Trading psychology describes your mental and emotional state as you're trading.
Success in trading is not just about understanding your market and recognizing patterns or using indicators to judge when to buy and sell. Success also depends on whether you can understand your emotions, habits, instincts, and biases to avoid making irrational decisions that, more often than not, lead to significant losses or missed profits.
The mental aspect of trading is a challenge for many traders. For instance, a common mistake is placing a trade against your strategy out of FOMO (fear of missing out), only to lose money. Overtrading motivated by frustration is another issue, as is analysis paralysis, which makes some traders miss great opportunities.
It's understandable to worry about making a mistake, but trading and taking risks go hand in hand. So instead of letting feelings and habits dictate actions, a trader should aim to take calculated risks supported by knowledge gained through practice and research.
Therefore, the ability to control one's emotions is critical for success in trading, which necessitates developing a robust and disciplined mindset.
Discipline is the foundation of any profitable trading strategy. It involves adhering to your plan, especially when tempted to veer from it. If you deviate from your plan and begin trading impulsively, you risk picking up bad habits (such as revenge trading or premature exits) and incur heavy losses.
Your trading strategies will only sometimes be successful, but you can always change them to get better results. Your losses from a poor trading strategy will be less than those from a lack of discipline.
It is best to create your own trading rules and strictly adhere to them to develop discipline. Some simple examples of this are as follows:
- Set a clear stop loss
- Trade with the overall trend of the market
- Don’t use high leverage when there's high volatility
- Do your own research - don't follow others
Making the right choice at the right time can be the key to trading success. An effective strategy involves knowing what you want to buy or sell and waiting until the right moment to act. This calls for restraint and the capacity to control strong feelings like FOMO.
In practical terms, you should wait patiently for the price pattern you use as a signal to fully form and then enter the trade when you see the trigger. If your strategy is unlikely to produce an entry, having a break from watching the market is helpful.
While it is sometimes possible to hold on to a winning or losing position for too long, impatience will more often trick traders into getting in or out of a trading position too early..
Here are some ideas for developing patience:
- Wait for a promising setup to fully form
- Ensure a trade matches all your criteria before entry
- Avoid taking a small profit purely from the fear of taking a loss later
The impact of losses on traders can be devastating, and traders can quickly lose faith in themselves and then trade hastily in the hope of quickly making up for their loss. But, unfortunately, even worse losses may result from this failure to manage the loss properly.
It's true that recovering financially and emotionally from a significant loss can be challenging. But traders will inevitably lose money. Even the most successful traders occasionally lose money. Treating a loss as an opportunity to learn will help you make better trading decisions in the future.
When you experience a loss, accept it and take a brief break from trading to assess the situation and identify the causes. If you do that, you'll be more prepared to trade successfully in the future.
One of the biggest challenges all traders face is keeping control of their emotions. Strong emotional control is necessary for profitable trading. When traders can't control their emotions, such as frustration or desperation, they will trade aggressively and try to outperform the market. This irrational behavior will eventually ruin their trading account if not promptly stopped.
A severe loss may cause you to make rash decisions or even rethink your trading career due to its emotional impact on you.
Even a significant win can lead to irrational trading due to euphoria. Therefore, being conscious of your emotions as you trade is essential. Here are some of the most common feelings experienced by traders::
- Fear of losing money
- Fear of missing out on profits
- Pressure during moments of high instability
It's not necessary to completely suppress your emotions. Instead, you just have to be aware of them and try to remain rational when you trade.
Eliminate bad habits
Decisions shouldn't be based solely on a habit, bias, intuition, or outside pressure.
Bad habits are difficult to break, so recognize them before they influence your decision-making.
Bad trading habits include continuing to make poor decisions merely because a previous mistake paid off through good fortune.
External influence is another problem. For example, some traders will copy other traders who may also be copying others, or they may follow someone in authority's advice without question.
The tendency of traders to succumb to their own biases, such as overconfidence or blindness, is another detrimental aspect of psychology. The bandwagon effect and attribution bias are two additional prevalent biases.
Being conscious of your bad habits, biases, and other psychological traps is the best defense against them interfering with your judgment. Decide which of your past losses were brought on by each of the numerous pitfalls traders fall into and learn from them..
Develop a winner's mindset
Here are some suggestions for controlling your emotions, trading with discipline, and avoiding bad habits and influences
Recording your trading activity, objectives, market conditions, results, plan, thoughts, and feelings is a good idea. Making notes can help you avoid costly errors by increasing your awareness of your habits, biases, and emotions.
Keeping a record will also help you:
- Build discipline
- Determine the reasons behind your wins and losses by analyzing them
- Become more detail-oriented
- Look for market trends
- Review and modify your trading tactics
Build your own trading plan
A trading plan helps you develop discipline critical to trading sensibly and profitably. You will also improve your tolerance for emotions and resistance to bad habits if you:
- Establish an acceptable level of risk.
- Set clear profit targets and stop losses
- Establish precise entry and exit strategies
- Write down and review your trading plans.
- Consider every scenario before making a trade.
- Determine specific responses for various situations.
- Don’t break your own rules
Understand your emotions
One of the most crucial parts of trading psychology is understanding your emotions. It's essential to be conscious of your emotions before they impact you and maintain a realistic perspective on the market. With self-awareness, you can anticipate and avert the undesirable effects that an emotional choice might have.
This does not mean you must completely repress your emotions; instead, it means that you must maintain control over them rather than let them control you.
Here are some tried-and-tested methods for controlling your emotions:
- Set reasonable goals
- Don't focus exclusively on your gains and losses
- Stick to your trading plan
- Put in place a risk management system to limit losses
- Make notes about your emotions while trading
- Do your own research, not follow others
- Take frequent breaks from trading
A trader should work towards having a winner's trading mindset:
- Be patient and disciplined at all times.
- Have confidence that you can accomplish your trading objectives.
- Don’t take losses personally
- Never allow strong emotions like thrill, panic, or FOMO to influence you.
- Act decisively in response to a sudden change in the market
Trading success depends less on a "holy grail" strategy and more on a solid mentality that avoids psychological traps and is resilient enough to keep learning and growing.