Trading Psychology: How Mindset Dictates Strategy

 

To trade successfully in the financial markets, you need to master practical skills, but just as important is your mastery of trading psychology.

 

Trading psychology has everything to do with your mental state, beliefs, and thinking strategies. This means that the success of your trading strategy is hugely dictated by your ability to think quickly, exercise discipline and keep emotions under control.Your core-beliefs will likely impact on your responses to successes and setbacks. If you are inherently optimistic, this may aid you in overcoming a setback, but equally, may lead you to overestimate successes. If you are inherently pessimistic, the reverse may be true.Neither is right or wrong, but you should be aware of your bias so that you can factor this into your assessment of your performance and better achieve an objective analysis.In the early days of your trading journey, it is likely that you will experience a range of emotions. It is important to learn quickly what these emotions are, what triggers them, and how they affect your behaviour, both inside and outside of the market.Two key concepts within the subject of trading psychology are fear and greed. It is important to understand them both. What triggers them, and how they commonly manifest in actions. Not just in yourself, but in others in the market..

Fear is a powerful emotion. Its purpose is to keep you safe and alive. In the right time and place, fear is excellent preserver, and as such, should always be heeded.However, when it is left untamed, it morphs into panic; and panicking while trading is not at all helpful. It clouds the judgement of a trader and can triggers irrational haste to exit the market, leading them to cut short profits.En masse, this can lead to the market becoming bearish and triggering significant panic selling. Panic selling that triggers more anxiety in the marketplace as prices begin tumbling as everyone seeks to mitigate their losses.The experienced trader, with a strong grasp of fundamental and technical analysis and trading psychology, can profit in these circumstances. By being able to see and understand that is happening, and trusting in a tested trading strategy, they can enter the market at an appropriate time. Once the fear dissipates, and the market begins to recover. The experienced trader will profit.When it comes to trading psychology, there are two common sources of fear.

 

Fear of Failure

This kind of fear puts a trader under pressure when they contemplate the loss of their capital in a trading position. They end up associating such a loss with their self-worth which affects their ability to execute trades with commitment and courage. Fear of failure often stops would be traders from entering the market in the first place, opting instead for lower-risk, lower-reward investments. But having entered the market, it can lead a trader to refrain from closing out a losing trading position when they ought to. Because they are concerned about taking a loss, they onto hold on to an asset in the hope that will bounce back. The further the price falls, the stronger the sense of fear becomes, until the trader is paralysed, at the mercy of market.A fear of failure can also be linked to chasing losses. Unable to manage their emotional response to having suffered a loss, the trader feels they “must get it all back”. This often leads to more aggressive trades. Deviating from the rational trading strategy, and with negative emotions in full control of the trader’s decision making,these circumstances commonly lead to even greater losses.

Fear of Success

A peculiar concept on the face of it, but if a trader is unable to comprehend themselves achieving huge successes they may become prone to self-sabotage, exiting trades prematurely and donating profits back into the market or distrusting their better judgements and not pursuing trades born of strong analysis skills.

Greed comes with an excessive desire for wealth, excessive to the point of clouding a trader’s rationality. It is often most apparent in the final phase of a bullish market, and is often born of a lack of gratification, leading to aggressive risk-taking and overtrading.

Greed makes it hard for a trader to define clearly what a profit or a loss is to them. They feel ungratified when taking profits in a position, thinking that they should have made more. They feel ungratified when closing a losing position thinking that they should have waited to recover the loss. When celebrating gains and agonising losses, a greedy trader does not know where to draw the line.

To satisfy their greed and earn more money, a trader to aims for unrealistic and abnormal profit, triggering a myriad of trading behaviours such as:

•Trading without researching or analysis

•Buying shares of an untested company just because the price is moving up rapidly

•Making high-risk trades

•Take large speculative positions

•Staying in a trade longer than it is advisable in the hope of squeezing extra profits from a trading position.

Overtrading

In the pursuit of greater profits, not only does the trader partake in more aggressive trading, but they stay at the table for too long. Overtrading is when a trader a strayed too far from their defined strategy and is no longer operating rationally. Impulse trading is common among greedy traders seeking to make up for previous losses or to chase larger profits..

When considering becoming a trader, it is important to be self-aware. Understanding the emotions and states of mind that you are prone to and planning for how to keep them under control should be at the heart of your trading strategy.

Set Clear Trading Rules

Trading rules will help you avoid impulse trading. It will also help you to understand your trading sessions, set out the times of the day you are supposed to trade and define the signals for you to enter or exit a trade.Have a profit or loss target and set a stop-loss to keep emotions out of the process. This will save you when emotions would otherwise get the better part of you.

Have Predetermined Closing Points

You can save yourself untold anxiety and stress down the line by defining clear limits on the maximum amount you are willing to win or lose in a trading day.When clock hits close, or you hit your predetermined amount of profit or losses for that day, go home.

Know Your Triggers

You should know the specific events or news releases, positive or negative, that will trigger your trading decisions to sell or buy in the market.Similarly, you should identify the kinds of events that trigger your emotional responses and have a plan for when you inevitably encounter them.

Seek Knowledge

Knowledge will change your belief concerning the financial markets and help you overcome fear. Become an expert in the markets that interest you. Stay on top of the news and read trading journals. Attend conferences and trading seminars and educate yourself by devoting time to research and studying charts.

Prepare for Both Wins and Losses

Approach trading with a sober and level mind. Do not just think of how you will spend your millions, but instead, take time to think of how you will deal with a loss when it comes. This will help you to easily adapt to different market outcomes.

Assess Your Performance Periodically

The best way to do this is to keep a trading journal. Reviewing not just your results, but the events that triggered your trades and the emotions you felt at the time will help you identify mistakes and correct bad habits. Over time, this increase self-awareness will enhance your overall returns.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when trading in CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

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