- Emotions are one of the most influential factors in decision making.
- Giving in on emotions often leads to mistakes and losses.
- Training ourselves to understand our mind, its strengths and weaknesses allow us to avoid wrong financial decisions.
- The set of rules can help minimize the impact of irrational behavior in trading.
Emotions and feelings impact the decisions we make. In trading, where cold-headed behavior is critical, our mind becomes our biggest challenge.
With no doubt, emotions are one of the most influential factors in making decisions. Even if we have a solid trading plan, our own psychology still interferes with it and incurs irrational actions.
The way we handle emotions determines whether or not our trades will be profitable in the long distance. In this article, we’ll analyze what emotional forces drive our trading psychology and what we can do about them. Is there a method of how to deal with our mind in order to become a successful trader?
What is trading psychology?
It is a common saying that successful trading consists of 20% of analysis and 80% of psychology. Following that it’s obvious that trading psychology is as much an important factor as a logical cold-headed technical analysis.
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Basically, trading psychology refers to developing a certain mindset and understanding emotions and minds that impact the trader’s behavior. Understanding these minds and their origin can help to have control over them.
But first, it is important to understand where these emotions come from. As you know, they do not emerge out of anywhere and usually are a result of our mind and previous experiences.
The influence of emotions: why and how they affect our decisions?
As experienced traders already know, the markets are driven by two main emotions: fear and greed. Although this is a simplified theory, giving in to those two fundamental emotions often leads to significant mistakes and losses.
Fear
New trader or a professional, everyone feels fear at some point. It is a universal human emotion that comes from the threat of potential harm. When the great gains or losses are at stake, fear often arises.
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Although fear mobilizes us to take action and protect ourselves from danger, it can also evoke long-lasting anxiety. Despite being a complex feeling, fear often has the same psychological symptoms: feeling overwhelmed, upset, or out of control.
Where does it come from?
New trader or a professional, everyone feels fear at some point. It is a universal human emotion that comes from the threat of potential harm. When the great gains or losses are at stake, fear often arises.
Although fear mobilizes us to take action and protect ourselves from danger, it can also evoke long-lasting anxiety. Despite being a complex feeling, fear often has the same psychological symptoms: feeling overwhelmed, upset, or out of control.
How does it affect us?
After losing trade, we usually start to question ourselves. It’s how our mind works. So when emotions take control over us, they lead to typical destructive reactions. Traders withdraw from the trades too quickly, hold their positions too long, or skip the trades because they are afraid of losing funds. Knowing how to handle losses is the only protection from further mistakes.
Greed
Greed leads us in a different direction than fear. Described as a desire to obtain more and better possessions, it can be a mover of evolution. However, the insatiable and uncontrolled greed leads to destructive trading.
Where does it come from?
Greedy traders are usually an outcome of a continuing bull market. They have a positive experience during trading, but are not satisfied with their profits and want more. Preferably as quickly as possible. Impatience and greed become the main factors that suppress logical thinking and strengthen the hope that the market will go in the trader’s favor.
How does it affect us?
Greed often triggers the fear of missing out (FOMO) and leads to making a number of risky and speculative trades that are mostly impulsive. Over-trading is one of the most common psychological problems that traders have to face. On the other hand, traders expect to take advantage of a winning trade and pour more funds into it. Most often, they enter the market before the right moment and lose.
Information bias
Fear and greed are the most common fundamental emotions that hugely affect traders’ behavior. Herewith are other psychological factors that play an important role in decision making.
Bias. In trading, bias refers to irrational assumptions, beliefs, and prejudices. Traders process loads of information and have to make fast decisions. Sometimes, it is too much to deal with, and brains make decisions based on predetermined beliefs rather than on obvious facts and figures.
The way we perceive facts and how we act depend on the information we’ve got. However, the sources that provide information and facts could also be biased, consciously or unconsciously. So while we believe we are following cold facts, it does not necessarily mean we truly do.
How to manage emotions in trading?
Emotions and cognitive biases are inevitable. We’ll have to live with them anyway. However, training ourselves to understand our mind and its weaknesses, can teach us how to avoid wrong financial decisions. Moreover, it can help us to take control of our emotions and lower their influence while trading.
Here is the set of rules that can help minimize the impact of emotions:
1. Know your own personality
Understanding your personality helps to explain why you act in a certain way. What are your character’s strengths and weaknesses? Are you impulsive, impatient, or otherwise, calm and calculated? How do you deal with stress? Are you flexible? The identification of your personal traits lets you find a way to control emotions more effectively.
Markets change in real-time, losses come more often than wins. Staying focused and rational requires psychological preparation. Knowing your personality and mastering self-discipline lowers the risks of irrational trading behavior.
2. Define a particular goal
Goals give us direction. Each goal works like a target, towards which we focus our actions. Further, it brings a sense of achievement when we accomplish it.
The important moment here is setting a realistic goal. The quality of our trades highly depends on the expectation we set in a goal. Every time we set a trading goal, we have to evaluate how reasonable these expectations are, do we have cold facts or statistics to validate them.
Having a goal requires a trading plan, which brings discipline and more consistency in our trading.
3. Create a trading plan
An organized approach to the trading process is a necessary part of profitable trading. A trading plan is a written and researched set of rules of how what and when we will trade. Following it helps to make trading decisions based on logic and prevent irrational and impulsive behavior.
The proper trading plan should include position entry and exit, position-sizing, and risk management rules. Traders also determine trading time limits and restrictions on which part of their investment portfolio value they are going to trade. Usually, it is not higher than 2%.
4. Broaden the knowledge
Information is power. In the trader’s case, it is money. No matter which digital currency you are going to trade, evaluate what you know about it.
Historical price charts and technical analysis are a rich source of data, but not enough to have a broader view. Analyzing the fundamentals provides information that can not be found on the price charts. Moreover, it helps to identify the true value of the asset.
Follow the fundamentals like the supply and demand, the scale of adoption, transaction volumes, competitors, major events, future prospects. The fundamental analysis requires a lot of research and keeping your finger on the pulse of the news. However, do not forget to check up the facts and search for various angles not to get biased by a single source of information.
5. Start a trade journal
At some point in trading, you’ll want to evaluate if the process is going with the plan. For this the documented data are necessary. You may consider starting a trade journal, which is an effective tool here, and helps you to monitor the trading process and analyze the decisions.
Write down your trade details or make screenshots. Document every trade you make and review your trade journal regularly (each week or month, depending on a trading timeframe). Recorded facts give the ability to observe the process, spot your strengths and identify the areas that can be improved.
Conclusion
The asset prices change every day due to various reasons and market forces. These forces, however, are often driven by sentiments, or the general feeling across the market. Differently from rational facts and figures, these sentiments as well as our emotions may be misleading.
Knowing how our mind works can help us to make the right decisions and avoid painful mistakes when trading. However, no less important side of trading psychology is developing key traits like discipline and consistency.
There are plenty of tools, like trading plans and trade journals that give ground and structure to our actions. Incorporating them into our habits can help us change our trading behavior and lower the influence of emotions.
