We tend to focus a lot on charts, analysis, market mood, corporate performance, and other external elements when we talk about stock market trading. Even when discussing the talents required of a successful trader, we emphasize market knowledge and awareness, analytical capacity to read and detect patterns from charts, and so on. The psychology of trading is an often-overlooked but crucial factor. Most of us have heard professionals advise against making trading decisions based on emotions. While this appears to be the case, human emotions are complicated. This page is focused on trading psychology. We’ll talk about which emotions to avoid and which to grasp on to have a successful career as a stock or forex trader.
Let’s start with some psychology:
What exactly is Trading Psychology?
Psychology is the study of the mind and how people act from a scientific point of view. As a result, when we talk about trading psychology, we focus on the majority of the sentiments and emotions that a stock trader experiences when trading. Understanding how our minds respond to particular stimuli and how it makes us feel, as in most parts of our life, may set the groundwork for a regulated mental state – a skill required to be a successful trader.
Humans have a wide range of emotions. Even though a stock’s price is declining, you can opt to hold on to it since you’ve been a loyal customer of the company’s goods and believe in it. The emotion at work here is ‘admiration,’ which prevents you from looking at the evidence and forces you to take huge risks. While we are not arguing that emotions are evil, knowing when to control them may help you avoid severe setbacks. Traders who are in control of their emotions tend to make more reasonable judgments than those who are not.
Traders’ Emotions
While we all feel a variety of emotions on any given day, there are a few that stand out that we’d want to talk about today.
FEAR
Fear is one of the first emotions that come to mind when discussing stock trading. It’s a natural emotional reaction to an impending threat. When you place a trade, you anticipate the market moving in the direction you predicted. When movement is in the other direction, fear starts to set in. The fear of losing mind keeps traders awake at night, causing them to make rash moves to square off their positions without planning. Because humans are evolved to fight or flee from fear, most traders choose to flee (or redeem) rather than battle the direction of the stock price movement. Fear is widespread among traders in the following situations:
- Fear of making a mistake prevents you from starting a trade.
- They don’t sell a losing trade since they have to book the loss, and there’s a chance of recovering losses if the price rises.
- Fear of losing gains, etc., causes many to sell too fast.
GREED
Greed is the most prevalent emotion that stock traders deal with daily, second only to fear. It’s a disproportionate drive for profit, to put it simply. This is a problematic emotion since traders are in the market to make money. So, what is too much profit? Why should they abandon a position if the markets are behaving as expected? Why not hold on to the position and profit more?
These are some of the common concepts that GREED instills in our minds. When the markets are bullish, prices increase. This is more prevalent. It encourages traders to hold winning positions open for far longer than is prudent and throw caution to the wind. While optimism is beneficial, there is a fine line between greed and optimism that each trader must recognize and avoid crossing.
HOPE
The only difference between stock trading and gambling is irrational HOPE. While ‘hope’ is a pleasant emotion, it can lead to significant losses when it is not backed up by reasoning. Consider buying a stock because your research indicates that the price will rise during the day. The stock price starts to fall after an initial jump of an hour. You’re perplexed as to why prices have dropped. So you hold on to your position for a little longer in the hope that the price will start rising again and help you recoup your losses.
Traders who can’t manage their HOPE are likely to lose their trading capital quickly. Because they HOPE for more, it prevents them from minimizing their losses and/or booking profits even when the markets are in their favor. When GREED combines with HOPE, the consequence may be disastrous!
REGRET
Assume you want to buy ABC Limited stock because you anticipate its price will rise during the day. You decide against it at the last minute and hold back. The stock price rises and doubles in value within an hour. This is when you begin to experience REGRET.
WHAT WOULD HAVE HAPPENED IF I HAD PLACED THE TRADE? I squandered a fantastic opportunity. I had a sense it would occur. Such ideas muddle your mind, and you may decide to buy the stock at a double price to compensate for the missed opportunity after telling yourself that the price would increase. While this may appear to be a sensible choice at the moment, it will be made out of REGRET rather than analysis. As a result, you’ll find yourself on the losing end of the trade more frequently than not.
Conversely, you may take a position even if you are unsure. Assume you are uncertain about ABC Limited’s price rise but decide to invest anyhow because many experts do. The stock price starts to decrease as the day passes. Another area where REGRET might intervene and force you to sell the stock without first examining its performance and possibility for recovery during the day. While trading stocks, it’s important to remember that you’re bound to miss some chances and make a few bad deals. Accept this fact and be calm whenever such a mind arises.
FEAR OF MISSING OUT (FOMO)
FOMO, a word popularized by social media, existed long before computers. Fear of missing out on an opportunity starts FOMO. Anxiety drives traders to take positions after the opportunity window has closed.
EGO
When trading stocks, keep in mind that you will almost certainly lose more deals than you win. While this may appear discouraging, if you understand and accept this possibility, you may use sound risk management to increase your gains and reduce your losses. Emotions might lead you to take trading judgments that are harmful to your portfolio. So, what are you going to do?
How to Control Emotions?
While trading emotions is a never-ending fight, the solution is actually easy. Professional traders always follow a tight trading technique that helps them contextualize their decisions and keep their emotions in control. Traders might use a tried-and-true trading strategy to regulate their emotions. A structured trading system provides a foundation of established logic on which traders may depend while attempt analyzing market data and their own emotions. Various rules help structure all investment decisions in an efficient trading strategy.
Rules Establishment
To deal with the psychological crunch, a trader needs to make rules and stick to them, and they must do this. Set rules for when to enter and quit trades depending on your risk-reward tolerance. You may also choose which specific events, such as a good or negative earnings announcement, should prompt you to buy or sell a stock. It’s a good idea to set daily limits on how much money you’re willing to lose or win. As long as you meet your profit goal, you can take the money and run away. In this case, fold up your tent and go back home. You’ll live to trade another day in any case.
Rules for Identifying Trades
The rules for selecting trades help traders stay on track and concentrate on areas where their knowledge and experience help. These rules are particularly useful in managing greed and fear of missing out since they keep traders in familiar asset classes rather than pursuing profits in unfamiliar asset classes. Trading is a lot like being a robot.
Rules for Executing Trades
Opening and closing trades is always the most stressful part of trading. Even the most well-researched trades might go wrong if the trader is too emotional. Having strict rules for when and how to execute trades helps maximize profits from good ideas and minimize losses from bad trades.
After-Trade Rules
Whether you have hit your weekly profit target or wiped out two days of effort, it is always prudent to have a system for calming down between trades. Every trade colors your emotional state. Thus the finest traders know how to purify themselves before moving on to the next.
Reviewing and Doing research
Traders must be professionals in their chosen stocks and sectors. Keep up with the news, educate yourself, and attend trading seminars and conferences if feasible. Give yourself plenty of time to investigate. That entails looking at charts, talking to managers, reading trade magazines, and undertaking macroeconomic or industry research. Fear may also be overcome with knowledge.
Flexibility
Traders must maintain flexibility and consider experimenting from time to time. You may, for example, think about utilizing options to reduce risk. Experimentation is one of the most effective ways for a trader to learn (within reason). The experience might also help in the reduction of emotional impacts. Finally, traders should regularly evaluate their own performance. Outline your trading plan, keep up with the markets, and assess your schooling progress. It can help traders fix errors, eliminate poor behaviors, and increase total returns.
How Can Emotion-Driven Trading Decisions Be Reduced?
It all starts with recognizing your emotional triggers and understanding how you respond to them. What do you do, for example, when you’re scared? Or is it regret? Knowing how you react to unpleasant emotions is the first step toward effectively regulating them.
Trading is all about trusting your gut. You must, however, try every effort to ensure that your instincts are based on facts and research. It’s a razor-thin line. Keep a notebook and track trades where you let emotions influence your decisions. While placing such trades, try to notice trends and consider your mental mind. It will assist you in making better decisions in the future. To ensure that you record profits and losses at preset levels without enabling hope, you must create a risk management plan.