Trading psychology: getting in the mindset of a successful trader
You can’t escape your emotions, but to trade at your very best you need to learn to manage them
Trading the financial markets is one of the most exciting ways you make – and lose – money. A whole range of emotions come into play, from fear to hope and greed to regret.
However, as any successful trader knows, it’s important not to let these emotions govern your decisions. Maintaining the right trader mentality will give you a higher chance of seeing a return on your investment, or at the very least, minimising your losses.
What is trading psychology?
This mindset is also known as trading psychology, and it refers to the various aspects of your personality and behaviours, which influence your trading actions. Such is the importance of psychology when trading, it has sparked a whole field of study, called behavioural finance, which looks at how emotions and biases drive share prices.
Ultimately, traders are not always rational and are influenced by their own biases. The key to improving your trading psychology is to recognise these biases, emotions and personality traits – and put a plan in place to manage them.
Ekaterina Serikova, Currency.com’s trade behaviour analyst, explains: “You can’t always control your emotions. However, the capability to perceive and recognise them and not let them rule your decisions, can take your trading experience to the next level.”
Trading psychology can be associated with a few specific emotions and behaviours that are often catalysts for market trading. Here are the key ones:
Fear: While fear is an important part of survival, it can be a performance inhibitor when trading. Fear is triggered by a perceived danger, which in trading is a threat to your profits. It’s most often seen during bear markets, when it can cause traders to panic and act irrationally in their haste to exit the market and minimise losses.
By working out what you are afraid of and knowing how you may react to those fears, you can work on a plan to help you move past the emotional response.
Greed: You may have heard the Wall Street expression, “pigs get slaughtered”, which refers to greedy investors hanging on to winning positions too long. Greed often occurs after periods of sustained success, leading to overconfidence and aggressive risk taking.
Greed often kicks in during the final phase of bull markets, when traders are seduced by the prospect of getting rich quick.
Regret: Regret is more complex. It may cause you to buy shares at inflated prices, after initially missing out on, or missing out on an opportunity due to a previous bad experience. However, there is also the regret theory, where traders anticipate regretting making the wrong decision, which can either make them risk-averse, or drive them to take higher risks.
Hope: We all need hope when trading, right? Otherwise, why would we do it? So it may surprise you that hope is one of most dangerous emotions in forex psychology. Hope is what keeps you in a losing trade after you have hit the stop, or prevents you from taking profits on a winning trade. It’s what makes traders make bad decisions in the hope of recouping past losses and it’s the main reason people trade with money they don't actually have.
How to master trading psychology
No matter how great a trader you are, or how well you think you handle your emotions, it’s impossible to remove them from the equation completely when trading. Emotions are what make us human, and they are tied up in almost everything we do.
This is why you shouldn’t try to repress or ignore your emotions – in fact, you need to do the opposite. It is only by recognising and accepting your emotions, that you can improve trading psychology, to ensure you don’t make trading decisions while under their influence.
“Successful traders don’t get rid of emotions,” says Serikova. “They experience them to the fullest and use them as additional information for trading.”
One way to monitor your emotions is to keep a trading journal. This may sound a bit sixth grade, but writing down how you feel every time you open or close a position will help you understand your psychological state.
“It can be hard to notice these emotions as they are happening – we get caught up in the moment,” says Serikova. “But once you get used to reviewing and analysing how you feel you will become much more proficient at being able to spot the impact your emotions are having on your behaviour.”
One you have learned to recognise these emotions, you can begin the next important step of pausing before taking impulsive action.
So often our actions are guided by our unconscious emotions. It’s why we might fly off the handle when our children play up, our dog chews our shoes, or someone takes our parking space. In hindsight, we know they are just being children/dogs/human (delete as appropriate), but our emotions in the moment are powerful triggers.
This is what “time out” was created for. It’s not just for the kids to calm down, it’s space for the parents to cool off – and to then manage the situation with a rational mind.
You need to employ the same tactics when trading. If you are caught in the moment of a strong emotion, allow yourself time for the feelings to pass before you do anything. Try counting to 10 or take three deep breaths, right down into your belly, or just take a walk. Anything that removes you from the situation and gives your head time to clear.
Brett Steenbarger, author of The Psychology of Trading, recommends meditation, exercise or self-hypnosis to enhance your focus and help you get in the “zone” when trading.
“These methods don't eliminate emotion; they build minds,” he says. “If we can exercise for 30 minutes a day and build our cardiac fitness and our physiques, maybe – just maybe – a similar commitment could strengthen our abilities to operate within life's zone.”
Have a plan
As sure as the sun rises every morning (unless you live in Finland), the market will always have uncertainty and there will always be losses.
It’s a dynamic arena with nearly limitless possibilities and there is nothing you can do to change or manage that. What you can do is manage your response to the market and to do this you need a clearly defined trading plan.
No two trading plans are the same, because no two traders are the same. So creating a plan is a very personal thing – it should reflect your trading style, psychology and biases. And by identifying them before you start trading, you might be less inclined to act on them.
Play out the possible scenarios of a trade in your head before opening the position and write a list of rules on what you will do when you feel your emotions starting to kick in.
“Your plan should clearly state the rules of entering, exiting and risk management, with as many different scenarios as possible.” says Serikova. “For example, what you will do if the market reaches the support/resistance line or a previous high or low? What will happen in case of surprise breaking news when you’re in the position?”
Printing out your trading rules and checking them off, one by one, can also help eliminate certain emotions.
Adapt to change
While it is important to have a trading plan, no two days on the markets are the same, so you need to be able to adapt accordingly. This can help to limit your emotional involvement, enabling you to assess each situation on its own merits – ensuring that you trade logically and rationally.
This may mean putting your trading activity on hold until you fully understand current marketing activity, on that particular day.
The key thing about trading psychology is that it is normal to experience emotions. Accepting them isn’t a weakness – it’s a strength. It’s when you can be truly honest about what you’re feeling and why, that you can learn from your losses and improve your skills as a trader.
FURTHER READING: Trading biases to avoid as a novice trader
FURTHER READING: Behavioural finance: how your biases affect trading