Trading Psychology

What Is Trading Psychology?

Trading psychology refers to the study of the impact of various emotional components on a trader's decision while trading securities. While this behavior affects their success and performance in the markets, traders use it to overcome biased and irrational trading decisions. Moreover, it improves their profits and efficiency by helping them manage their mental and emotional quotient.

Traders use multiple techniques like meditation, self-reflection, and journaling to tackle and improve their trading psychology. Moreover, trading psychology plays a vital role in seeding and nurturing emotional control, discipline, and patience in traders, helping them stick to their trading strategy to improve their performance, forecasts, and profitability in trading securities.

• Trading psychology is the examination of how psychological elements impact a trader's decisions when trading securities. Thus, this can influence their performance and success in the markets.
• Traders can overcome biased and irrational trading decisions and improve their profitability and efficiency by using them. This is achieved by helping them manage their mental state and emotional well-being.
• To improve trading psychology, traders should identify their personality traits, design a proper trading plan with a risk-reward ratio, conduct proper research on markets, keep a reliable trading journal, set realistic goals, develop a positive mindset, and seek the help of an expert.

Trading Psychology Explained

Trading Psychology is stated as a trader's mental and emotional state in play while deciding to trade security assets in the market. It covers many areas of mental health, emotional stability, self-awareness, discipline, and risk management. To be a successful trader, one needs to have a sound trading psychology. However, one must work hard to teach it and sustain a healthy emotional and mental state to succeed.

Hence, trading psychology involves a lot of technical aspects that need to be dealt with:

1. Fear plus greed badly influences traders' trading decisions, leading to risky and impulsive trades.
2. Traders begin to feel the pain of losses more than the happiness of profits, making them overly cautious. 
3. Traders may become highly overly confident in their judgments and start ignoring ambiguous and conflicting information.
4. Traders have the inbuilt tendency to act as per their anchoring bias, which forces them to trust the very first piece of information they get for trading.
5. Gambler's fallacy tends to advocate a trader that a past event determines the probability of occurrence of future events, although it may not be accurate and not profitable.
6. Lastly, traders get inflicted with fear of missing out (FOMO) on gainful opportunities, become impulsive and make risky loss-making trades to benefit from potentially lucrative buying and selling.

The above shortcomings of traders are resolved by developing the best trading psychology. After a trader has learned to identify and improve their trading psychology, they avid loss-making decisions and gain in almost all situations.

How To Improve?

In addition to being an intelligent trader, one must also try to become an excellent profit-making trader. Let us know some points to improve trading psychology as noted below:

1. First of all, try to identify the type of personality traits present in oneself to know the inherent emotional weaknesses in themselves.
2. Then, a proper trading plan must be designed to overcome trading psychology, such as the risk-reward ratio. 
3. It should be accompanied by proper research about markets, securities behavior, and the financial health of firms and the economy using charts, news, & trading peers. 
4. One must have a good, reliable trading journal to keep abreast of the patterns and progress of one's trading. 
5. One must set up realistic goals in trading.
6. Investors must learn to control their emotions to prevent them from making irrational trading decisions by being objective.
7. Moreover, one must create and stick to well-defined rules to teach the discipline of trading. 
8. One must try to learn from the mistakes committed during trading.
9. Additionally, it would be advisable to develop a positive mindset to remain steadfast for success during turbulent market conditions.
10. Lastly, an expert in trading, like a trading coach or therapist, must be consulted to fight emotional trading habits. 

Mistakes

Traders keep on making some repetitive trading psychology mistakes like the ones below:

1. Emotional Trading

Many traders allow their emotions to determine the manner of decisions they make, which is a critical mistake. Emotional traits like greed and fear of missing out and greed lead to illogical decisions, leading to considerable losses in trading.

2. Revenge Trading

It is another mistake where traders try to recover their losses through impulsive trades. Hence, it leads to huge losses and monetary downgrades.

3. Overconfidence

Such a psychological predisposition usually encourages traders to have impractical expectations and a lot of risk-taking without any returns. This behavior of traders has often resulted in their taking positions that are too large and directed at irreparable losses.

4. Failure To Learn From Mistakes

Most often, traders need to learn from their past mistakes during their trade. They need to examine their errors more critically and constructively. In short, they need to improve upon their trading strategies to prevent continuous loss of money.

5. Short-Term Focus

Every trader tries to take out maximum gains from trading in the market on a short-term basis. As a result, they take unnecessary risks instead of going for long-term profits. Hence, traders keep on faltering and losing money in the process. 

6. Neglecting Physical And Mental Heath

Many traders aim for higher returns in a short time, leading to huge tensions in their minds. Such tensions often blur the clarity of their thinking process. In such a condition, trading strategies go wrong, rational thinking gets badly affected, and their physical and mental health deteriorates. Thus, it leads to losses and suffering for the traders in trading.  

Examples

Let us use a few examples to understand the topic.

Example #1

Consider a scenario where a trader, let's call him Alex, has been consistently profitable in recent trades. Riding on a wave of success, Alex becomes overconfident and starts deviating from his well-established trading plan. The winning streak instills a sense of invincibility, leading Alex to take larger positions and neglect risk management practices.

However, the market is unpredictable, and a sudden shift occurs, resulting in a series of unexpected losses. Instead of acknowledging the changing market conditions, Alex, driven by ego and denial, refuses to cut losses and holds onto losing positions, hoping for a reversal. This failure to manage emotions, specifically overconfidence and denial, leads to significant financial setbacks.

This example highlights how trading psychology can significantly impact decision-making and outcomes in the financial markets. Emotions like overconfidence, fear, and denial can cloud judgment, leading to poor choices and financial losses.

Example #2

Consider a trader named Michelle who, after a series of successful trades, starts to experience a period of unexpected losses in the stock market. Faced with this downturn, Michelle feels a growing sense of fear and frustration. In a moment of panic, she abandons her carefully crafted trading plan and sells off her positions hastily to minimize losses. This emotional reaction is driven by a fear of further declines and a desire to regain a sense of control.

However, shortly after liquidating her positions, the market rebounded, and the stocks Michelle sold began to recover. In hindsight, Michelle realizes that her fear-driven decision was premature and not in line with her overall trading strategy. This example illustrates how emotions, particularly fear, can lead to impulsive actions, causing a trader to deviate from a well-thought-out plan and miss potential opportunities for recovery. Successful trading psychology involves recognizing and managing these emotions to make decisions based on analysis rather than reacting emotionally to short-term market fluctuations.

Example #3

Suppose Sam was new to the world of trading. Although he was not familiar with most of the crucial concepts of the stock market, he wanted to trade and make significant financial gains. His first few trades resulted in a total loss of $100. Sam thought he had to recover the losses and believed that he could do so by taking advantage of the uptrend in Apple stock.

Source  

On January 21, 2021, he bought 100 shares in Apple at around $136 per share, hoping to make significant profits. Since he did not have any idea regarding a stop loss, he did not place one. As we observe from the above chart, the stock went into a downtrend. When Sam realized that the stock was in a downtrend, the price was already around $123 on February 23, 2021. So, he incurred further losses when he sold the shares. From this experience, he realized that he made a mistake by engaging in revenge trading. From next time, he became extra careful to avoid such trading psychology mistakes.

For similar charts of stocks and other securities, one can visit the TradingView platform.

Importance

It relates to the success of a trader through making the right decisions of trading security using the best mental state and rational trading psychology. Hence, its importance can be summarized as:

1. It helps traders put rational control over their emotions like greed, anxiety, and fear, which are the primary causes of wrong decisions in trading. 
2. Every successful trading session needs discipline that is offered to the trader by trading psychology.
3. It also allows the personality of a trader to harbor confidence in themselves, leading to correct decisions for profit.
4. It decreases stress in the minds of the traders as they can control stress-causing emotions, allowing room for rational thinking, accurate decisions, and a healthy lifestyle.
5. They also play a vital role in gaining knowledge, reviewing mistakes, learning more strategies about profitable trading, and building upon the success of trading.

Frequently Asked Questions (FAQs)

Recommended Articles

This has been a guide to what is Trading Psychology. Here, we explain how to improve it, mistakes, examples, and its importance. You can learn more about financing from the following articles –

• Stock Market Psychology
• Investment Psychology
• Stock Trading