The psychological approach to trading financial markets is one of the most crucial and frequently misunderstood elements of being a trader. In this section we cover some of the most important aspects that will help you understand the thought process which can help you become a consistently profitable trader.
Trading and Emotions
There is an emotional aspect to trading which is often overlooked or underappreciated by people when they first start trading. Most new traders think that if they just pay attention to a few technical indicators then they will be successful in the markets. Unfortunately, it’s a little more complicated than that.
Following the rules of a strategy is the first thing you need to be able to master, and most new traders are very aware of this. What they are less aware of is what it is that truly motivates their actions. Human beings walk around thinking that we are logical, rational decision-making machines, when almost the complete opposite is true. Human beings do not always act in logical and rational ways. If you think about it, most of the big decisions that we human beings make are emotionally based and then backed up with logic. To buy a house, to get married, to get divorced, to have children, actions in extreme moments, are all emotionally driven.
Understanding that our actions are driven more by emotion than logic, is very important step to becoming self-aware of how we make our trading decisions and the motivations behind them. Self-awareness is an attribute that almost all successful financial market traders will have.
Now, why do we say that emotions are so important when it comes to trading? Well, the answer to that is because a trade will normally either turn out to be a winning trade or a losing trade (forgetting, for the moment, break-even trades). What is it that a trader is “winning” or “losing”? The answer is simple: money, and money is an emotional topic. It’s very easy to see how emotionally charged humans are over money. Human beings are hardwired to feel great when we have money in our pockets and we generally feel bad when we have debt hanging over our heads. Taking it a step further, studies show that a lack of money, or how it is being spent are amongst the main reasons that couples argue.
So how does this all pertain to trading? Well, something that a lot of new traders don’t realise is how their “last trade can impact on the next trade”. Quite often a trader will start out in the market and have a few early wins. This may be put down more to beginner’s luck than perfect execution of the trading strategy. But it also provides some false proof that the new trader can easily get positive results from the market. Then what starts to happen is that the new trader begins to believe that trading is easy, due to their past results.
They may also start to develop a bit of confirmation bias. This is where they start to look for information that confirms their pre-existing belief, that trading in the markets is easy. They then start to take trades that don’t perfectly match their criteria because they are looking at the market in an overly-positive fashion. The same thing can happen when it comes to experiencing a string of losses. This can cause new traders to start doubting themselves, their strategy, their skill or the broker, leading to a feeling that the market has something personal against them. This is when they start to become very hesitant to place a trade: they doubt the set up, they fear the trade and they fear the loss. They fear the pain of money being deducted from their trading accounts.
The best traders understand that they must move to a place where the last trade doesn’t affect their next trade. Ideally, we want to get to a level where we are not emotionally moved if we have a win or a loss. In this way it won’t influence the way we see the next trade set up. As with most worthwhile things in life, this is easier said than done. But, the first step to becoming emotionally flat in the outcome of any one trade is to become self-aware. Becoming aware as to how we are feeling before we enter a trade. Where are our emotions? Are they making us see or miss something we otherwise would not be seeing or missing?
Once you get a good idea of where you are emotionally, then this will help you significantly in your trading success. Below, we are going to cover how to best balance your emotions to help you be in the best possible mind-set to enter the markets.
