Trading psychology is an underrated part of the market game. Trading requires special knowledge about the markets and the platform you are using. An individual character has also an influence on trading performance. But having a plan and knowing strategies is not all. Trading psychology is no less important. How and why? You will find the answers in today's article.
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Trading psychology
By trading psychology, we mean a set of traders' behaviours and emotions that are crucial for one's trading. We may include here the ability to maintain discipline, readiness to take risks, emotions like fear, regret, greed or hope. All these influence making trading decisions.
Greed is a very intense desire for something. It causes irrational behaviours. Traders are more prone to taking high-risk investments, opening transactions without doing previous research or keeping a position open for too long.
In opposition, fear is an emotion that leads to closing transactions too early because of being afraid of great losses. Risk tolerance is very low. Sometimes, fear develops into panic and causes rapid selling of the assets.
Technical analysts make decisions based on charting techniques. This helps them to spot trends and good entry points. However, trading psychology is also important as it helps to get a feel for the market. Sometimes just following a chart is not enough. You need to back this up with your own knowledge and intuition. This helps to maintain discipline and confidence. And these in turn are factors that contribute to successful trading.
Behavioural finance
Various market anomalies such as sudden rises or falls in share prices can be caused by psychological influences and biases. These are often responsible for making irrational decisions in the market. This is what behavioural finance takes into account.
The aspects most commonly included in behavioural finance are following:
- Mental accounting determines what purposes people are willing to invest money for.
- Self-attribution is making decisions based on overconfidence in one's own abilities and skills, believing that one has an inner talent. Assessment of the situation is often inadequate in relation to objective considerations.
- Anchoring is about linking the level of expense to a certain benchmark. For example, spending based on satisfaction rates or on a pre-defined budget.
- Herd behaviour is an assumption that people behave like the majority of the herd. They sell or buy if the majority does so.
- An emotional gap is taking action in strong emotions of fear, excitement, anger or anxiety. The truth is that emotions are responsible for a majority of irrational choices.
- Loss aversion can serve as an example. Loss aversion is a psychological error that is not infrequent. It consists of the fact that investors have a great fear of losses and forget about the pleasure which can come from market gains. Consequently, they focus more on avoiding losses than on making profits. It is not uncommon for such investors to completely abandon their activities in order to avoid risks that from a rational point of view are perfectly acceptable. Investors tend to sell their winners in order to realise gains quickly and they hold to their losses. But such a procedure results only in greater loss.
4 Fundamental trading psychology tips
- Remember that the trading result is made up of many individual trades. This means that you should see your trading as a process, where losses and gains add up to the end result, and that end result is supposed to be positive.
- The market is unpredictable. You probably trade based on a strategy, so you assume in advance some price behaviour on which you want to make money. However, the market will not always do what you expect. And that is fine. You have to accept that.
- Cut all the noise out of your trading. Focus on what you are doing. Don't look for counterarguments to the positions that result from your strategy. Create your own unique trading style and don't get distracted by what others say.
- Learn to accept risk. It exists, has existed and always will exist in the market. To be successful in the market you must take risks. But that is not all. You have to accept the risk. This means that if you decide to open a trade, you must be fully mentally prepared for it to end in a loss. There is no room for disappointment or sadness after a failed trade. They are part of trading.
How do you manage your trading psychology?
How to enhance your trading psychology?
- Train a lot. Trade, conduct trades on demo and training account with real money.
- Learn a lot about successful traders and investors. Their stories are very educational.
- Remember, you are dealing with real money, and it needs a professional to take care of it. You are that professional.
- Start each day with mental preparation. Make sure you are comfortable with your work. Remember that the market cannot be predicted. Assume at the outset that you will accept losses and gains from individual trades that day. Remember that you are acting on the basis of a set trading plan.
Trading psychology is very important in your trading performance. Knowing the platform, the indicators and having a strategy is not all. You should be always aware of the state of mind you are currently in. Avoid making decisions when you feel extreme emotions such as greed or hope. They will not help you in making money.
Make your research and stay calm.
Everyone is different and this should always be kept in mind. Everyone develops their own methods of dealing with difficult situations. However, not all methods are effective. If you have any advice on trading psychology, please share it with our readers in the comments below the post.
Best of luck!