Most of us know that our emotions play a major role in our decisions. They influence everything from our daily life choices to major financial decisions in trading. Understanding trading psychology and using it effectively can help you be a better trader.
Emotions like anxiety, fear, and greed can influence our decision making during trading. If we don't manage these emotions, we can end up making mistakes and lose out on trading profits.
Fear, especially, can have different effects on a trader’s performance. The fear of losing profits can cause some traders to miss trade opportunities or make premature entries and exits. This will lead to lower gains. After experiencing several consecutive losses, fear can build up and make traders question their strategies, often leaving them stuck in a cycle of self-doubt.
On the other hand, a buildup of greed after a few straight profitable trades can lead to miscalculated trades, causing either losses or lower profits. In an open trade, greed for more profits can make the trader postpone the exit strategy, leading to loss.
Anxiety can have some similar effects on trades. The anxiety of losing capital on a trade can cause the trader to close trades prematurely. After facing unexpected news, anxiety can cause the trader to second guess opening trades, leading to a missed opportunity on a potential profit.
Sustained losses in trades will affect a trader’s mental, financial, and emotional health. A lengthy run of losses will usually lead to higher stress. This will end up affecting decision-making negatively. The result will be overtrading, along with potential mental and physical health issues.
Loss aversion is another common issue in trading psychology. In this, traders will try to hold on to trades for too long or exit prematurely out of fear of losing profits. If you are going through something similar, it is important to remember that losses are an obvious part of trading.
To achieve long-term success, traders should see their losses as learning opportunities for the next trade rather than setbacks.
Self-awareness is your ability to observe your feelings, reactions, and their impact on (trading) decisions. Self-awareness skills can be learned and boosted by using the following techniques. These allow you to understand your mind and how it responds under certain conditions.
Write in a journal regularly or after major trades and reflect on yourself. It is important to also note down the justification for opening or closing a trade and your emotions and thoughts afterward.
Keep track of situations and conditions that cause emotional outbursts and analyze the reason for their occurrence.
Keep note of changes in your body language such as clenched fists, elevated heartbeat, and other indications of stress and tension. Once recognized, make sure to take a break from trading to recover, recollect, and resume once comfortable.
Take frequent breaks to perform self-reflection and mindfulness exercises to recover and remove excess stress and tension.
These will improve efficiency in trading, and reduce chances of emotions taking over decisions while trading, along with preventing headaches, insomnia, and mental exhaustion.
The basic rules of trading psychology are discipline and emotional control. Traders MUST avoid letting their emotions dictate their decisions.
Practically, this means analyzing the condition of the market objectively. Traders should be able to learn from their mistakes and prevent them from recurring, instead of making up for the losses by impulsive dealing.
