‘Getting the psychology right’ is one of the phrases that floating traders often say. If you ever seriously want to make money on the financial markets, you need to understand the psychology of trading. It’s the difference between a trader and a jockey on a horse. Good teeth, good form, good bow action – but can they ride? Like a good polo player, a jockey has a sense of positioning and balance when they’re in the saddle. It’s a feeling more than anything else. While technical skills and insights into market knowledge are valuable in the financial markets, the realm of illusions, misunderstandings and cognitive biases in our trading psychology is equally important.
Aside from mathematics, the key discipline that effective trading psychology demands is the management of fear and greed. Fear can cause a trader to feel he has had enough on a winning day and sell too soon, or make him reluctant to take needed risks. Greed, by contrast, might lead him to run a winner for longer than is sound strategy, sometimes to tremendous loss. Successful traders create a psychic condition that is as cool as the ‘law of large numbers’ behind it requires, rather than being buffeted by the latest booms and busts.
Furthermore, high self-awareness is an important aspect of a resilient trading mindset: it’s a way of recognising your triggers and patterns of behaviour. It’s about spotting how you operate – what your strengths and weaknesses might be – and then deriving trading strategies that suit your psychological profile.
After all, the right trading psychology can never be learnt and then set aside; as V~iac~e~s advises, it must be developed and adjusted indefinitely, until it matches the self that the trader is transforming into. This necessarily idiosyncratic notion places the market experience in conversation with the human experience, as few other things do. Viewing each trade as a test not of a system or strategy, but of the self, means that losses must be parallel to gains as steps along a path toward becoming a better, more knowing and more compassionate investor.
For traders, the psychological traps can absolutely ruin confidence and decision-making but, nonetheless, hold us back from making good decisions or derail us into situations that end badly. A classic psychological trap is the experience of overconfidence; that is, thinking that you are considerably better at picking winning trades and plays in the market than the next guy. The outcome is frequently taking on more risk than is appropriate given the true risks at hand. Typically this overconfidence leads to major losses when the market shifts in ways that were unexpected.
Another common error is loss aversion. The prospect of a loss upsets people more than the prospect of making gains. Traders hesitate or refuse to cut their losses, and instead hold on too long in the attempt to retrieve their trades. This is a sinking game.
Worse, trading psychology is under the grip of confirmation bias – the tendency to seek information that supports existing beliefs or assumptions. At its worst, confirmation bias shuts out conflicting data that, when analysed rationally, would redirect or kill a trade.
Furthermore, herd pressure is not trivial – the fear of losing status with the crowd or other traders by not adhering to prevailing market sentiment or peer perceptions may lead individuals to abandon their own strategies in favour of breaking with the herd’s general trend, irrespective of its analytic basis.
If we don’t recognise these biases and their effects, we might lose our trading edge and sink into traps of irrationality. Learning to identify these mental mirrors of human psychology and counteract them can fortify our emotional discipline and enhance our performance in the market.
Trading decisions are often guided by emotions that play a crucial but neglected role in financial markets, where traders can be swayed by a ‘hot’ miscue of fear, greed and anxiety. Fear might cause hasty exits on anemic days when stocks are in free-fall, as traders give up safe positions fearing further losses down the road and are tempted to sell everything and go fishing. Greed might tempt traders to overinvest or take riskier positions than usual on good days, thinking that all they need is one more disaster to get rich.
Furthermore, emotions can blind us to reality and cause cognitive biases. Confirmation bias might prompt a dealer to look for confirmation of what he or she already believes. If the trader wants to buy and suspects tension in the market, information might be sought that shows that the market is locking up. Such a dealer is likely to make bad decisions and exacerbate the very outcomes that he seeks to avoid.
Furthermore, as collective emotions drive volatility in the market, successful traders need to understand this rippling effect. Practices such as mindfulness, Tai Chi and meditation can all be employed to foster emotional awareness for traders While traders may never feel detached from their emotions, they can view them as mere tools, alongside technical analysis, trading platforms and their laptop. By developing self-awareness and using mechanisms such as buy-and-sell stop-losses or even resorting to meditation practice or possession of a Lucky Dime, traders can help to mitigate emotion’s negative influence on judgement.
Moreover, getting to grips with the psychological side of trading is just as important as the acquisition of technical/market or hard skills; it is a life-long learning process, a discipline in the truest understanding of the word, to remain profitable in a deeply uncertain environment.
traders must eliminate emotional decision-making, and greatly improve their trading discipline to achieve good resultsWith a detailed trading plan in place, including entry and exit criteria, risk management including stop-losses, take-profits and/or trailing stops, regular post‑trade reviews, consistency and discipline can be maintained in your trading.
The second is a trading journal. Record every trade, the reasons why you made it, your emotions on the way out, how it turned out. Reflect on and learn from your mistakes; identify repeated patterns of failure; note your emotional triggers and how they affect your own decision-making.
Furthermore, thinking in the longer term rather than imagining each trade to be a life-or-death battle improves discipline; traders have a chance to gradually refine their strategies and skills (again, using poor performance as a signal for strengthening trading practices, not for panicked or average-downing abandon), rather than obsessing about this week’s bottom line. With this perspective, fear of missing out (FOMO) and chasing losses diminish.
Lastly, by being mindful and using various mediation techniques to strengthen self-awareness, traders can better regulate their emotions while trading. This might be by remaining calm in front of the screen using mediation or deep-breathing exercises. Self-awareness can help traders stay cool in the most extreme market situations, which improves self-discipline and promotes more effective trading generally.
A resilient trader is almost necessary for functioning in such perilous markets. Financial markets are beset with uncertainty and risk. When shared between our thoughts, our feelings and our invested money, these stressors can easily derail us into emotional turmoil and decision-making paralysis. A resilient trader frames challenges in a healthy way, seeing setbacks as learning experiences instead of insurmountable obstacles to be conquered.
The first aspect to developing such a mindset is cultivating self-awareness: holding up a metaphorical mirror to one’s brain and being able to acknowledge the existance of emotional triggers, and how these feelings can influence decision-making processes; observing patterns of behaviour in the past, when trades were going well and times when losing trades were experienced, and finding coping mechanisms to remain ‘in the zone’ under pressure; spending time with oneself, recognising patterns of behaviour, and developing the discipline required to ‘trade to a plan’ when engaging in the market.
Furthermore, resilience in trading means thinking in the long run. One who is successful in this field learns to acknowledge and deal with all the temporary losses; each failure becomes an additional training for winning in the future. For this reason, one is much less likely to panic over losses and be driven by emotions of fear and greed.
Furthermore, surrounding oneself with a community can significantly increase one’s resilience. If you have a network of people you regularly trade with, then there’s another group where you are able to share your ups and downs and know that others are in the same boat.
Developing a resilient and hardy trader’s spirit is more than just emotional intelligence, it is also learning analogous practical tools, and infusing both with confidence. Hardy traders can endure the psychological pressure of the market and learn to bounce back when a less fortunate moment makes them question what they are doing – believing in themselves and having been mentally prepared to do this by their education.
For a trader, reflection — the practice of stopping and thoroughly examining the qualitative and quantitative results of your work — is an absolute necessity. Trading isn’t just about the technical aspects of the concrete transactions. It’s actually a really emotional game, and the trader has to navigate a lot of mental and emotional territory: market volatility, personal biases, risk management, earning outcomes and even our own sense of self-worth. Often, we’re so hellbent on breaking through that glass ceiling, and winning this incentive race, that we have very little time to pause and really delve into how we’re making decisions.
A second practice of traders is reflection, the examination of trades that have already taken place. Good traders can look back on how they made decisions during their trades, and use this examination to develop their judgment about whether they are letting emotions lead them to bad trades, and whether they can avoid superficial analysis in the future – and how.
A third component to our reflective practice is the virtue of continuous learning, an ongoing proactive search for external sources of information that can inform our trading during ever-evolving market conditions and psychological circumstances. The financial environment is in constant flux, requiring us to adapt our game plan based on varying new circumstances. Reading books, taking courses, or simply discussing our trading with others can be a source of new insight that can refresh the way we trade.
Finally, developing a habit of reflection and lifelong learning can make traders tougher. Mistakes happen but they can be potent learning material if one is open to hearing it. Committing to a cycle of questioning and learning can help traders get better, and even create a tougher psychological infrastructure for playing the market.