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Psychology is a key element of financial trading, and how you perceive and react to your trading can have a major impact on your success. In this module we go through some elements of trading psychology and identify a few common mistakes to watch out for.
|Trading psychology||Before you trade||Trading mistakes||Technical mistakes|
|IntroductionEmotionsSentimental tradingPatienceStaying calmBeing decisive||Being unpreparedAssuming easy profits||Over-reliance on softwareBad timingLack of record keepingNot calculating Risk v Reward ratioDeviating from the planNot cutting your lossesOver-reacting to wins||Limiting your optionsOver-diversificationOverexposureUnnecessary risksTrend misconceptions|
Psychology – how you feel about and respond to your trading – is a major part of the trading process, and yet it is a factor that is often overlooked. All traders watch the same prices, read the same news, and analyse the same charts – so what goes on in the mind that makes some traders profitable and others not?
A wide range of emotions can affect your trading, in both a positive and negative way. Emotional trading can take many forms, but is almost always a bad idea.
Fear – some people find it hard to make the transition from using a ‘demo’ account with ‘play money’ to a real live trading account. When their own money is on the table, they can suffer anxiety that cripples their trading. If you find yourself afflicted, remember the lessons you learned in the demo environment – they will stand you in good stead.
Greed – when your trades are going well, it’s only natural to be excited about the potential for even greater gains. At these moments, it’s vital to stick to the rules of your trading plan: if the signs indicate it’s time to close your trade and take your profit, don’t keep holding on in the hope of making even more money.
Stress – it makes sense for you to avoid trading at stressful times. Divorce or illness, or even moving house or changing job, can distract you and cloud your judgment.
Joy – particularly happy times can also affect your trading (and rapidly ruin your mood if all doesn’t go well). You might feel overly optimistic and more inclined to take risks that would usually be outside your comfort zone. Be aware of how your feelings are affecting your decisions.
Anger – you should especially avoid knee-jerk reactions. So, for example, you should never try and ‘get back at the market’ after a losing trade. Sometimes you may feel angry with yourself for making a wrong decision – put it down to experience, as nobody can get it right all of the time and we all learn from our mistakes.
You should try and avoid bringing sentimentality into your decision making. For example, some traders might go back to particular shares that have been profitable in the past, without properly considering the current situation.
Just because a particular instrument has performed well for you in the past does not mean that it will automatically be profitable in the future.
Patience is indeed a trading virtue, and one that is learned mostly through experience. After entering a trade, you should give the market time to react as you expect it to – don’t get impatient and trade out before the market has had time to move.
Similarly, chasing markets that have already moved is a sign of lack of discipline. If you miss an opportunity, let it go. You’re far better off waiting until the next clear signal comes along, rather than entering a trade once the moment has passed.
You’re more likely to make informed and prudent decisions when you are calm and thinking clearly. Here are two ways that you can reduce your stress levels:
1. Create a defined trading plan and stick to it. A trading plan is a way of making your decisions away from the emotional moment – all you have to do is implement it, without any sentiment at all. You can find out how to do it in our developing a trading plan module.
2. Trade in sensible sizes. Smaller trading sizes mean you don’t worry about every little tick – no single trade should cause you a significant amount of stress. If you’re glued to your screen in fear of every movement, the market is telling you to scale down your trades to a more comfortable size.
Some people are calmer than others just by their nature, but the world of financial trading can be hectic for even the most level-headed people. When the fast pace of the financial markets becomes a bit too much, we all need to find strategies to keep our minds clear and our nerves steady.
The other side of the ‘staying calm’ coin, however, is the importance of being decisive. You need to be willing and ready to act, because your window of opportunity may be small, especially when things are moving as fast as the financial markets can.
Don’t be afraid of making the occasional little mistake. If you follow your trading plan and manage your risk sensibly, you’ll soon learn the techniques needed to improve your chances of profitability. Our managing risk module explains how you can protect yourself against excessive losses.