Are you an emotional trader? Do you make more trades based on your feelings than logic or your trading plan (if you have one)?
The answer lies in your personality, which can influence your trading and investing activities. For example, if you easily get angry after losing a game, you're likely to be emotional when you lose a trade.
Well, let's find out what kind of personality you have that will influence how you'll act and react when trading the Forex market.
Take this personality test that is part of the book 17 Proven Currency Trading Strategies: How to Profit in the Forex Market by global finance thought leader and best-selling author Mario Singh. He dedicated an entire chapter about the importance of understanding your profile so you can trade Forex exactly the way you should based on your lifestyle and personality.
If you're serious about trading, you might want to get your hands on this book. After all, knowing how to match your personality with the right strategy is just one aspect of being a trader. You should aim for a holistic approach.
Now, based on your trades alone, if most of them are done out of fear, greed, or revenge, you should work hard on your trading psychology. If your personality test shows you mostly operate on emotions, all the more reason to do so. You must acquire the ability to separate emotions from logic, which is exactly how the brain is designed.
Norman Welz, an expert in trading psychology, believes that trading is 100% psychology. Unfortunately, fear and mental resistance cause people to behave differently, resulting in failure to achieve the desired outcome.
In this article, we'll explore in depth the following topics:
- What is trading psychology?
- Why is trading psychology important for a trader?
- What are the most common emotional triggers that plague a range of traders?
- How do you develop and master the right trading mindset?
While our focus is mainly on Forex trading psychology, the details outlined in this article are suitable and applicable for all investors. Whether you trade currencies or stocks, you're still going to experience emotions like everyone else.
What is trading psychology?
Forex is not just the largest financial market in the world, but it also provides traders with several benefits and disadvantages, including the ability to trade and profit from a slow economy or during a crisis. It's a recession-proof investment vehicle, after all.
No matter the market conditions, there's money in Forex trading. However, many traders lose more than they earn whether they're new or old in the game, and it has less to do with the system or strategies they use and more to do with the mindset.
More often than not, their trading plans are superseded by their emotions and biases. This is where trading psychology plays a pivotal role.
This refers to the mindset, which includes the emotions and feelings that a trader experiences while engaging the market. It looks into how you manage your emotions, the trading decisions you make, and the thought processes involved as you trade currencies, stocks and other securities.
The main focus of trading psychology is awareness. Being aware of negative emotions and biases, various pitfalls, and the positive traits and behaviour you should have as you trade can increase your chances of earning larger payouts.
Why is trading psychology important for a trader?
In part one of a two-part video 3 Rules of Trading & Investing, Mario Singh clearly summed up the value of mindset in the formula of successful trading.
According to him, trading strategy accounts for 15%, money management takes 30%, and state of mind accounts for 55%. This debunks a popular concept that strategy is everything.
To prove Mario's point further, here's another example. Long-Term Capital Management (LTCM), a massive hedge fund in the '90s, had some of the world's most brilliant minds on its board, including two Nobel Prize winners (Myron Scholes and Robert C. Merton).
Considering the level of analytical skills these people have, the company would have survived many challenges. Unfortunately, reason was overpowered by greed and euphoria. Combined with false calculations, LTCM collapsed in the late 1990s.
Clearly, the best strategies and analytical skills can be reduced to nothing if a trader starts to panic or deviate from the plan due to unchecked fear or happiness.
When you develop the right trading psychology, however, you will learn to:
- Manage your emotions, particularly negative ones
- Understand and better deal with the fear of missing out (FOMO)
- Understand the logic behind common trading mistakes and avoid them in the future
- Control and overcome greed and better deal with a losing streak
Most importantly, you will realise and appreciate the importance of consistent trading. This is thanks to a mindset to trust your trading plan, especially if it has winning returns.
What are the most common emotional triggers that plague a range of traders?
Before we can formulate a trading mindset, we must first understand what some would consider the demons of trading. Although different traders are psychologically stimulated in different ways, there are common emotional triggers and biases that most of them experience.
Fear
Fear of missing out on a winning trade is just one of the manifestations of this emotion.
Beginners are fearful of the market because they're not confident of their strategy. Others experience fear after a series of losing trades.
Some often fear that no matter the decision they make they will not be profitable in the long term.
What's disastrous about fear is that it keeps you from making a profitable trade. You could end up making one mistake after another until your next big step is to quit.
Greed
You're a greedy trader if you:
- Risk too much on a trade in the hope of a bigger payout
- Don't take profits because you're sure the trade you made will be favourable to you forever
- Add a position whenever the market moves in your favour
Every Forex trader wants to make money and a strong drive to do so is essential to financial success. However, when the impulse to profit directs your trading decisions, you're just being greedy.
Now, you might wonder why Warren Buffett says, "To be fearful when others are greedy and greedy only when others are fearful.”
Aren't fear and greed bad for trading?
Don't take this famous quote literally, especially without understanding the full context of it. Buffett was referring to timing the stock market and not being fearful and greedy per se.
Anger and revenge
After a disastrous loss, you feel angry and decide to take revenge on the market by opening another trade where you think you can recoup your losses and even earn a profit. If you were blinded by anger and you ignored your trading plan when you did, your rash decision is likely to yield the opposite of your desired outcome.
There's always a possibility of loss in trading and investing. If you try to jump back in the market every time you lose, you'll end up in a vicious cycle of losing and losing some more.
Euphoria
Being happy after a big win isn't exactly a negative emotion, but it can damage your account if you let your overconfidence and ego override your trading plan. It's natural to want to trade again after your "perfect" setup yields five winning trades or more. You should think twice, however.
Panic
Someone's loss on a long currency trade is someone else's gain on a short trade on the same currency pair. This should keep panic to a minimum if not eliminate it. However, as market volatility runs for long periods and price fluctuations increase in depth and frequency, panic sets in. Traders start to lose confidence in their trading setup and resort to making rash decisions. People rarely make wise moves in a panic.
Top 10 strategies to develop and master the right trading mindset
Now that you know what emotions will adversely affect your trading decisions if you allow them to rule over logic and reason, it's time to change your state of mind. You want the logical side of your brain to dominate during your time on the market. How do you make this happen?
1. Practise mindful trading
If you're aware of your emotions and biases, you'll be able to do two things:
1a. Learn to manage your emotions
Whenever you experience fear, greed or overconfidence, refer back to your setup or trading plan. Always keep in mind that luck has nothing to do with failure or success. Rather, it is a result of the logical consequences of the choices you make.
1b. Overcome predetermined psychological biases
Sometimes, your emotions result from a trading bias that you've experienced in the past. For example, you opened a trade because the market shows a trend that previously gave you a big payout. In a bid to replicate a past successful trade, you forego analysis and base a decision over your confidence on that trading bias.
2. Develop and follow a trading plan
Trading with a plan not only reduces risk but also prevents emotional trading. Different traders have different trading strategies, so you must personalise your own. It's important to constantly test and backtest your strategy's efficacy.
If your trading plan often results in losing trades, don't let anger and revenge get the better of you. Switch to a better setup instead.
3. Always use tried, tested and proven strategies
As previously mentioned, test your trading plan until you come up with a strategy where you win more and avoid losses easily. Stick with it and you should be more profitable.
In the event that the strategy you've been using underperforms, you can backtest it manually or automatically. Based on historical data and previous trades, you'll be able to identify where improvements can be made. Both MT4 and MT5 platforms allow backtesting, but the latter has more strategy testers that you can use.
Check out what other features and functions the MT5 platform has to offer.
4. Keep a trading log
Doing so will help you track your trades and thoughts as you spend time on the market. You can easily create a trading journal, and the most basic should have the following entries:
- Reason to enter a trade
- Entry price
- First target
- Stop loss
- Position size
- Risk percentage
- Exit price
- Pip profit/loss
- Notes
- Thoughts on the trade
Based on the information you gather in one day, you'll have a fairly good idea of what went right or wrong with your trade. Keeping a trading journal also develops the discipline to stick to your trading plan.
5. Never trade for the sake of trading
Always check if the market provides the setup you trust before you open a trade. If it doesn't, then don't trade at all. Only take what the market gives you and don't let that feeling of missing out take hold of you. Tomorrow's market could present bigger and better opportunities.
6. Always stay positive during your time on the market
This may be difficult to achieve, especially after successive losses, but it's the best way to keep negative thoughts and emotions from disrupting your day.
Treat every trading day different from the last. If yesterday was a loss, today could be a win. If you keep a positive attitude on the get-go, you're sure to make better trading decisions and place winning trades.
7. Take a break
Whether it's your third consecutive wins or losses, walk away from your trading den and give yourself a breather. This is because your next move is highly at risk of being motivated by overconfidence or frustration, respectively. By this time, you’re well-aware of how these emotions can damage your account.
8. Become an organised trader
This requires two things--your trading journal and trading plan. If you use both consistently, your thoughts and feelings won't be all over the place when the markets move against you. Even if it moves in your favour, you'll remain calm, collected, and calculated when you're on the market.
9. Keep learning until you gain mastery
Books like Unlocking the World's Largest Financial Secret: 12 Keys to Forex Freedom by Mario Singh and The Investor’s Quotient by Network Press' President and CEO Jake Bernstein will provide you with valuable insights into how to deal with the market with more logic and reason. By educating yourself on both the technical and non-technical aspects of trading, you'll be able to develop investing and trading mastery.
10. Accept the uncertainties of trading
You're going to get your trades wrong at one point or another, even with a "perfect" setup. If you let your ego rule over you, you're going to make rash decisions. If you end up losing money, you'll either feel despondent and entertain thoughts of quitting, or you'll feel greedy and trade without thought to take revenge on the market or try to recoup your losses.
Let’s sum it all up
Emotional trading is often triggered by:
To avoid trading with emotions:
Just remember, the moment you experience any emotional triggers as you trade, activate the side of your brain that is ruled by logic or reason. You won’t drop down the bottomless hole of mistakes and bad decisions.
Ready to grow your wealth from the world's largest financial market? No better place to start than right here with us! Begin trading with Fullerton Markets today by opening an account:
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