is to continue trading, but with smaller position sizes. Opening trades at 25 or 50% of the normal size will minimise mistakes while you learn to manage your emotions and improve your emotional control.
Taking the time to work on the psychological aspect can improve your trading career, and if you are a beginner, it can lay the foundation for a good start. Part of trading is a mental activity, and it's important to keep a close eye on your emotions to identify them and keep them from taking a turn for the worse. By following the tips above, you will be able to move forward by mastering your emotions.
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