Trading psychology – A brief analysis

An essential component of successful trading is psychology. By the term psychology we refer to the state of mind a trader should have while trading.  

New traders are concerned only with making money. They celebrate when their trades are profitable and ignore trades that lose money. This is a bad idea. The path to becoming a long-term successful trader requires an understanding of why the trades lost money. Then it becomes possible to reduce the number of trades that failed. In other words, if you cannot find a strategy which results in a consistent and rising equity curve then you should fare better by finding other strategies than the ones you are unsuccessful with. 

We all make winning and losing trades, simply because of probability. Some, but few, traders are skilled in predicting market direction. However, most traders, including professional money managers, have a difficult time outperforming the market averages. Studies have shown that most individual investors fail to understand this simple principle and tend to believe that their results are better than their actual results. In other words, they believe they do better than the market averages when in fact they perform far worse. 

If we have no special skills when selecting our trades, then we must develop some skills that give us a trading edge. With no edge, we can expect to win about half the time. When we add in the cost of trading (i.e., commissions) we must do one of two things as traders: 

• Earn a profit well over 50% of the time.
• Be certain that we do not lose more money from losing trades than we earn from winning trades. 

To meet that goal, we must practice good risk management and be certain that our losses are limited to acceptable levels. However, that is not the only thing we can do to achieve success as a trader. The way we think, the trader mindset, contributes a great deal to the success or failure of almost every trader. 

What Is Trading Psychology? 

Trading psychology deals with the mental state and emotions of traders. It’s the influence of your behaviour and characteristics on how you trade. It also touches on your discipline and risk-taking. 

Your mind plays a big role in your success at trading financial instruments in the long term. Understanding how you think about trading can be just as important as your knowledge about the market and your trading skills.   

Let’s look at two biggest and influential emotions in trading: 

• Greed. 
  
  Greed can make a trader stay in a position too long just to try to wring every last cent out of it. It can also be a factor in taking on risky and speculative positions. It’s most common toward the end of a bear/bull market when speculation runs wild among traders. 
   
• Fear. 
  
  Fear of being stopped out or fear of taking a loss. The usual reason for this is that the trader fears failure and feels that he can’t take another loss. The trader’s ego is at stake. Fear is the opposite of greed when it comes to trading. It’s the reason people exit an open position too early to cut losses and avoid taking on extra risk. 

These emotions and many more play an essential role in your overall trading strategy. Mastering them is fundamental to becoming a great trader. 

Key Characteristics of a Winning Trader 

Psychologically, the very best of traders share the same key characteristics, including the following: 

• They are all comfortable with taking risks. 
  
  People with very low-risk tolerance, who cannot accept losing trades, are not cut out to be winning traders, since losing trades are simply part of the game of trading. Winning traders are able to emotionally accept the uncertainty that is inherent in trading. Trading is not like investing your money in a savings account with a guaranteed return. 
   
• They are capable of quickly adjusting to changing market conditions. 
  
  They don’t fall in love with, and “marry”, their analysis of a market. If price action indicates that they need to change their view on probable future price movements, they do so without hesitating. 
   
• They are disciplined in their trading and can view the market objectively, regardless of how current market action is affecting their account balance. 
• They don’t give in to being excessively excited about winning trades or excessively despairing about losing trades. Winning traders control their emotions rather than letting their emotions control them. 
• They make the necessary effort and take the necessary steps to be self-disciplined traders who operate with strict money and risk management rules. 
  
  Winning traders are not reckless gamblers. They carefully calculate potential risk against potential reward before entering any trade. 

Conclusion

Trading the financial markets is most certainly not a get-rich-quick exercise but rather a slow and consistent journey towards reaching your financial goals and ultimately becoming financially independent. 

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