Trading psychology is the most underestimated aspect of day trading and investing. Any trader aspiring to become successful in this area must master the psychological skills related to the world of finance.
Day trading is a fast-paced and challenging environment with countless obstacles to be overcome on a regular basis.
What Is Trading Psychology?
Trading psychology is about how the human mind relates to trading decisions. It involves how emotions affect a trader’s ability to think logically, and why successful traders think the way that they do.
Emotional turmoil will wreak havoc with even the most skillful trader’s decision making process. Learning about trading psychology is a step towards preventing these types of mistakes. The psychological profile of each individual trader has a large influence on whether or not they are able to perform to their potential.
The Role of Emotions in Trading
Two emotions, in particular, are responsible for preventing the success of many traders—fear and greed. Both of these emotions have been proven to negatively affect a person’s complex decision making process dramatically.
If a trader cannot conquer the issues these emotions present they are unlikely to ever be successful. A trader must not only identify any potential issues but they must also work to overcome them. Mindset is everything.
Fear - The emotion of fear is an evolutionary device that promotes survival. Fear helped the human species to survive throughout history, but it isn’t always so helpful.
In a trading context both fear of failure and fear of success are obstacles to overcome. Fear of success occurs less frequently, but it can still be a serious issue for many traders. Self-sabotage is an aspect of modern psychology describing people who don’t believe they deserve success and actively work against themselves.
Fear of failure comes about because of perfectionism. A trader ends up being unwilling to make trades because of a risk of loss, no matter how small. This mindset leads to increased stress levels and a downward spiral of overall trading performance.
Greed - This emotion applies to everyone to some degree. It is a part of our nature to want more of a good thing. But in the world of trading and investing this attitude can lead to a fast downfall.
A trading strategy is necessary to be a successful day trader. Moving away from what the strategy dictates is a recipe for disaster, and yet this is what many traders do because of a poor knowledge of trading strategy.
Overtrading can creep in, eating away at the profits. This leads to ever more increasing risk taking, and eventually the loss of the trading capital.
Greed can often be fed by the euphoria of successful trades. Traders must beware of getting drawn into feeling that every profitable trade is down to their mastery, and that more is better.
The Need for a Trading Plan
A comprehensive trading plan is necessary for success regardless of how talented or skilled the trader is. Not only will a profitable plan succeed constantly over time it will also assist the trader from making trades based on emotion.
Any high quality trading plan utilises a stop loss. Risk management not only ensures that losing trades do not become disastrous, it also takes emotion out of the decision to pull the plug. The trader simply follows the strategy.
The rules for the trading plan can be changed as the trader gains experience. But it is crucial that these rules are not interfered with mid-trade. This will only allow emotion to creep into the decision making process.
Trading psychology is a vast subject that all traders must get to grips with. It is a crucial part of learning to trade using only logic, free of emotion. Fortunately it is incredibly interesting and something that traders can work on throughout the entirety of their careers.
