Psychology and Its Importance in Trading

by FX EA Review
Psychology and Its Importance in Trading

Psychology is a study of mind, behavior, emotional, and mental processes. It is a major discipline that includes many inner branches under observation, such as human development, clinical, sports social behavior, health, and cognitive functions. Human psychology has a significant part in our lives as it affects our daily routine and actions.

Relationship between psychology and trading

It may come as a surprise, but psychology constitutes 70-80% of the trading. Strategy and risk management comprises the rest of 30%. Many newbies and even amateur traders ignore this critical factor, and this eventually leads to failure. The markets are mostly driven by greed and fear responsible for the bullish and bearish trends. Investors will start to close their positions, fearing that the price will turn as soon as it reaches a potential resistance level or any critical economic event. Similarly, the fragrance of money leads to more buying driving the asset upwards.

Sometimes panic buying and selling results in significant movements and change in the overall trend that can all be understood if one knows market psychology. A trading chart represents the collective mindset of traders and their thoughts.

Difference between losing and winning

Trading psychology can be a huge factor in determining whether a trader will quit or continue on the path of trading in his early days. A few people make a considerable amount of money when they begin their career, which results in euphoria. Their luck soon turns over as they blow up the accounts resulting in fear of markets and depression. Entering, managing, and exiting a position involves handling your feelings. The overall outcome, i.e., winning or losing, is dependent on your decisions driven by psychology.

Essential emotions other than greed and fear

Addressing the following emotions is particularly crucial when it comes to trading:

  • FOMO, or fear of missing out, is one of the driving forces that ruin a trader’s career. A person who has his eyes glued on the charts with a poor mindset will believe that he is missing out on something. Such an emotion forces him to spot an unnecessary idea against his strategy and eventually results in a loss.
  • Overconfidence or pride usually interferes when one is on a winning streak. The trader feels like he has beaten the markets. As the financial industry is random and any setup is bound to have hiccups, ultimate disappointment is seen in the trader’s eyes when he loses. Those with inadequate risk management suffer even more as they put big bets when they are not losing.
  • Nervousness and anxiety are present in the eyes of many novices, amateurs, and sometimes even professional traders. Shaking hands, sweating, tapping the legs, etc., are usually signs which show a trader is upset. Pressing that buy or sell button to get into a trade takes a lot of effort on the traders’ side. It can have a severe impact on trading performance.
  • Doubt gives birth to many hurdles. Such a trader will always be in confusion about whether his idea is valid or not.

Does every trader have trouble managing his emotions while trading?

All the traders who reach the pinnacle of their financial industry’s success have to go through constant refinements that include their thoughts. If two traders are given the same account, risk management, and strategy and asked to trade on, the results will be different. The range of emotions experienced by one while on the desk is dissimilar to the other. The contrasting nature is due to the difference in psychology; therefore, each person has to tend to his garden, managing their mindset.

Useful tips to improve your trading psychology

Trading psychology certainly takes some time to master. Even professional traders have a hard time getting around with it. Many proprietary firms and investment banks have hired top psychologists to help their traders get the right mindset. The points mentioned below can help you get around this vital trading factor:

  • Having a trading plan and a strict set of rules can help manage your emotions while in the markets.
  • Identify your personality and see what makes you tick the most. Is it anger or frustration that convinces you to make bad decisions, or is it fear? Being honest with yourself in analyzing is a must.
  • Take a break after consecutive losses. Trading is challenging, and sometimes you can be on a losing streak. Proprietary firms advise their traders to walk outside and come back after some time if they think nothing is working out.
  • Be humble on your winners and journal all your trades. Once it sees a winner, your brain will release dopamine and serotonin, the chemicals responsible for joy and happiness. It is important not to act out with these, keep your emotions in line, and see each position as a breakeven.
  • Accept that losing is a part of trading, and you must lose your way to trading success. Numerous top traders were in a significant drawdown at first before they became successful.
  • There are many books on managing your mindset. Please give them a read and have a good mentor to help you out in having the best possible trading psychology.

Trading psychology summed up

As humans, we are certainly driven by emotions that result in an outcome-based on initial feelings. Having a good mentality can give your trading a boost. Most trading mentors have psychology as their main focus in the initial stages where they teach novices. The reason why big institutions have psychologists is enough to make anyone realize that a good mindset matters a lot in trading.

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