Trading psychology refers to the way you approach your emotions and mental state, which in turn helps you to succeed or fail in your trading. It represents the various aspects of your mindset and behaviour that affects how you trade. Your trading psychology affects your behaviour in the market. Besides your trading plan and risk management, your trading psychology has a major role in guaranteeing your success.
Knowing how our mind works helps us to comprehend the way motivations affect our perception of different situations and choices we make. It also aids in understanding the goals, desires, and behaviours of others, whether we want to assist them or gain the upper hand over them.
Understanding Trading Psychology
Trading psychology helps us understand why traders act and decide un rationally in the market.
Trading psychology represents market dynamics and traders’ emotions. Market dynamics are the consequence of certain conditions generated by previous events, company reports and political tensions. It tells us the overall atmosphere of the market.
A trader’s sentiments are often taken negatively as a trader should act rationally and calmly. Understanding market dynamics and controlling one’s own emotions leads to better trading performance.
Rookies in traders are naturally more susceptible to emotional trading. They frequently doubt the rationality of their choices which causes them to prematurely close their good holdings. Conversely, they might hold a losing position too long hoping to attain bigger profits, only to miss the right moment to close it and see their gains turn into losses.
It might surprise you, but emotions can be one of the biggest obstacles to trading successfully. Controlling emotions and practicing discipline are components of what we call trading psychology.
Many emotions can adversely affect your trading performance. Two of the most significant ones are greed and fear.
Mastering Greed and Fear: The Two Nemeses
Greed can be defined as an unsatiable urge for gain that, at times, compromises rationality and judgment. This description of greed-inspired investors implies that this greed can drive traders to engage in a variety of unfavourable behaviour. This could be making high-risk trades, purchasing stocks in an unproven business or technology simply because its price is rising quickly, or purchasing shares without doing any proper research on the underlying venture. Greed can mostly be seen in Bull markets where rates are getting higher and higher.
On the other hand, fear causes traders to close positions too early or to refrain from taking risks. Fear is apparent in bear markets where traders, in their haste to leave the market, make irrational moves. Fear of big loss leads to Panic selling in the market.
Containing your emotions to trade smarter
Regret is another strong emotion experienced by a trader which might drive him to get into a trade after missing out it initially, because the market moves so fast. This is against trading discipline, which results in direct losses as security prices fall from peak highs.
Controlling your emotions and sentiments makes you scrutinize the data, think fast and trade smarter on new positions.
The logical approach in trading psychology is to accept the fact that trading consists of ups and downs. Learning from your mistakes leads to long-term success. Following the gut instinct was the traditional approach in trading to make key decisions, but in recent times this has been substituted by a much more data-driven approach. Every decision should be subjected to risk reward ratio and evaluating the cost and the potential benefit you gain from it.
The study of effects of psychology on traders and financial markets. It explains why investors often lack self-control and take decisions based on emotions rather than facts. A trader should practice rational financial behaviour to be successful. Once you achieve the right level of rationality, you will able to leverage your insight on market dynamics successfully, leading you to profitability.
Effective Trading Psychology Habits
The trading psychology of successful traders is the result of effective trading habits such as:
- A good trader sets out a trading plan and follows it religiously.
- Set out rules based on your risk-reward ratio and make a schedule for when to enter or exit a trading position.
- Identify your emotional biases and keep them in check.
- To avoid emotions running in your trading, put a stop loss in place and set a profit target.
- Additionally, you should plan when specific events should trigger you to do trade.
- Dedicate your time to researching and learning about the market you are willing to trade in.
- To avoid random mistakes and repent later, educate yourself and attend seminars and conferences before you start trading.
Although nothing can guarantee that every trade will bring in profits but with the right mindset and skills, you can increase the probability of profitable trading.