Investors and traders start their journey in the financial markets with the aspiration to earn profits, double, and triple their capital. They learn about different segments and asset classes and hope to find an approach that suits them the best. For instance, one may study the pros of intraday trading in the derivatives segment and choose to trade in that segment after understanding the risk. They do their best to accumulate knowledge regarding intraday derivative trading, yet never find any success.
It is unfortunate that the majority of traders still lose money in the stock market. That is because knowledge and skill are not the only attributes determining a trader’s success. Regardless of how much the trader knows, they will not reap the fruits of success unless they trade with the right mental state.
What is trading psychology?
Trading psychology concerns a trader’s emotional state that dictates their decision-making in the financial markets. It explains well why traders see success or failure in trading securities. For example, traders learn that a stop-loss order can protect their capital from volatile market moves, news, and other events. That said, many traders still trade without a stop-loss order and end up losing money in the stock markets. The factors that influence their trading psychology are the reasons for trading without a stop loss.
The aspects of exercising discipline, taking risks, and containing emotions are components of trading psychology. A disciplined mental framework lets you stick to your strategy and stops you from diverging and making unwarranted trading decisions. For that, it is necessary for you to not let your emotions influence your trading or investing mindset.
Emotions Related to Trading Psychology
The two primary emotions associated with trading psychology are fear and greed. They are the root of the irrational behaviour we witness in the stock markets. The emotion of fear prevails in bear markets. Bad news regarding a stock, an industry, or the economy instil fear in investors’ minds. The anticipation of a bear market can result in investors hastily selling off their investments. That in turn leads to panic selling, resulting in a significant sell-off that marks the start of bear markets.
At the same time, fear is why many investors or traders miss great investing or trading opportunities. It restrains one from taking positions or making investments due to fear of incurring losses. For instance, an investor may fail to buy a company’s shares at an attractive valuation, as they may hold the premonition that the share price is yet to fall.
On the other hand, when greed mars the mind, all an investor or trader can think of is the desire to make more profits. So, when excessive greed infiltrates the mind, it prevents one from making prudent judgments. For example, greed will lead to holding onto positions when it is time to book profits. Likewise, a greedy mind can also lead to making high-risk trades or investing in overvalued shares. It shapes one’s perception to believe the upward trajectory is perpetual. The emotion of greed is more or less omnipresent during bull markets. However, a disappointing financial quarter or bad news can switch the tide and transition greed into fear.
These two emotions give rise to other emotions like regret, anger, and hope. Coming back to the point where we discussed why traders do not use a stop-loss, When traders take a position but the price does not move in the direction they predict, many still hope the price will see a reversal any second. Their unfounded hope leads them to hold the position, which is why they would not want a stop-loss order enforcing an exit from the trader. However, the price could continue to move in an undesirable direction, leading to a significant loss of capital and time. You may very well be familiar with the pros and cons of intraday trading, but you can lose much more than what you would have with a stop-loss.
Set rules and maintain discipline.
So knowing about profit strategies, fundamental analysis, or charting will do you no good if you let emotions influence your trading decisions. To prevent your feelings from getting the better of you and getting you to make a series of irrational trading decisions, always trade only after you have constructed a set of rules. Construct your trading or investing rules as per your risk-reward tolerance. Have profit targets, book partial profits, or trail your stop-loss. Educate yourself regarding the impact of macroeconomic policies on the markets so that you can rationally think ahead of the market.