Introduction to Trading Psychology
The importance and impact of trading psychology on forex traders cannot be overemphasized. Every trader whether a pro or a newbie has had or is having a challenge of trading psychology.
The success rate of a trader’s journey is more hinged on trading psychology as it does strategies. Irrespective of how powerful a trading strategy is, the psychology of the trader greatly affects its execution.
Mark Douglas, the writer of the book; ‘Trading in the Zone’ once said: “If your goal is to trade like a professional and be a consistent winner, then you must start from the premise that the solutions are in your mind and not in the market.”
That which is going on in the mind of a trader is responsible for the continuous success or failure of that trader. This is a principle that works in all endeavours.
Let’s consider the following real life events that happen in the life of many traders which underpins the relevance and effects of trading psychology:
- Mr. Maguire went bullish on GBPUSD after careful analysis, but the trade went into $100 drawdown. He went ahead to close it in order to avoid further losses. Notwithstanding, to the amazement of Mr. Maguire, the trade reversed to his originally determined take of profit which should have given a profit of $1000.
- Mr. Kingsley also made $100 on a bearish GBPUSD trade which he anticipated to give him a total of $1500 profit. Since he was afraid of the reversal of the trade against him, he closed the trade with a profit of $100. Afterwards, the trade proceeds to $1500.
- In the case of Mr. Adams, he felt he was an invincible trader since he hadn’t lost a single trade for about two months. His confidence in his competency began to overwhelm him such that he lost guide on his trading plan and management. He began risking more than necessary and taking trades he originally wouldn’t. He began losing trades upon trades.
Considering these scenarios, what do you think is responsible for the non-profitability of these traders?
The problem with Mr. Maguire is his impatience undergirded by fear. He is fond of prematurely closing trades in losses before they reach their required or anticipated profit targets. The emotions of Mr. Maguire is interfering with his good market analysis which should have made him successful.
The trade eventually obeyed his analysis by hitting his take profit, but he rather incurred losses because of premature closure of trades. A perfect understanding of the forex market structure indicates that the market doesn’t move in a straight line – impulse-correction- impulse-correction.
To continue with, Mr. Kingsley has also missed an opportunity to make $1500. He only made $100 due to fear of losing his profit, probably because of his low-risk appetite. If Mr. Kingsley had learnt to manage his emotions, he would have capitalized on a good trade such as this one. Setting up a trading plan is one thing and sticking to it is another.
Without proper trading psychology one cannot stick to any trading plan. This kind of trading leads to more losses than wins because traders will easily get out of good trades but may be fond of holding losing traders till marginal profits are made.
Lastly, Mr. Adams has gone through the rudiments of forex trading, has managed his emotions adequately but has developed an overconfident mindset because of the long winning streaks he’s had.
This is another challenge every trader especially advanced traders must watch. Mr. Adams has a well-planned winning strategy that works, but overconfidence caused him to deviate, leading to preventable trade losses.
What is Trading Psychology?
Having gone through the scenarios written afore, it is important to understand the concept of Trading psychology. Psychology is simply how your mental state affects your behaviour. Trading Psychology is a discipline that deals with the study and understanding of the psychology and emotion of traders’ and how they influence the decision-making, behaviour, and productivity in financial markets. It involves examining the impact of emotions, cognitive biases, self-control, discipline, and mental states on trading outcomes.
It’s crucial to understand that traders are not just rational beings; they are also influenced by various psychological factors. These factors can result in biased thinking, impulsive actions, and suboptimal decision-making.
Trading psychology stresses the significance of self-awareness, emotional regulation, risk management, discipline, and resilience to enable traders to make more objective, consistent, and successful trading decisions. By addressing psychological barriers and cultivating a balanced mindset, traders can enhance their ability to navigate market volatility, manage risk, and achieve long-term profitability.
Emotions That Affects Traders
The common emotions affecting traders include fear, impatience, greed, and boredom. Traders can easily become fearful, stressed, and anxious.
Fear
Fear is an unpleasant emotion usually caused by anticipation or realization of danger. It is one of the major emotions every trader who wishes to be successful must overcome. The following are ways fear manifests.
- Fear of losing trades – Many traders have this inherent fear of losing trades. The emotion is heightened by a losing streak of trades. They are pained when their stop losses are triggered. Eventually, these traders stop trading and miss a lot of profitable opportunities due to the fear of losing trades. Losing trades is part of trading hence inevitable, and all traders must be ready for loss trades. The diagnosis of traders who have the fear of losing trades is realized in their inability to take trades when opportunities present themselves whilst allowing losing positions to run into more significant losses.
- Fear of losing profits to the market – many traders also fear losing the profits back to the market after having a great winning streak of trades. They become so emotionally attached to their profits such that they fear losing them. It is important to note that, any trading decision based on emotion is an example of emotional trading no matter how sensible it might seem. These of traders cannot allow their trades to run their full course to greater profit. Due to the fear of losing their floating profit, they close their trades prematurely
- Fear of missing out (FOMO) – Another major trait of fear is the concept of FOMO. While others are afraid of taking trades, some traders are afraid of missing out on any lucrative trading opportunity. This fear of missing out on trading opportunities, causes them to take trades that do not follow their trading plan. They trade based on thoughts and emotions. This way of trading will surely land you in the ditch.
Greed
The importance of greed to one’s trading career cannot be overemphasized. Most traders graduate from fear to greed. They are not afraid to lose but are not ready to close their trades, hoping for bigger profits, and then they end up losing their profits or even their capital. They end up over-trading to make more money, a catalyst for unnecessary losses and trading burnout. Greedy traders must set profit targets and adhere to them.
Boredom and Impatience
Due to the many advertisements from brokers and other forex trading agencies, many traders enter the market with false expectations. These false expectations have to do with the get-rich-quick mentality. When these expectations are not met with time, they enter the arena of boredom leading to impatience. They are bored waiting for the right time to trade and the right to be successful in the market. They begin to take illogical steps based on emotions to trade without any clear strategy. The end result is always devastating.
Managing your Psychology
To manage your emotions successfully, take some time off to develop a robust trading strategy and guideline. Ensure you follow them irrespective of how you feel. It is a sure way to manage your emotions and psychology. These guidelines can include setting risk/reward tolerance levels for entering and exiting trades. When to take profits, when to enter and exit trades, and how many trades to take per time vis a vis your account size.
Ensure you take some breaks to rejuvenate yourself and reward yourself after following your strategies to the latter. This will condition your mind that there is a reward for doing the right thing.
Ensure you keep a journal to record your trades so you can monitor your trading activity intermittently. Above all, plan your trades and trade your plan.
