Psychology of Trading
There are many reasons why online traders struggle to succeed but the one I am focusing on today is the Psychology of Trading. It is hard enough to make money that you don’t need psychological factors to work against you but that is the reality. As with all my discussions, everything I say comes from experience and not from anything I have read in a textbook.
Retail traders need to avoid those blowup days when you lose control and take a large loss that is hard to recover from (see How to Avoid the Forex Trading Death Spiral). This does not mean you won’t have losing days or trades but the key is to avoid those out of control blowup days. My hope is that this trading psychology discussion helps in this regard.
Psychology of Trading
1) Rapid Eye Movement
Have you ever put on a position, stared at the screen watching the price changes, see the market go against you, then see it come back to your entry level where you get out only to see it continue in the way of your original trade? You initially breathe a sigh of relief that you did not lose money but then kick yourself for getting out. You then look at your trade recap. You were in the trade for a minute and a half, not a length of time anyone would consider long enough to give a trade a chance to work. While this may be an extreme case, even 5 minutes staring at price changes can sometimes feel like 5 hours. This is where the deck is stacked against you.
To illustrate, I picked a random point in time yesterday when the market was active and calculated the number of price changes in the EURUSD. Guess how many? 91 price changes! This is about one and a half price changes per second.
I call this rapid eye movement because there are so many ticks going on that it can make it feel like you have been in a position forever. I am sure it was not even a consideration when electronic trading started but it certainly has a psychological impact that favors the broker. Brokers count on traders taking off winners or potential winners too soon while letting losers run. Rapid eye movement is one reason this may happen.
There is no easy solution to this as long as you are watching the price changes. Being aware of what I call rapid eye movement may help you take a deep breath, see the market with a clearer eye and give your trade to time to play out.
Psychology of Trading
2) Don’t Trade Scared
No one likes to lose money even though it is part of the game. This is easier said than done because I don’t think I have ever put on a trade where I didn’t have that feeling of trepidation immediately afterwards waiting to see if I timed my entry right.
However, don’t confuse trader anxiety with being scared. We all get butterflies when waiting for a trade to unfold but anxiety is different from being scared. The former is part of trading. The latter is a psychological impediment.
3) The Market is Not Your Enemy
Psychology of Trading
This is one of my favorite topics as I believe it is a downfall of many traders and suggest reading it closely.
- Have you ever had one of those trading days? Have you ever lost money trading and gotten mad at the market?
- Have you ever taken it personally, lost discipline and tried to convince yourself the market is wrong?
- Did this make you feel like the market was your enemy?
- Did you repeatedly fight the trend in order to beat the market only to see your trades stopped out?
- Did you ever try to flip from long to short and back to long, each time buying the top or selling the bottom, determined to outsmart the evil empire?
- Did you double your leverage in an attempt to make back your losses, determined to beat the market at its own game?
Some of this has probably happened to most traders at one time or another but it is not something you want to repeat. Think of it this way. If you ran into a wall and smashed your head you would not do it a second time. Just as the wall is not your enemy, the market is not your enemy. Falling victim to the psychology of trading is your worst enemy.
Psychology of Trading
I saved this forex trading post from a few years ago and while the levels are different, it is as applicable today as it was at that time. In this example the trader repeatedly bought USDJPY even though it was in a downtrend and falling (oh how the trend has changed but not the trading psychology).
Last 2 weeks it was very painful experience being long this pair to no avail. It was more a lesson in patience than any profitable venture at all. I’m constantly asking myself why I persist as I have myself pointed out that it is mainly a side show now.
Now that you asked me I must admit it was a psychological anchor from the past that I “know” they will come in and give it a lift so I was AFRAID to trade it from the TREND perspective which I have said many times I’d favor.. So YES, I’m persisting on the wrong side of the market and I got my share of pain on that one…
Now, this is where the “market is my enemy” can take over. You can’t believe the market is acting irrationally and keep buying (or selling) at every pause. Each time you get stopped out you get angry, not at yourself but at the market. You can’t believe the market is doing this to you and stiffen your back. You forget about what charts are saying, throw discipline out the window and become determined to catch the top by selling (or bottom by buying) when charts are telling you the opposite. By the time the move stalls out, you are a beaten trader. You have taken your lumps in what has been an emotionally draining day battling with an unemotional market.
Does this sound familiar? If so, then don’t repeat it. Step back when that feeling comes and take a deep breath. Walk away and come back with a clear head. Remember, the forex market is not your enemy. It is not a living organism. It is only a place where trades are transacted and prices set. When that feeling comes, remember the adage, “The market can remain irrational longer than you can remain solvent.”
4) Get Rid of the Emotion
Psychology of Trading
It is hard to get the emotion out of trading but the best way is to take a systematic approach that gives you confidence. Once you let your emotions take over you lose objectivity and discipline. I remember when I was a bank trader I would play a game with myself that no one would know when I was having a good or bad day trading. It helped me (and still does) contain my emotions and stay disciplined. This brings up the next subject, which is something many retail traders fall victim to.
5) Don’t Base Trades on Emotion or Intuition
Do not make trading decisions because a currency feels like it is too low (cheap) or too high (expensive). Brokers count on it. Traders lose by it. This is another psychological factor as you may be making trading decisions based on emotion or intuition and not what your analysis is saying.
One way to get around this is what I call going out of body.
The term out-of-body experience is defined by Wikipedia as An out-of-body experience (OBE or sometimes OOBE) is an experience that typically involves a sensation of floating outside one’s body and, in some cases, perceiving one’s physical body from a place outside one’s body
There is usually a negative connotation associated with an out-of-body experience as it is not done intentionally.
I use it differently and positively for trading. For me it means stepping back from the emotion of trading and taking an objective look at the market so you can make objective trading decisions. This is not easy to do in the heat of battle when you are staring at your platform, but if you can master this you will eliminate some of the psychological factors that work against you.
6) How to Build Confidence
Psychology of Trading
So you may ask how to overcome some of the psychological impediments that may impact your trading?
Unless you want to go automated and that route has limitations, it is an ongoing battle. The first step is to remove the psychological obstacles to trading. Step two is to build confidence. For me, and I can only speak for myself, and without trying to sound like an infomercial, I believe confidence comes from trading on the strong side of the market. As those who follow my thinking know I feel that finding the strong side of the market is more than half the battle. There are many ways to determine the strong side of the market. Find one that works for you and see how it feels when you trade from that side.
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