What is Trading Psychology?

08 July 2020

Having a proper attitude and developing a trader's psychology is essential for success in trading. Trading psychology is associated with the traders’ mindset and how they are managing their emotions, thought processes, and trading decisions.

Even though psychological stimuli are subjective and different for individual traders, there are still some universal influences that determine how people conduct their trades. These stimuli include:

Fear
Anger
Impatience
Greed

Fear paralyzes traders and makes them miss trading opportunities.

As for impatience and greed, greed leads to overtrading and breaking risk management rules. Our main motivation as traders is to make money, however, when we are at our trading desks, the money should be the least important. The most critical is to trade the right way, and the money will follow. Impatiens and feeling bored makes traders open orders that are not worth the risk, which is always a bad idea. Poor setups lead to losses. Anger causes revenge trading. Revenge trades are further increasing chances of losing more funds as trades are usually poorly planned.

In order to overcome fear and anger, and manage impatience and greed, traders need to practice their psychological responses to various situations, just as they practice their actual trading skills.

watch our trading psychology and money management video

Trader mindset/psychology of trading – why is it important?

Psychology in Forex trading is critical for making money. Learning how to trade, how to conduct technical and fundamental analysis is one thing and following your rules is the other. For instance, we all know that having a healthy body requires avoiding junk food, exercising and having a good sleep. We all want to be fit and healthy, however, very few people actually follow the universal health plan. The same is true in trading. Mastering the psychology of Forex trading is not easy, but it's totally worth it. Trading process becomes much easier and simpler when you are following your rules. What's more, disciplined traders are the ones that make money in the market consistently. Yes, market conditions change and your strategy might stop bearing fruit, but when you have your emotions in check, you can develop a strategy that fits the new conditions much more easily.

Learning how to trade professionally takes years. Beginners first learn how to use trading platforms, terminology, technical and fundamental analysis, risk management and probabilities. The next step is developing a trading strategy that fits a trader. You see, there are various strategies and techniques that you can use to make money in the market. However, what is effective for one trader, might not work for another. For instance, a trader that can make up his/her mind fast, has fast fingers and loves active trading will find intraday, high frequency or news trading interesting. For traders that like to thoroughly plan their trades, swing and position trading will be more appealing.

After a trader find his/her strategy and trading style, the next challenge is learning how to manage emotions. There are various psychological stimuli that affect the traders’ decisions. In fact, they are very subjective and individual traders experience different responses. However, trading psychologists still outline some of the more universal stimuli that tend to emerge all across the board. More specifically, we will review four of those stimuli:

Fear – Fear usually occurs after losing trades. Traders lose confidence in their trading system and are unable to place orders, even when great trading opportunities present themselves. Every trading strategy experiences drawdown periods, it's important to study whether the drawdown is temporary or the market conditions have changed, and the strategy has become useless. To overcome fear after a series of losing trades, professional traders decrease their position sizes or demo trade. Which helps them regain confidence in their system and, simultaneously, limit the drawdown amount.
Anger – Anger takes place after experiencing loses. Most inexperienced traders lose money because they are unable to take small losses. Losing is a part of the process. After loses, traders try to get back the lost amount quickly and open new positions without proper planning. "I'll close the position when I'm even" - you'll often hear such words from revenge traders. Revenge trading almost never ends well. Yes, you might win back the amount you've lost due to luck, but now you have learned very bad lesson and will try the same thing again in the future. Losing money and learnng what not to do is better than making money and getting a bad lesson.
Impatience – Position trading requires waiting for trading opportunities to come, planning and trading the plan. You can't force markets to give you trading opportunities. On many occassions, there are days without apearance of reasonable setups. When not in active positions, most traders think that they are wasting time. They feel bored and unpoductive, which makes them open poorly planned orders and overtrade. Overtrading leads to destroying trading balance.
Greed – Greed also leads to overtading. As already mentioned, we all start trading because we want to make a lot of money. However, making money should be the least on your priorities list when trading. The number one priority is not losing money, the second one is trading the right way and the third one is making money. Greedy traders focus on money and ignore the other two. Greed makes traders overtade or trade using large trading positions. It's obvious why overtrading is bad, it leads to trading poor setups. Trading using increased sizes is an equally bad idea. Consistantly successful trading is dependent on probabilities. When trades become oversized, everything starts depending on single trades. Even when the setup has high success rate, there's always a chance of price going in the opposite direction.

All of these Forex trading psychology stimuli lead to the deterioration of traders’ perception of what is really happening in the market. Let’s take a look at each of them more closely and see how they manifest themselves in trading. We will categorize these responses in terms of their psychological characteristics. Fear and anger – as they’re more negative in a sense that the outside world is having a greater influence on a person. As for the impatience and greed – they’re more positive in a sense that a person is trying to extend their influence on the outside world.

Fear and anger

One thing that is absolutely essential to understand is that both fear and anger are innate feelings that every single person experiences in their lives. It’s pretty much impossible to completely eradicate them. However, with some practice and mental work, we can learn to better react to them. Humans are not robots. We all have emotions. The key to success in trading is learning how to manage them. As already mentioned, one method of fighting the fear is to decrease position sizes or demo trade until the confidence is restored. In addition, it's important to only trade using the funds that you can afford to lose. In case trading is your main source of income, make sure that you have an emergency fund as every strategy experiences drawdowns at some point. You don't want to find yourself in a position when you are forced to trade to pay your bills. Forced trading almost never works.

As for the anger, it’s also an incremental part of our emotional build. When the market goes against the trader and causes them to lose funds, anger tends to get hold of them in various ways. This, in turn, clouds their perception of market development and makes them open/close positions based on emotions, instead of calculations.

Now, while these stimuli are certainly natural and unavoidable even, for developing successful trading psychology, traders need to be aware of what they’re afraid of, as well as what makes them angry beforehand – that is, before the accident has already happened. This is possible through mental exercise and the realization that while there will definitely be many difficulties along the way, traders can actually turn them into their advantage by thinking clearly and not yielding to emotions.

Impatience and greed

Next up, let’s talk about impatience and greed in trading. Unlike fear and anger, these psychological stimuli usually emerge when traders have a more positive experience during trading and want to have more of it.

One of the biggest misconceptions in trading is this idea that people can instantly get rich just by starting trading in Forex, stocks, or any other market. They believe that with a single position, they will get a huge payout. It is possible to make a lot of money using a single trade. But what are you going to do afterwards? The trade has already tought you a bad lesson and most likely you will risk it all to make even bigger payaout. Eventually, losing trade will occure and wipe out your account. To avoid such developement, proper risk management is essential.

Having a proper psychology in trading Forex leads to gradual gains. Gradual increase of your trading balance will attract investors and you'll be able to reinvest your profits and use the power of compounding to your advantage. Compounding and managing large amounts of money is the safest way to make a lot of money in the markets. Greed can ruin your trading history and make you as a trader unattractive.

Impatient traders tend to make rushed decisions due to feeling bored. And more often than not, such decisions lead to losses than payouts. One way to avoid placing orders due to feeling bored is to have a side job or a business that can take your attention away when markets are not giving good trading opportunities.

As for greed, yet another critical factor in the psychology of trading, it also is innate to our character. In trading, there is a common saying that “pigs get slaughtered,” meaning those who want more and more of the payout will get caught and start to actually lose funds.

Traders, who find a perfect spot where their position generates payouts, tend to maintain that position for a long time in an attempt to take every penny out of the market. Unfortunately, the market tends to make drastic swings after a long period of upward/downward trend. Therefore, it is better to stay careful at all times and not yield to whims and instincts.

Some tips on how you can improve your trading psychology

Having listed some of the most widespread psychological stimuli that influence the decision-making process in trading, it is also critical to propose a method that can help people overcome them. As we noted earlier, the sound and present mind can be just as effective in trading as skills and knowledge. Therefore, here are some tips for developing successful trading psychology:

Discover your personality – when deciding to trade on a financial market, it can be of massive help to find out your personality trait: whether you’re an impulsive person or someone who doesn’t fall for emotions that easily. If you find out that you’re an impulsive trader who can be overcome with fear or greed, knowing it beforehand will help you control the emotions more effectively. And if you’re more stable in that sense, you will know that you can trust yourself during the most critical times;
Set up a trading plan – when you’re doing something, you first set out a plan and then follow it until the end. The same is true for trading. If you develop a plan, you will know exactly how much time you dedicate to trading, as well as how much money you put in it and what strategy you will stick to till the end. In short, the plan will guide you through every step of the way;
Don’t expect fortune right away – as we noted earlier in the article, success doesn’t always come knocking on your door right after you’ve started trading. In fact, your individual positions will likely generate smaller payouts. But that shouldn’t upset you because that is how it usually happens in trading anyway. Successful traders stick to a plan and take things one step at a time, which ultimately results in a successful trading career – at least there are more chances of it;
Don’t be greedy – this next tip may seem pretty straightforward, but still many traders tend to choose this way. While it seems like a good idea to always stick to one strategy that generates payout, you need to be aware that the market always changes its direction and will never be in your favor all the time. Therefore, expanding your knowledge, reading some of the best trading psychology books, and employing new strategies will help you adapt to new situations and always be prepared.
The first priority is not to blow up your trading account. The second priority is to trade the correct way. The third priority is to make money. Remember, consistancy in trading is highly rewarded by the investors.

These tips are by no means everything that a trader needs to know about trading psychology or how to improve emotional responses to the market developments. However, taking them into account can still have a significant effect on how they react to the payouts or losses and how they make trading decisions. Market conditions might change but Forex market psychology remains the same.

Trading psychology basics – Key takeaways

People trading in various financial markets need to have various skills in order to lead successful trades. The first thing traders learn is use of platforms, terminologies and conducting market analysis. The final step that is required to consistently make money in the market is learning how to manage emotions.

Trading psychology is an essential aspect of trading stocks, Forex, or virtually any other security. In fact, it is no less significant for conducting a successful trade than, say, trading skills and knowledge or current market conditions.

As the trading psychology definition goes, when traders stay reasonably cool-headed and rational, they tend to have better chances of generating larger payouts. Besides, they can even minimize the amount of loss they take.

In this article, we talked about 4 of the most wide spread and universal psychological stimuli that affect traders mentally:

Fear of a loss during drastic market fluctuations
Anger from losing funds
Impatience for getting large payouts right away
Greed for getting more and more of the payout

These emotional stimuli manage to cloud the judgment of a trader, leading them to make rash trading decisions and ultimately lose funds. Therefore, it can be a good idea to sort things out with your current emotional state, develop a certain plan, be patient, and adapt to new occurrences. This way, traders tend to yield less to emotions and more to reason.

FAQ on the basics of trading psychology

What is Forex trading psychology?

Forex trading psychology is one of the most important aspects of trading that can have a massive impact on how people conduct their trading positions. In fact, trading psychology is no less critical than trading knowledge/experience or regularly following market developments.

Basically, trading psychology refers to the traders’ emotional responses to various market developments. There are lots of different biases and passions hidden deep in our character, and certain events manage to wake them up. And while these responses are very subjective and individual, there are still some universal psychological responses found in trading:

Fear
Anger
Impatience
Greed

These stimuli emerge during different occurrences. For example, traders are afraid of losing funds during a serious market fall, which leads them to liquidate their holdings and stay away from opening new positions. By yielding to these emotions, their judgment becomes blurry, and they fail to make more effective trading decisions.

How to master trading psychology and be more rational during trades?

As noted in the article, it is as important to have a proper mindset as it is to have proper trading education/experience. This way, you’ll be able to better cope with sudden changes in the market or other events that cause you to have emotional responses.

One of the best ways of restricting emotions is by finding out what type of personality you are. If you’re someone who easily yields to emotions, finding that out before you start trading can help you be prepared for what is coming. That is because even though we seem to know ourselves, our character doesn’t fail to impress us. And if you know that you have a tendency of making rash decisions during emergency situations, you won’t be surprised and overwhelmed by your actual decisions and will be able to come out of the situation more easily.

Another tip that can possibly improve the psychological response to various market development is to have a certain plan. In fact, a trading plan is important even if you’re not concerned about your mental condition – that is, you tend to remain cool-headed and rational. It allows you to dedicate a certain amount of time, funds, and resources to the trading and have a strategy to follow. This ultimately helps your mind be less stressed over not knowing what to do next.

What are the best day trading psychology tips for Forex traders?

Traders can choose one of two methods of trading: they can either open a position and have it open for a long period of time (for days, weeks, or even months) or they can open and close their positions within a day. This latter strategy is called day trading, and there are some day trading psychology tips you can use:

The first obvious tip that can be applied to any type of trading is to know your mental condition better. We already discussed this tip in the previous answer. A piece of more specific advice would be to take things very slow and not expect to suddenly get rich. As a day trader, you should realize that more often than not, your short-term positions won’t generate large amounts of the payout. Instead, you’ll have to take things one step at a time, open smaller and more rational positions, and slowly get to your own point of success.

Another piece of day trading advice is to be as adaptive as you can. During the short-term trades, it is possible to find a certain trend (uptrend or downtrend) and successfully stick to it for multiple trades. Now, while it may actually generate payouts, you have to know that in a short period of time, a trend that has been going on for a while can reverse pretty dramatically. This will instantly make your current strategy useless. Therefore, being adaptive and exploring new strategies will help you during such drastic changes.

How can trading emotions and psychology put your Forex positions in danger?

What is trading psychology? Why is it important to keep in mind? As psychologists and behavioral scientists suggest, our actions are based on our emotions quite substantially, therefore, we're bound to make mistakes when we are in an unhealthy mental state. And all this can manifest itself in a poor Forex psychology.

For example, when you experience a loss in your trading position, it's very easy to get angry and lose the ability to make clear decisions. And with such psychology of trading Forex, you can make rash decisions, go after the price movements that aren't beneficial for you, and ultimately, get into more losses.

Similar cases can be made on other psychological impulses. Success can also cloud your clear thinking and let you believe that anything you do can bring more payouts in the market. In short, maintaining healthy trading psychology in Forex tends to me a more sustainable way towards success.