The influence of psychological factors on your trading process

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4 psychological factors that affect your trading

In the financial trading world, emotions are the biggest barriers between traders and success. According to many experts’ studies, the most significant difference between a profitable trader and an unprofitable one is how they manage their emotions. If your emotions are well-controlled, you already have 60% chance of becoming a successful trader.

With that being said, controlling emotions is always easier said than done. Crappy tips like “you have to control your emotions” or “you have to strictly comply with a trading system” are always overwhelming on the internet, but they don’t say how to do those things in detail.

The best way to control your trading psychology is to understand the psychological risks you face when trading. In this article, we will provide you with a detailed description of the psychological factors that affect your trades and methods to control them.

Psychological Factors That Affects Your Trading Results

People are an entity associated with emotions. Like it or not, you still have to deal with your emotions every day. You will still lose your temper when unexpected events occur, or be touched when watching a movie like Titanic. You will still get angry when you are slandered, and will feel sad when you are abandoned.

The above things are perfectly normal because emotions are one of the things that maintain human existence. However, in trading, emotions do not bring many benefits. They affect your ability to make rational decisions, leading to a poor trading result.

There are many different types of emotions such as happy, sad, angry, afraid, and others. However, they are mainly made up of 4 psychological factors: greed, fear, hope, and revenge.

1. Greed

Greed is the most dangerous psychological factor that hinders a trader from success. The most obvious expression of greed is when a trader no longer appreciates risk management in trading.

For example, as a general rule, a trader should only risk up to 2% of his account balance on each order. However, because he is overconfident in his predictions, he increases the risk to 5% with the hope to make more profit. That is when greed begins to ruin his trading results in the long run.

The long-term effect of greed is that the risk increases significantly.

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2. Fear

The second psychological factor that seriously affects your trading results is fear. Try remembering, have you ever cut an order early just because you had feared that it would not have reached the profit-taking level?

The long-term effect of fear is that profits will be smaller than risks, resulting in balance shrinkage.

3. Hope

Hope is the third psychological factor that ruins your trading results. The expression of hope is when a trader holds on to losing trades with the hope that things will be fine in the end.

Hope and fear are a perfect couple keeping you stuck in the small profit – large loss loop, which will kill your account at the end. Trading professionals rarely hold on to losing trades; they have a habit of cutting losses early and letting profitable orders run.

4. Revenge

Last but not least, revenge is the fourth psychological factor that negatively affects your trading results.

Most beginner traders experience revenge trading, especially when they have a series of losing trades. They always want to regain their losses from the market; hence, instead of taking a break to calm down or reduce the position size, they constantly open new orders hoping that they will get something back.

In most cases, revenge trading makes traders get deeper into losses.

As a trader, you will always face these 4 psychological factors throughout your trading career. They are the source of negative emotions like anger, boredom, anxiety, overreaction, and others. You will not be able to remove them completely; however, you can learn how to control them.

Methods to Control Emotions When Trading

To control greed, you will need to keep in mind the importance of risk management. Always remember that trading is a game of probability; if you risk too much on an order and lose, your chances of having future profitable orders will be reduced. Therefore, always comply with risk management principles when trading.

To control your fear and hope, remember that you will never know what will happen in the market. You should establish your setup carefully and let your order run until it hits stop-loss or take-profit. You can also trail your stop-loss levels towards the entry point when the order is profitable, to minimize risk and preserve profits.

To avoid revenge trading, you need to keep a cool head. Whenever you feel that you are losing your temper, just leave the trading platform and take a break until you calm down.

Maintain a work-life balance

Work-life balance is a term used to describe the balance between work-related and life-related activities of a person. Failure to maintain a work-life balance not only negatively affects your concentration and ability to make correct trading decisions, but also harms other areas of your life.

A bad trading result is the consequence of an unhealthy mind. So, to keep your mind healthy, you should try to maintain a work-life balance.

Believe it or not, revenge trading is closely related to a symptom called “trading addiction”. According to the legendary trader Steenberger, trading sometimes “ becomes a vehicle for destroying mind and soul “. A trader may be considered addicted when he lets the trading work negatively affect his health or financial ability.

Trading addiction is also considered one of the factors causing a work-life imbalance. If you think you are being addicted to trading, try abstaining from it for a while or seek help from experts.

Apart from this, to ensure balance in life, you also need to maintain social contact with your family and friends. Besides, take time for sports and exercise; they are great ways to reduce stress and keep a healthy mind.

The Bottom Line

Trading psychology management is extremely important for every trader. No matter how good your trading system is, you will not succeed if you let emotions affect your discipline.

Greed, Fear, Hope, and Revenge can be controlled in different ways. However, the most effective way is to keep a work-life balance and a healthy mind. Trading is a lonely and stressful profession; therefore, you should prioritize rest and outdoor activities to balance your life.

If you find it difficult to control your emotions, Finmax’s specialists can help. At Finmax, you will be supported directly by account managers and financial experts, who have years of experience in the market. They can give you useful advice on managing trading psychology, or at least company with you in your trading path.

“General Risk Warning: Binary options and cryptocurrency trading carry a high level of risk and can result in the loss of all your funds.”

Trading Psychology

What is Trading Psychology?

Trading psychology refers to the emotions and mental state that help to dictate success or failure in trading securities. Trading psychology represents various aspects of an individual’s character and behaviors that influence their trading actions. Trading psychology can be as important as other attributes such as knowledge, experience and skill in determining trading success.

Discipline and risk-taking are two of the most critical aspects of trading psychology, since a trader’s implementation of these aspects is critical to the success of his or her trading plan. While fear and greed are the two most commonly known emotions associated with trading psychology, other emotions that drive trading behavior are hope and regret.

Key Takeaways

  • Trading psychology is the emotional component of investor’s decision making process which may help explain why some decisions appear more rational than others.
  • Trading psychology is characterized primarily as the influence of both greed and fear.
  • Greed drives decisions that appear to accept too much risk.
  • Fear drives decisions that appear to avoid risk and generate too little return.

Understanding Trading Psychology

Trading psychology can be associated with a few specific emotions and behaviors that are often catalysts for market trading. Conventional characterizations of emotionally-driven behavior in markets ascribe most emotional trading to either greed or fear.

Greed can be thought of as an excessive desire for wealth, so excessive that it clouds rationality and judgement at times. Thus this characterization of greed-inspired investor or trading assumes that this emotion often leads traders towards a variety of behaviors. This may include making high-risk trades, buying shares of an untested company or technology just because it is going up in price rapidly, or buying shares without researching the underlying investment.

Additionally, greed may inspire investors to stay in profitable trades longer than is advisable in an effort to squeeze out extra profits from it, or to take on large speculative positions. Greed is most apparent in the final phase of bull markets, when speculation runs rampant and investors throw caution to the wind.

Conversely, fear causes traders to close out positions prematurely or to refrain from taking on risk because of concern about large losses. Fear is palpable during bear markets, and it is a potent emotion that can cause traders and investors to act irrationally in their haste to exit the market. Fear often morphs into panic, which generally causes significant selloffs in the market from panic selling.

Regret may cause a trader to get into a trade after initially missing out on it because the stock moved too fast. This is a violation of trading discipline and often results in direct losses from security prices that are falling from peak highs.

Technical Analysis

Trading psychology is often important for technical analysts relying on charting techniques to drive their trade decisions. Security charting can provide a broad array of insights on a security’s movement. While technical analysis and charting techniques can be helpful in spotting trends for buying and selling opportunities, it requires an understanding and intuition for market movements which is derived from an investor’s trading psychology.

There are numerous instances in technical charting where a trader must rely not only on the chart’s insight but also their own knowledge of the security that they’re following and their intuition for how broader factors are affecting the market. Traders with a keen attention to comprehensive security price influences, discipline and confidence show a balanced trading psychology that typically contributes to profitable success.

The Importance of Trading Psychology

Containing emotion and exercising discipline are key to making money

There are many skills required for traders to be successful in the financial markets—the ability to understand a company’s fundamentals and the ability to determine the direction of a stock’s trend are two of them. But neither of these technical skills are as important as a trader’s mindset: the ability to contain emotion, think quickly, and exercise discipline—what we might call trading psychology.

The psychological aspect of trading is extremely important. Traders often have to think fast and make quick decisions, darting in and out of stocks on short notice. To accomplish this, they need a certain presence of mind. They also, by extension, need discipline, so they will stick with previously established trading plans and know when to book profits and losses. Emotions simply can’t get in the way.

Key Takeaways

  • Market psychology refers to the prevailing sentiment of financial market participants at any one point in time.
  • Investor sentiment can and frequently drives market performance in directions at odds with fundamentals.
  • Understanding what motivates fear and greed can give you the discipline and objectivity needed to be a successful trader and take advantage of others’ emotions.

Understanding Fear

When traders get bad news about a certain stock or the general market, it’s not uncommon to get scared. They may overreact and feel compelled to liquidate their holdings and go to cash or to refrain from taking any risks. If they do that, they may avoid certain losses, but they also may miss out on gains.

Traders need to understand what fear is: a natural reaction to what they perceive as a threat—in this case, to their profit or money-making potential. Quantifying the fear might help, and traders should consider pondering what they are afraid of, and why they are afraid of it.

By pondering this issue ahead of time and knowing how they may instinctively react to or perceive certain things, a trader can hope to isolate and identify those feelings during a trading session, and then try to focus on moving past the emotional response. Of course, this is not easy and may take practice, but it’s necessary to the health of an investor’s portfolio.

Overcoming Greed

There’s an old saying on Wall Street that “pigs get slaughtered.” This adage refers to greedy investors hanging on to winning positions too long, trying to get every last tick. Greed can be devastating to returns because a trader always runs the risk of getting whipsawed or blown out of a position.

Greed is not easy to overcome. It’s often based on an instinct to try to do better, to try to get just a little more. A trader should learn to recognize this instinct and develop a trading plan based upon rational business decisions, not emotional whims or potentially harmful instincts.

Setting Rules

To get their heads in the right place before they feel the psychological crunch, traders need to create rules. They should lay out guidelines based on their risk-reward tolerance for when they will enter a trade and exit it—whether through a profit target or stop loss—to take emotion out of the equation. Additionally, a trader might decide that in the wake of certain developments, such as specific positive or negative earnings or macroeconomic news, he or she will buy or sell a security.

Traders would also be wise to consider setting limits on the amount they are willing to win or lose in a day. If the profit target is hit, they take the money and run, and if losing trades hit a predetermined limit, they fold up their tent and go home, preventing further losses and living to trade another day.

Doing Research and Review

Traders should learn as much as they can about their area of interest, educating themselves and, if possible, going to trading seminars and attending sell-side conferences. Also, it makes sense to plan out and devote as much time as possible to the research process. That means studying charts, speaking with management (if applicable), reading trade journals, or doing other background work (such as macroeconomic analysis or industry analysis) so as to be up to speed when the trading session starts. Knowledge can help a trader overcome fear, so it’s a handy tool.

In addition, it’s important traders remain flexible and consider experimenting with new instruments from time to time. For example, they may consider using options to mitigate risk, or setting stop losses at different places. One of the best ways a trader can learn is by experimenting (within reason). This experience may also help reduce emotional influences.

Finally, traders should periodically assess their performance. In addition to reviewing their returns and individual positions, traders should reflect on how they prepared for a trading session, how up to date they are on the markets, and how they’re progressing in terms of ongoing education, among other things. This periodic assessment can help a trader correct mistakes and change bad habits, which may help enhance their overall returns.

The Bottom Line

While it’s important for a trader to be able to read a balance sheet or a chart, there is a psychological component to trading that shouldn’t be overlooked. Being aware of how fear and greed can impact trading, exercising discipline, developing trading rules, experimenting, and periodically self-reviewing are crucial to a trader’s success.

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