Trading Psychology

Psychology of Trading

If you have been trading for any length of time…… you probably have come to understand that the emotions and preconceived ideas we bring to the trading table tend to work against us in the world of aggressive trading.

To succeed in the trading business we need to develop a trading psychology that gives us the ability to do exactly the opposite of what our emotions and preconceived ideas are telling us…… and train ourselves to Focus on our objectives. This is where understanding your own trading psychology comes into play. To accomplish this effectively……. it is necessary to find out the real reasons why we are trading in the first place.

While “making money” is probably the most obvious reason….. there is in fact a whole host of reasons why we try our hand at commodities and stocks. These range all the way from accumulating lots of money , to having those warm fuzzies about ourselves…..knowing that we were right about the trade. Also, another reason is gaining the respect of family and friends.

These reasons are equally as strong as the money factor, and when you get right down to it…… for some people money is usually the means for achieving something else, like respect.

Therefore, if we are to be successful traders, it may be helpful to realize what our own true motivations are. Regardless of what your reasons are for trading……it is essential that you learn to keep your ego in check because it is the one thing that will lead you to make the wrong moves. Improper trading psychology always results in either Fear or Greed.

I’ve gathered some of the best information on the web concerning Trading Psychology in hopes of giving all of us a more complete understanding of “The Mind Game”

Understanding your own Trading Psychology

Overcoming emotions is one of the biggest challenges in my opinion. One common mistake that beginner traders make is to trade on impulse without a clear strategy or level head which can lead you to place trades which you would later regret. I find placing stop/limit orders for exits seems to work better for me as it takes the emotion completely out of the equation.

We have found through experience that our investment performance improves when we follow the rules listed below: –

  • Develop your own style and stick with it. E.g. are you a short-term technical trader or a medium-term trend trader?
  • Be patient. If you are a trend trader review as many markets as you can and find a market that is trending – and having found it, get in and stay in for as long as you can. Many people use a 20-day moving average of the market they are in to monitor any change in trend. There are usually several great opportunities a year to profit from market timing, so be ready to take full advantage of these moves. Extremes in market psychology usually mark the major turning points – i.e. bullish or bearish sentiment dominates the attitude of the majority of market players.
  • Don’t drain yourself emotionally by trying to trade all the time – take regular breaks of a week or more.
  • Set your stop losses and stick with them. Losses should be taken early, systematically and ruthlessly to protect your investment capital. If you are a medium-term trader manage your position, especially if you have been successful in letting a position run. Once you have a decent profit build up your position. However, after a large move in your favour, it is prudent to move your stops to lock in some profit and/or close down some of your position.
  • Try not to focus too much on the profit/loss of a trade while the trade is ongoing. Thinking about how much money you are making or losing on a live trade may cause the emotions of greed or fear to influence your decisions.
  • Be even-tempered; don’t let your emotions of greed and fear get in the way. Be as objective and ‘cool’ as you can be. Hope is often associated with unrealistic expectations and causes an investor to cling to a losing position, magnifying the losses unnecessarily. Greed causes an investor to buy at the wrong time, such as near the peak of a rally, and to risk excessive amounts of money. Fear prevents an investor from buying at a time when the market presents the best opportunities to buy, and likewise prompts him to sell at the worst possible time (normally at the bottom of a correction or bear market).

I have increasingly used spreadbetting recently to offset against a potential ever growing tax burden! It seems though that as much as I try my behaviour or psychology is very different than when I physically own a stock. I can’t really put my finger on it, maybe it’s something to do with the constant flashing numbers in front of me, I just don’t seem to be able to hold a position for very long! I tend to hold spread bets for about a month or two but never to see them reach expiry… – Tom

You are right – the spread betting argument is IMO totally psychological, if it weren’t then I would hold a lot more of my holdings in spread bets. It can be very difficult to see all the reds, particularly when you are just starting out but it helps to set your stops and limits and then proceed to walk away only acting on unexpected news or significant changes.

I have at last got around to it and just started. I am being mega cautious. I had a few bets on the FTSE 100/Dow using the introductory 10p/point low bet limit at IG Index just to get the hang of the system, limits/stops etc. Made a quid here, lost 50p there and so on. Like others have said, it is quite uncanny how the market reacts as soon as you open a bet, I could swear there was a webcam behind me watching what I was doing. Open a long on the FTSE thinking it had bottomed, within minutes it would spike down to exactly my stop, and then soar away.

I have no intention of betting the indices for real, at least not for a good while – I will be sticking to small individual stock bets for now. As you say, protection of capital and risking tiny proportions on each bet is the way. It does make initial progress a bit painfully slow though! If only I could shove 50 grand in my account. I opened a limited risk account but I am already getting fed up with the wider spreads and the inability to bet some stocks. I think I will be converting it soon. – Nathan

P.S. If you want to read a good book on trading psychology you could do a lot worse than The Way of the Warrior Trader. Remember: Trading is kill or be killed. No room for the squeamish…

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