May 29, 2020 |James Messi
Trading Psychology: Definition and Best Practices
If until this moment you ignored your trading psychology, this article will convince you to begin to give it the attention it deserves.
What is Trading Psychology?
Most of what you do while you are trading takes place within your own mind. Trading is mostly psychological. Psychology is a study of behavior and mental processes – the thoughts, feelings, and motives that individual experiences.
Trading psychology refers to all the human impulses and emotions that have an effect on the market and trading activities. These emotions and mental states help to dictate success or failure in trading. In fact, a good trading system will consist of as much as 60% of psychological factors and only 10% trading strategies and 30%risk management factors.
Trading Best Practices
Trading means hard work, knowledge, practice, patience, discipline, psychological stability, and persistent adherence to the trading strategy. Psychology in trading is extremely important. Even an experienced, but an overly emotional trader is likely to make costly mistakes that will hinder any trading strategy. Therefore, for the strategy to work and not only retain capital but also multiply it, it is necessary not so much to master sophisticated indicators and knowledge of many patterns as the following trading best practices that focus on trading psychology. These include:
1. Managing fear and greed
2. Practicing patience
3. Developing discipline
4. Continuous self-education
5. Making regular performance review.
Managing fear and greed
Even the best traders fall prey to emotions such as fear and greed. Problems begin if this fear is so strong that it does not allow the trader to take the next steps in the trade. For example, fear of losing money and doubt about one’s strengths can be so strong that the trader will trade for months on a demo account. How to get out of this trap? First, it is necessary to rethink the very essence of trading and accept that it is associated with risk. Next, take this risk under control and learn risk management strategies.
Greed can be helpful if used in the context of your risk management plan. Greed, however, can be counterproductive if you only think about profit and completely abandon your strategy or trading plan in the hope of getting more. Typically, this type of greed occurs when the market goes beyond the planned take profit level, and you decide to hold the trade for longer. Of course, the worst happens when the market changes direction, and your profit turns out to be a loss. Then, you get angry with yourself and decide to continue holding this position until the market moves in your direction. Your anger turns into fear, and as a result, it leads to excessive losses.
Do you ever struggle with patience in your trading? Did you know you need to remain patient to succeed and profit? Patience is a huge part of trading. When you come to the market, it is a marathon, not a sprint. Sometimes, you actually have to sit on your hands and wait for your strategy to show you an opportunity to enter or exit the market.
A trader does not always need to be active in the market and always have a live position going on. Sometimes, it does require an element of being patient and waiting for that opportunity to appear. You do not want to wait too long because you are going to miss the boat, and you do not want to dive in straight away because being impatient means that you are trading when you should not be.
How do you make decisions? Do you have a set of rules or do you just react? The trader must enter the trade when the desired meets all of the criteria. You should not wait any longer. Calculate stop loss in advance.
If there is no signal – keep on waiting and do not deviate from the developed technique after you started using it. Work on this method again and again until its full potential is revealed. Only repetition will strengthen success and the necessary skills. Discipline is your ability to follow trading rules, manage emotions and money. The market will reward you for this, but only the most diligent.
If your trading strategy means relying on technical analysis and charting techniques, then it does not mean that trading psychology does not play an important role in your trades. Often signs that technical charting gives are not enough to make decisions. Traders also need to use their knowledge of the market and instrument they are trading as well as experience to make the right decision.
This is where trading psychology and intuition come into play. A trader will be able to control fear and greed because he or she knows the market well and developed intuition that is not based on emotion but personal experience. You will never be satisfied when the market moves against you, but if your strategy shows losses, you will feel more comfortable with the planned losses.
Thus, every trader should spend as much time as possible on self-education, which means being up to date on all the news, attending trading seminars and conferences, reading trading journals, studying charts, and analyzing the market and industry the trader works in.
Making regular performance review
Develop an understanding of your own decisions. Keep a journal of your decisions and why you traded the way you did. Write down any changes you make in the journal, so you can get a log of your trading decisions in real-time. Did you change the stop losses? Lowered or increased goals? Closed a position earlier?
Analyze every action and create a list of mistakes you made before and record your best trading scenarios, so you can refer to them during your next trading session. Regularly re-read the journal and compare the results of trading with the emotions you experienced during that trade. This assessment and review of your performance will allow you to determine when you are right and think analytically, and when you are under the influence of excitement and other emotions during trading.
Why is Trading Psychology Important?
Trading psychology is an area that is often ignored by traders, especially when they start. Nevertheless, experienced traders who have spent years in the market understand that traders who are going to stay for long are those who have mastered their trading psychology. Trading is an incredibly emotional experience. The cold reality is that a trader will either control emotions or they will control him.
If you feel angry or sad when faced experiencing losses, you let emotions to trap you and determine your trading actions. Your emotional state will force you to make wrong decisions in subsequent transactions. Once you begin to understand your psychological problems and work on them, you can rise to a new level in your trading, and the percentage of your profitable transactions will increase. You will start to make fewer mistakes and less give in to emotions.
As you can see, psychology plays an important role in trading. This is something that cannot be mastered to perfection since trading psychology is a continuous process of self-improvement in areas of your weaknesses. This can be fear, inability to follow the trading plan, or simply lack of sufficient knowledge that leads to other psychological trading mistakes.
To profit over a long period of time, you need to remember and avoid all the psychological mistakes of the trader described in this article. You can achieve this by:
● Overcoming psychological weakness by learning from your own mistakes and assessing your performance;
● Creating a trading algorithm that will open and close positions automatically and without involving emotions;
● Doing both at the same time. You can automate trading to generate revenue and gain experience in a variety of market conditions. With this approach, trading skills will be improved, income will be generated and new ideas will appear to adjust automated trading.