OctaFX presents a comprehensive guide to identifying and overcoming emotions that harm your trading.
Developing a trading strategy is not enough to succeed as a trader. The strategy will give you consistent positive results only after you master the psychology of trading and overcome emotions that negatively impact your decision-making process. Fear, greed, and various biases all affect how you perceive the market and open orders. Traders use several techniques to handle them and maintain financial discipline.
First, let’s describe the most common trading psychology mistakes and some ways to avoid them.
Five ways your emotions can influence your trading
At the moment when you have to press that ‘buy’ or ‘sell’ button, emotions hit different. Your brain tells you stories of imminent success and utter failure, causing you to make impulsive trading decisions. At the core of it, there are five ways emotions can influence your trading:
- Fear of missing out (FOMO). Traders sometimes open new orders when they feel they could earn on a particular market movement, often promoted by financial influencers on social media. However strong it may seem, it is better to avoid placing orders on rumours and first carry out thorough analysis and use risk management tools.
- Relying on gut feeling and intuition. This is never a good way of conducting trading activities. As lucky as one might be, after a few winning trades, there will inevitably be a streak of losing ones wiping away all profits and possibly resulting in greater losses.
- Gambler’s fallacy. Some traders erroneously believe that just because they had several losing trades in a row, the next one would be a winning one. However, the streak of orders-gone-red might not end until the whole deposit is spent.
- Hindsight analysis. It often seems easy to identify good entry points for orders in the past. Consequently, trading might seem simpler than it is to beginners, which could lead to upsetting results. While such analysis can be helpful, you should always have a consistent strategy to base your decisions on, as you will likely give way to emotions in the real-time, high-pressure market environment.
- Keeping your orders open for too long. Seeking proof that you are right and staying in a trade for too long could result in a costly mistake. Try to stay objective and exit a trade when it’s gone past your acceptable loss level.
How to avoid trading psychology mistakes
There are several ways you can put your emotions under control when trading.
- Develop a trading strategy and keep to it. A well-defined trading strategy will help you stay focused on your goals and prevent impulsive decisions. Your trading plan should include clear entry and exit points, risk management techniques you are going to use, and a trading schedule based on your preferred time frames and instruments.
- Capital protection comes first at all times. Before trying to maximise your profits, ensure your trading capital is protected. A good rule of thumb is to use no more than 4% of your capital on a single trade and keep your loss-per-trade at a maximum of 25%. If you quit it every time it gets there, no matter how you feel about the future market movement, your capital will be quite safe.
- Keep a trading journal. A trading journal can help you analyse your trading performance and identify areas for improvement. Keep track of your trades, including entry and exit points, the reason for the trade, and its outcome.
- Take a break when you need one. You are more likely to make mistakes if you are stressed or tired. If you have a series of consecutive losing orders, you might also need a break. Get some rest from the emotional pressure and carefully analyse what happened.
- Learn from your mistakes. They are inevitable. Remember that mistakes are there to help you refine your trading approach and make it more profitable.
Trading psychology is critical in achieving your trading goals. Traders who can successfully manage their emotions are more likely to succeed in the long run. However, it is a wide-ranging topic with its points of application on every level of the trading process.
