Amongst the many skills that you need to trade successfully, a disciplined mindset as a trader is at the top of the list.
Trading psychology can be explained as emotional discipline and understanding. The two main emotions we talk about in trading are fear and greed, and you need to control both of these emotions to be able to trade successfully.
In this article, we take a look at how these emotions affect traders and why trading psychology is important. Understanding how to trade is the first step, and the next step is getting your head in the game. You can also learn what price action trading is here.
What is trading psychology?
Trading psychology refers to your mental and emotional state when trading. Your mental and emotional state is an important and often overlooked aspect of trading and investing. It affects the outcome of your trades, especially if you are easily overwhelmed by the fast-paced timetable of trading.
Trading psychology also represents certain aspects of an individual's character and behaviors. These aspects have an effect on what they choose to trade in, how often they choose to trade, and when they choose to trade.
Two important aspects of trading psychology are discipline and risk-taking. These are especially important because they deal directly with the traders’ success and whether their trading plan will work.
Additional aspects and emotions include greed, fear, hope, and regret. Each plays an important role in trading psychology and has an effect on the success of the trader.
The basics of trading psychology
Here, we discuss the emotions and behaviors related to trading psychology and their effect on the success of a trader.
Before you jump into trading, we advise that you check in with your mental health to ensure that you’re in the right headspace to begin trading and putting your money on the line.
Managing your emotions
One of the most important aspects of trading psychology is the ability to manage your emotions. Fear, overconfidence, greed, and excitement are all common emotions that traders experience. If you want to be successful, you need to learn how to manage your emotions to ensure that they don’t negatively affect your trading.
For example, you might be overconfident in your abilities and knowledge which might cause you to make reckless and risky trades. Those poor decisions could negatively impact your financial well-being as well as your confidence.
Effective risk management is vital to the success of your trading plan. Risk management also has numerous psychological benefits. Implementing risk management allows you to understand the target and stop loss before jumping into a trade.
You will also be able to weigh the pros and cons of a certain trade before you make a decision. This will help you decide whether the risks associated with the trade will be worth the potential profit.
Fear is possibly one of the most powerful emotions that you will have to overcome and deal with when you begin trading. It is understandable. None of us wants to make bad trades and lose our hard-earned money.
If bad news hits the market or the market fluctuates in a way that negatively affects your trades you might feel the urge to liquidate your assets and get out while you can. While this strategy may protect you from incurring additional loss, it will also prevent you from potential gains.
It is natural to be afraid, but you shouldn’t let fear dictate the choices you make.
Learn how to quantify your fear. Think about what you’re afraid of and why. Having the answers to these questions makes you aware of what triggers your fear, what your automatic response is, and how to manage this in a healthy way.
Another aspect of fear that isn’t spoken about nearly enough is ‘FOMO’. FOMO is the Fear of Missing Out. Whether that be on a potential trade or an outing with friends.
FOMO is generally common in beginners who are filled with excitement and the fear of missing out on the ‘trade of a lifetime’. However, you should keep in mind that there will always be another trade. In trading, nothing is make or break. It takes time, patience, and dedication.
Greed is a common emotion associated with trading and, if you don’t learn how to manage and overcome it, it could lead to your downfall.
Greed causes you to hold on to a position longer than needed, just to squeeze the last bit of value out of it. While it may work the first few times, this is risky business as stock prices and market exchanges are in constant flux. Holding onto a position for too long could lead to a devastating loss, instead of a profit.
Greed, much like fear, is not an easy emotion to overcome. Often, traders just want to do their best and earn just a bit more but, feeding into this instinct is not always a good thing.
Much like with fear, you should try and think about the reasons behind your actions. Why do you want to earn a bit more? Why should you take the risk? And is it worth it?
These kinds of questions help you get a handle on your emotions and understand the reasoning behind them. They also help you manage your greed.
The importance of trading psychology
Being aware of trading psychology and the effects it has on the success of your trading and trading plan is vitally important. This is especially relevant to beginners who have just started out and do not yet have the know-how to manage their emotions when trading.
Understanding trading psychology and how it affects you personally helps you get into the right mindset when trading. It also helps you become aware of your weaknesses, automatic responses, and how to mitigate these responses in a healthy way.
By doing this, you increase your chances of success.
When we first got into trading, trading psychology hadn’t crossed our minds. We were young and optimistic, and we were overconfident. So, we made mistakes. Reckless trades and investments just because we were afraid to miss out on a trade.
We don’t want you to make the same mistakes we did.
Trading psychology deals with more than just emotions. It also refers to behaviors and character traits that might never have been an issue before. You should be aware of how trading psychology affects you, and how to ensure that it does not negatively impact your trading strategy.
We all want to be successful but be sure that you are in the right headspace before jumping in. Remember, trading and investments are a marathon, not a sprint. Don’t be afraid to take your time.