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How Understanding Trading Psychology Can Make You a Better Trader

How Understanding Trading Psychology Can Make You a Better Trader, FP Markets

Reading Time: 8 Minutes

Without a thorough understanding of one’s mindset, trading can be one of the most exasperating endeavours you undertake, irrespective of the Forex trading strategy used. The emotional state of an individual’s character can influence the approach and create trading mistakes.

All traders are unique, whether beginner or expert traders and all deal with psychology in different ways. Fortunately, market participants can learn to regulate their emotions with practice, patience and research.

Fear and Greed

Fear and greed are two primary emotions. According to some researchers, greed pulls people in, and fear pushes them out.

Fear and greed have the power to affect our trading performance, in a way that coerces us to put aside common sense and self-control, as well as provoke change. When it comes to individuals and money, fear and greed tend to be the driving force behind trading decisions.

Fear of Missing Out

In terms of trading and investing, the fear of missing out, sometimes referred to as FOMO, is one of the most hazardous emotions. FOMO may strike when other Investors discuss a significant shift in the market or when a major news event occurs. This will, as you can imagine, influence a security’s price movement as more traders engage with the market.

Regret is another emotion commonly associated with FOMO. You may regret not entering from well-defined support, for example, one which holds and generates a substantial return. It is, of course, about striking a balance on how to proceed with the next trade without letting FOMO inhibit those decisions.

How Understanding Trading Psychology Can Make You a Better Trader, FP Markets

 

Biases

Emotional biases include loss aversion (fear of loss), overconfidence, self-control and regret aversion. For example, the overconfidence bias refers to a person’s tendency to overestimate their skills. It may lead an individual to believe they are a superior trader or investor. Those that are overconfident may also make transactions that increase risk exposure, which could ultimately lead to losses.

Techniques Used to Help with the Psychology of Trading

  • Using a Demo Account

The use of a demo trading account involves simulated funds and will not arouse the same emotions as if trading with a live trading account.  Traders, therefore, should try to use the demo account as if it is real money as this can help train your mind to handle the pressures of a live environment. You are encouraged to follow your trading plan and build a trader’s mindset while learning to trade.

  • Identify Your Own Traits

You will need to be honest with yourself when trading. The more personal traits you can identify, the easier it will be to overcome: impulsiveness (impatience), anger, overconfidence, optimism and pessimism, for example.

Ask someone you trust about your traits: a close friend or family member. They will probably see things you don’t and ultimately help you recognise your strengths and weaknesses.

  • Develop a Trading Plan

A good trading plan is imperative and maintaining your trading discipline is important. Due to circumstances beyond a trader’s control, maintaining discipline is sometimes just not possible.

For instance, the Russia-Ukraine conflict. No one can predict conflict, but within your trading plan, there should be rules to help handle geopolitical tensions. An example is to focus on the ATR (Average True Range) and adjust protective stop-loss orders accordingly.

  • Expectations

Expectations in trading need to be realistic. Delay any get-rich-quick schemes. Set sensible goals and do not use funds that are allocated for everyday living expenses.

Many traders recommend setting monthly, quarterly and annual goals. Focussing too much on daily goals, or even weekly goals, can pressure a traders and lead to trading mistakes and unnecessary pressure.

  • Keep a Trading Journal

From the outset, keep a record of your past performance associated with your investing. Log any trades you make: winning or losing investments. You should also record market conditions at the time of trading. It’s easy to keep records using screenshots: photographs and text.

What a trading journal does is allow you to recognise strengths and weaknesses, which you may otherwise miss if you do not possess a trading journal. This will help with the decision-making process going forward and will assist in placing successful trades.

  • Algorithmic Trading

Robot Trading and Expert Advisors all come under the same umbrella. Using a form of robotic trading will help reduce emotions, but this does not guarantee successful trading.

  • Dealing With a Loss

Everyone suffers losses, but how you deal with a loss is important. Depending on the severity of the losing trade, this should determine your next course of action. After suffering a loss, or consecutive losses, it is recommended to step away and take some time for yourself to recollect your thoughts.

Clear your head and process why you are experiencing losing trades. Was it due to you not adhering to the trading plan, or was it simply losing trades within the system itself? Does your trading plan need adjusting to avoid the same mistake again?

In your trading plan, there should be a risk management section to help avoid drawdown in the account.

  • Winnings

It is not advisable to rush in again if you have a profitable trade. Do not let your ego get the better of you. However, if you have a string of profitable deals, always refer to your trading plan and let that guide your next move.

  • Exercise And a Healthy Diet

How do diet and exercise affect the psychological elements of trading? Eating sensibly and avoiding alcohol while trading, while obvious, will help the thought process. Remain active during the day by stretching and walking if you’re seated throughout the trading session. Every 30 to 60 minutes, it is suggested that you stand and move around.

Conclusion

Controlling emotions—your psychological makeup—is a crucial part of your FX trading journey to become a consistently successful trader. Maintaining the right mindset is crucial.

Trading in the Zone by the late Mark Douglas is a book many recommend to grasp the psychological components of one’s mindset. It is a book many have claimed helped them understand psychology as the book delivers a straightforward, easy-to-read account of the psychological influences traders face.

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    FP Markets is an Australian regulated broker established in 2005 offering access to Derivatives across Forex, Indices, Commodities, Stocks & Cryptocurrencies on consistently tighter spreads in unparalleled trading conditions. FP Markets combines state-of-the-art technology with a huge selection of financial instruments to create a genuine broker destination for all types of traders.

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