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Trading, at its core, is a quest to generate positive returns within the dynamic landscape of financial markets. Yet, for all the intricate chart patterns and complex algorithms, it's often the mindset that holds the reins of success or failure.
Although there are several reasons many try their hand at trading—common examples could be to generate an income to possibly leave the 9-5 to spend more time with family, to fund a retirement plan, or to teach their kids a method of investing so they would be financially set up in their future. Whatever the case may be, the primary goal is to generate a consistent income.
As many find out early in their journey, achieving consistent success in trading is not an easy feat and requires willpower and determination to succeed. Andrew Carnegie said it best: ‘Anything in life worth having is worth working for’. And work you must to achieve success in trading.
One of the issues hindering aspiring traders from attaining consistency is their trading mindset. Unbeknownst to many, a hidden orchestra of psychological influences tunes every investment decision, manipulating actions in ways both subtle and profound.
Trading psychology, despite being an often-overlooked subject, is as important as other trading concepts, such as market analysis and risk management. Unquestionably, emotions and one’s mental state can influence trading actions (fear and greed are two common emotional influences experienced in trading [and in life]).
You can have the best understanding of markets and a trading strategy that rivals most, but deprived of a handle on your trading mindset, your trading journey is unlikely to generate positive long-term returns. This is how important an understanding of trading psychology is; trading psychology is one of the first things often recommended to be understood.
Professional traders have learnt to suppress their emotions, not remove them; this is impossible. According to professional traders, one of the keys to trading success is emotional discipline, not so much your intelligence level. If intelligence were the determining factor for trading consistency, a lot more people would be making money consistently in the markets. Doctors, lawyers and engineers, some of the world’s most intelligent people, attempt trading and often fail, yet there are successful traders who have limited education and are able to generate long-term success. The determining factor is often their trading mindset.
Two terms you will often hear traders talk about are the fear of missing out (FOMO) and revenge trading, both of which are inextricably linked to one’s emotional state.
The fear of missing out on something is not only prevalent in the financial markets for traders but also in everyday life. As its name suggests, this event in trading defines the fear one experiences if one feels they’re missing out on a potentially profitable trade, which, understandably, can trigger a range of irrational emotional triggers (and cause impulsive decisions) that may adversely affect a trader’s account equity. This emotional pressure can push you into chasing hot trends or taking on inappropriate risks. However, remember, sustainable trading is a marathon, not a sprint.
An example of FOMO might be as simple as a currency pair that’s experiencing a notable rally, which other traders are talking about through social media. Should this encourage action, inspiring a trader to deviate from their trading strategy that guides rational trading, this can open the door to irrational trading. It is even worse if the trade taken—the one triggered on the back of FOMO—is a winner; this encourages the practice and will ultimately result in losses down the road. Additionally, this can transition into what’s known as ‘revenge trading’ (something we’ll touch on shortly) and ‘overtrading’.
It may seem cliché, but circumventing FOMO can be achieved by adhering to your trading plan. This includes following not only the rules for entry and exit (the trading strategies) but also risk parameters. You will find that many traders and investors succumb to this emotion if they’re trading with a strategy that has not been fully back-tested. This is why it is important to validate any trading idea before live trading to ensure you trade with confidence in your trading system.
Revenge trading is a recipe for disaster: impulsive, ill-considered decisions that often exacerbate trading losses.
When a trader experiences trading losses—every trader has losing trades—how they handle these losses can mean the difference between success and failure for some traders. Revenge trading pressures a trader to re-enter the market after consecutive losses or a large loss (think price gapping beyond one’s protective stop-loss order, for example).
Rather than looking to their trading plan to make sensible decisions around the incident, revenge trading prompts traders to jump back into the market to recoup losses (regularly with increased position size/excessive risk). And that’s when things can become challenging. This can cause a vicious cycle that has to be avoided at all costs.
A trading mindset is built gradually, an approach that involves a shift in thinking, a shift that eventually enables the trader to operate from an objective standpoint. This will help the trader develop objective decision-making skills and trade only optimal setups and, importantly, not make rash decisions in the face of trading losses/fear.
Depending on who you ask, some claim that a demo Trading Account has limited use. However, what paper trading offers is strong evidence of what your trading could be like, void of emotion. Demo traders navigate the markets and often generate consistency (assuming they adhere to their trading strategy’s rules of engagement and employ effective risk management), though once they trade a live Trading Account and experience the same losses they did on the demo, they often throw in the towel and commit impulsive trading decisions as the emotional influences can be overwhelming.
Starting small is another necessary building block to developing a trading mindset. Many traders make the mistake of starting with an unnerving account size and trade risk they are unfamiliar with. For example, you must find out your risk tolerance: how much are you comfortable losing per trade? This must be an amount that you can lose and largely not be fazed by, meaning you should be able to continue trading and not be affected by the previous trade. Once you generate consistency with this account value/risk per trade, you can then consider increasing the account size and, subsequently, the risk. This is how you familiarise yourself with the notion of risk and fear and build a trading mindset slowly.
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