Trading isn’t for the weak at heart, it’s a lot more emotional than you may think, and before you can master trading you have to learn to master your emotions.
Trading psychology – what does it mean and why is it important?
Trading psychology is about understanding the way we react mentally to the stresses and pressures of trading
Controlling your emotions is essential to successful trading, without a clear mind you won’t be able to make rational trading decisions.
The Emotions of trading
When trading there are two emotions that are more common, and more dangerous, than all the rest; fear and greed.
Fear and greed can ruin even the best trading strategies
One moment of fear or greed can lead to a moment of madness and months of hard-won profits going down the drain
Uncontrolled emotions should not be an excuse for losses and losses should not be an excuse for uncontrolled emotions
Remember!! Trading affects psychology as much as psychology affects trading
Greed
“You can’t feed on greed”
- Many people think that greed is thinking that the sole aim of trading is to make money.
- This is NOT what greed is
Greed is trying to make money too quickly
There are lots of ways to be greedy in trading;
- Trading in sizes that are too large
- Trading too frequently
- Having unrealistic expectations
- Dreaming of the big hit trade, rather than steadily building your equity
Fear
Fear in trading has two faces;
- Fear of loss
- Fear of missing out
The fear of loss compels traders to close profitable trades prematurely, meaning they miss out on potential profit
The fear of missing out compels traders to abandon their trading strategy so they do not miss a major price move
Fear is NOT good as it leads to overtrading and miss-timed entry and exit points
So
DON’T BE SCARED!!
Managing risk and emotion
Risk management involves determining how much risk you are willing to take in order to profit.
Return to the “Risk” Module for a more in-depth look at risk and risk management tools.
It is critical for traders to understand the importance of risk management when trading; it teaches you to pace yourself, think logically, and most importantly, it helps you keep your emotions under control.
When trading, there are a few factors to consider.
Trade size – Start with small trades
When taking a hot bath, you don’t just jump in; you first test the water temperature with your toes. Trading is no exception. Never enter the market with all of your money. Before taking a full stake, test the market with a smaller trade.
- Excessive trade sizes for your account might result in exaggerated price movements, wreaking havoc on both your account and your emotions. This might lead to errors brought on by fear or avarice. As previously said, trade has an impact on psychology just as psychology has an impact on trading.
- Remember that a trade can go wrong – if you’re hoping to make a substantial profit by taking a large transaction size, keep in mind that this high-risk trade can also result in a loss equal to the profit you’re hoping for.Risk/reward ratio
Aim for at least a 3-1 or at worst a 2-1 Profit/Loss ratio
- For example, if you are aiming for 60 pips profit, your maximum loss should be around 30 pips. Or, if the maximum loss you are prepared to take is $1000, your profit target should be at least $2000
- If your trading style is to get in and out of the market for a small profit each time then make sure your losses are also small.
Planning your risk/reward ratio means that you can prepare yourself mentally for the loss that you might face and prevent emotional trades.
One wrong emotional trade can produce a large enough loss to wipe out the profit of many profitable trades
P/L targets
- You should have exit points in mind before you make a trade
- You should daily have P/L targets
Once you reach this target you should stop trading so as to avoid giving profits back to the market
P/L targets help to avoid fear and greed compelling you to overtrade and/or increase your trade size
Market volatility
Some times of day are more volatile than others:
Afternoon in London, which corresponds to morning in New York, is the most volatile time of day for most markets, with the largest price swings and profit potential and losses.
During periods of extreme volatility, it is usually best to stand aside if you are not an experienced trader.
Trading tips
Here are some more trading tips that you may find useful
Implement risk management
Use stop losses and limits – these take the emotion out of closing a trade and reduce the risk of unnecessary losses as a result of attachment to a position.
Traders allow losses to grow as their emotional attachment makes them hope the price will reverse
- The hardest thing a trader has to do is manually close a losing trade; placing a stop loss order at the same time you make a trade will avoid having to do this.
- Traders often complain when their stops hit then the price reverses; never cancel a stop loss order after you have placed it. You placed the stop when you were calm before you entered the trade; now you are stressed because the trade is moving against you
Trust your original judgment!
Treat trading as a business not a hobby
You wouldn’t invest $10,000 in a business enterprise on impulse – so don’t do it when trading!
Make sure to make time for researching the markets when you are not trading
An informed trade is always a better option than an impulsive trade
Patience
Patience is a virtue in trading; it is different to not trade through fear
Patience means…
- …waiting for the price to hit your indicators before trading
- …waiting hours if necessary, for the correct time to enter the market. Trading profitably is what matters, not the number of trades per day
- …not jumping in and trading just because you see the price moving or you are bored
- …not trading on a tip. You will find wildly divergent opinions even among so-called experts. Do your own research before you trade
Standing aside is a valid trading decision
Overtrading
- Overtrading is a common mistake made by new traders as they try and catch every small price move
- The price moves down so they sell, it moves up so they buy, in doing so they are always chasing the market and usually losing.
Learn to anticipate price moves, not just follow them
Time frames
- Short term trading is highly intensive and requires lots of discipline and concentration so make sure you are ready for this level of intensity and can trade without distractions
- Longer term trades do not have to be monitored constantly and are more appropriate for traders with other commitments
Coping with losing trades
Learn to love your losses
This is a term heard often in the trading world, and if you don’t learn to embrace your losses, your trading career will probably be short lived.
So, what exactly does “learn to love your losses” mean?
It means you should understand why you made a losing trade;
- Did you misread your indicators?
- Did you fail to anticipate the release of an important piece of economic data?
Some losing trades are not your fault; for example, an unpredictable event such as a terrorist attack could move the market, but…
The majority of losing trades are because the trader made an impulsive decision
- To lessen the psychological impact of a loss, redefine a loss from being a failure, to being an opportunity to learn
- Do not blame the markets for your losses, the markets don’t owe you anything – look at your strategy and adjust accordingly
Trade based on what the market is doing rather than what you think it should be doing. Trends and market conditions can change; make sure your strategy changes with it.
Taking profit
Cut your losers and run your winners
- Don’t take profits too early through fear. Fear causes the mind to question and react while the trade is still “safe” and in profit, no matter how small.
- Conversely, don’t let a winning trade turn into a loser
Set yourself rules to follow; close a trade if the market retraces 20% from your profit target. This allows you to make sure that your emotions don’t get out of hand when trading - Except in special circumstances, get in the habit of taking your profit “too soon”
- Don’t torment yourself if a trade continues not to move in your favor. A common mistake is to close a position that is in profit and keep one that shows a loss.
Building your account equity
Don’t try to make your fortune in a single trade – you will never be satisfied if you have unrealistic expectations
- Aim to build your account steadily
5% per day is a great return - Remember you will have periods of equity drawdowns or sideways movement
If you have 3 losing days in a row, take a step back from trading for at least a day to collect yourself.
Use this time to reassess your strategy and analyze the market
To summarize, don’t underestimate the power of your emotions…
TAKE CONTROL OF YOUR TRADING, DON’T LET TRADING TAKE CONTROL OF YOU
