Trading Psychology

Trading Course (Get Started In Trading) Trading Psychology

So far in this course, we’ve looked at the practical things you need in order to start trading. However, a really important component of successful trading is that of managing your own emotions and psychological stresses, when you’re actually carrying out the trades. Getting to know your own thought patterns, emotions, and behavioral patterns is a prerequisite in order for you to be able to carry out what’s written in your trading plan!

In this lesson, we’ll look closer at some important bits and pieces of trading psychology. However, as you might expect given the complexity of the human mind, this is a vast and inexhaustible area where there always is more to learn. Furthermore, theoretical knowledge can never replace the experience and self-understanding that comes from real trading!

Introduction

How come that two traders who use identical trading strategies and setups, still can yield surprisingly different results from their trading?

Well, the reason, as you might expect, can often be explained with the help of trading psychology.

Throughout our lives, we have been hardcoded with certain thoughts, emotions, and behavioral patterns that serve the purpose of keeping us from experiencing pain and disappointment. This is something that affects us not only in our trading but also in our everyday lives.

Of course, these patterns serve a purpose, and often work well. However, when attempting some tasks, such as trading, they can instead pose a significant hindrance, and keep us from succeeding.

To become successful traders, most of us need to bring these hidden tendencies of ours to the forefront, and learn how to deal with them. Otherwise, the chances are that they’ll make us deviate from our trading plan and strategies, essentially helping us make irrational and foolish decisions.

Once you’ve dealt with your inner demons, you’ll have a much better chance of understanding your own preferred trading style, and can use this insight to tailor the methods you use to your own personality!

In short, the principal psychological forces we have to learn to deal with, are fear and greed!

Fear and greed

Take a couple of minutes and think through the varying and different situations in life when you’ve reacted with fear or greed. Try to imagine the effect of the emotions that these situations have instilled in you. Were you able to keep calm and react sensibly, despite the emotional turmoil at that time?

Below we are going to look at a few concrete examples of when these very emotions are at play. Perhaps you’ll be able to identify with the scenarios below?

Scenario 1

Imagine that your strategy provides a buy signal, and you have gone along and bought shares in that company. A few days after the entry, your strategy once again provides a signal, but this time to close the trade.

You start to hesitate.

Why close the trade now? You’re sure that the share will continue up for a couple more days, and don’t want to miss this perceived chance!

As a result, you remain in the trade for a few days. You couldn’t resist your own greed, and deviated from your set rules.

Scenario 2

After having refrained from buying shares in a company, you still cannot let the thought of taking that trade fade away. The following day, you check in on the stock, and notice that the share is up almost 4%.

In this scenario, many people will succumb to their emotions of greed, and take the trade, even if the signal is not active any longer!

Scenario 3

Your strategy gives a buy signal, but upon inspecting the chart of that very share, you notice that it has been falling a lot for three whole days in a row. As a result, you start to fear that selling pressure has been released, and that the stock will sink like a stone.

To add insult to injury, you notice that the downturn has formed after a quite weak earnings report.

Out of fear, you decide to not take the trade. You simply let fear get the upper hand!

Scenario 4

You have bought shares in a company, and the day right after, it gaps up by 2%, and continues to rise during the first hour of trading.

You decide to sell the stock, and take the profit you have made so far, instead of waiting for the actual sell signal. Again, you have let your fear take the upper hand!

After reading the examples above, are there any scenarios you can identify with? We assume there are, as these are situations that nearly all people will find themselves in.

The difference between profitable and losing traders often is not that the former does not suffer these types of stresses. Instead, they have learned methods to deal with them!

So with that said, let’s look at some tips that will help you alleviate a lot of the psychological stresses that are part of trading!

Mastering the Psychology of Trading

Try to identify the varying emotions and feelings that are evoked by certain types of situations. The best way of doing this, is to keep a trading journal. For each trade you place, you jot down how well you managed to follow your trading plan, the emotions you experienced, and how it affected you throughout the trade. We’ll look closer at the trading journal in the next lesson!
Create a trading plan that aims to support your actions and help you deal with psychological stresses. The trading plan could, for instance, include the use of daily routines and checklists to master the psychological hardships experienced in trading. In the coming lesson, we’ll look closer at how you could go about designing a trading plan that suits you.
Take a long term approach to working with your own perceptions of and attitudes towards issues, to form a “trader’s mindset”. This will help you remain disciplined, focused, and safe, even in the most challenging of times.
Learning from practical experiences. Paper trading is a great tool, and one that we recommend to help you get started in trading. However, it’s first when you start to trade with real money, that you’ll have to confront your inner demons and psychological pitfalls.
Get a “trading buddy”. Many experienced and successful traders have stressed the importance of having a trading buddy. Having somebody to share your thoughts and experiences with is a great way to gain new perspectives on issues, as well as to keep developing as a trader!

Conclusion

In this lesson, we have had a brief look at trading psychology. At first glance, it’s a topic that seems crystal clear and obvious, but just as with many other things, it’s really easy to identify other people’s mistakes, while still remaining blind your own.

In addition to looking at the issues surrounding trading psychology, we have also looked at a couple of tools you may use to master your own psychology. As we mentioned, some of the most important tools are the trading plan and the trading journal, which both play a role in getting us to adhere to the rules we set out in the beginning. Again, these will be covered in greater detail in the coming lessons!

If you want to expand your knowledge on the topic of trading psychology, we highly recommend the following resources.