Emotions/Psychology

Trading psychology refers to the mental state that helps dictate success or failure in trading. This represents a wide range of aspects of an individual’s behavior and character that influences their actions. If you have ever traded before, you understand just how much your emotions impact your trading. Getting to know these emotions and learning how to minimize their effects is vital in finding success.

One common emotion experienced while trading is greed. Greed pushes us to want more, in fact, so much more that it can cloud our rationality and judgment. Greed drives us to make decisions that can be too risky or dangerous to our account. This emotion is most apparent in the final phases of a bull market when caution is thrown out the window. Overcoming greed can be a difficult task, but isn’t impossible to beat. It is important to set specific trading parameters on when to take or not take a trade. This, along with a risk-reward ratio should be written in your trading plan.

Another common emotion most traders encounter is fear. Fear causes us to avoid risk and therefore, produce lower returns. This can also cause traders to exit positions too early in fear of taking a loss. When we see a trade going in the opposite direction, we tend to get scared and sometimes overreact by closing our position. Quantifying the fear is one way we can help minimize it. We should go into a trade thinking through the possible events and negative effects that may occur. This way if things do not go in our favor we have already thought out what could happen. It is also important to think through why you had entered the trade in the first place. If you believe it was a good trade to take, do not let fear drive you out of it.

Other emotions and habits that cost traders money

• Revenge trading. After a loss, the urge to win it back right away leads to bigger size and worse setups. One loss turns into a lost day.
• Fear of missing out (FOMO). Chasing a move that has already happened means entering late, with a wide stop and little room left to the target.
• Overconfidence. A winning streak makes risk feel smaller than it is. Many traders give back a good week by raising size on Friday.
• Hope. Moving a stop further away because “it will come back” turns a planned small loss into an unplanned large one.
• Boredom. Taking trades because the market is slow, not because your setup appeared, is the most common cause of overtrading.

Practical ways to keep emotions out of your decisions

1. Trade a size you can ignore. If you watch every tick in your profit and loss, your size is too big for your account or your nerves. Micro contracts exist for exactly this reason.
2. Decide the exit before the entry. Place the stop and target with the order, so the decision is made while you are calm.
3. Use a daily stop. A fixed loss limit or a maximum number of losing trades ends the day before revenge trading can start.
4. Take a break after a loss. Stand up and step away from the screen for a few minutes before the next trade.
5. Journal how you felt, not just what you traded. Over a few weeks the pattern shows up: the trades you took bored, rushed or angry are usually the losing ones.
6. Practice new strategies on simulation first. Confidence in a setup comes from having seen it work many times, and simulation lets you collect those reps without the pressure.

Rules beat willpower

Willpower runs out at the worst moment, usually after a string of losses. Rules written in your trading plan, and enforced by your platform where possible, keep working when you are not at your best. That is why some traders move to automated systems, and why many more automate just their exits and their daily loss limit with tools like our Account Risk Manager. If you want to go deeper, our list of great trading books starts with the best one written on this subject.