What is Trading Psychology? Why its Important?
Trading is not just a mechanical process where traders make transactions, analyze numbers and graphs, and utilize the different trading strategies. It is a more comprehensive process that is affected by one’s emotions-whether negative or positive.
Hence, this is why it’s very important to have a sound trading psychology if you want to become a successful trader.
What is trading psychology?
Whether you’re a seasoned or a beginner trader, you must’ve noticed or at least suspected that your emotions and current mental state do affect your trading decisions. After all, emotions are part of our daily life and they often factor into our decisions and plans.
However, when trading, it is important to keep those emotions in check in order to make the right decisions that benefit you and your portfolio. In a nutshell, trading psychology is about the ability of handling generating gains and dealing with losses.
It is basically about traders’ ability to deal with the emotional aspects of investing and risks while sticking to their pre-set trading plan. Hence, handling your emotions makes up a significant part of your trading psychology as a whole.
To be able to make the right trading decisions, traders have to be on top of their trading psychology. Let’s take a closer look at it to learn how to understand and handle our emotions better.
The basics of trading psychology
As we mentioned earlier, trading psychology includes the individual’s behaviors and traits that weigh on trading actions.
Through the trading process, several emotions are considered to be more prominent than others. This is why controlling your emotions in trading is crucial. Fear and greed are definitely one of those emotions that traders can get hung up on.
As a trader, your mission is to adapt to those emotions and harness them to enjoy a mindset that is not hinged on these two powerful emotions.
There are many techniques that a trader can resort to to create the best trading psychology there is. Many traders choose to read trading books to acquire the necessary discipline needed to maintain a sound trading psychology.
Consider religiously reading “the psychology of trading”,” trading psychology 2.0”, and “market mind games” as a start.
Note that having a trading plan helps tremendously and allows you to stay focused and trade mindfully. After all, you’ll use it as reference when emotions are running wild as prices move up and down.
You might find yourself experiencing both emotions-fear and greed when prices fluctuate, and this certainly part of the process. But the most important thing you should focus on is managing risks.
Fear could portray the fear of missing out on market opportunities or fear of price fluctuations. One way to maneuver that is to always remind yourself that the market is full of opportunities from those who have a good eye and do their research.
As per greed, it’s a byproduct of the process. After all, as a trader, you’re seeking to make profits. A right mindset accompanied with the objective of making more profit is the way to go in such cases.
Remember, even if you have the best plan in place, sometimes things don’t go according to plan. As a trader, you should definitely make peace with that. Sometimes, you’re going to have to make decisions in the moment, but a trading plan will keep you grounded and prevent too many sudden decisions.
The importance of developing a trading psychology
Trading Psychology revolves around the way you approach and feel about the stock market and the trades you’re executing. Your trading psychology naturally weighs on your behavior in the market; thus, affecting your performance in the market. This makes it one of the most important factors that affect it.
How to avoid emotional trading?
There are many steps that you could follow to avoid the shenanigans of emotional trading.
- Have a good trading strategy in place
- Recognize your risk tolerance
Have a good trading strategy in place
For starters, you must have a well-defined strategy. Don’t go about changing trading strategies every now and then. This way, you’ll allow your emotions to interfere.
Recognize your risk tolerance
Some traders remain in control when taking big leaps, others not so much. Hence, it’s important to know your risk tolerance beforehand to be able to understand yourself more.
Now, let’s get to the gist by understanding how to improve one’s trading psychology.
How to improve your trading psychology
Before we work on improvements, let’s review the facts. By now, you must know that the driving reason behind stock market movement is the psychology of stock trading. If we were to show them in detail, we’ll have to use a stock chart, which is merely a representation of people’s feelings.
Now that you’re more informed, here’s how to actually trade mindfully. One way to start is by practicing trading psychology exercises as follows:
- The Gratitude Exercise
- The Relaxation Exercise
- The Cognitive Restructuring Exercise
The Gratitude Exercise
This activity is meant to help you see the positive aspects of your life even when times are hard on the economic front. In this exercise, you’ll start by listing three things for which you are grateful for each day. This definitely aids in turning your attention away from the bad and toward the good.
The Relaxation Exercise
This practice is intended to assist you in lowering your stress and anxiety levels. If you use the relaxation method, like deep breathing or progressive muscle relaxation, for five minutes per day, it will enhance your capacity for concentration and judgment.
The Cognitive Restructuring Exercise
This activity aims to help you alter your perspective on trading by making you challenge thoughts for five minutes each day and simultaneously making them more positive. Identifying unfavorable attitudes and beliefs, followed by confronting and changing them, is the goal of this activity.
In order to feel better and perform better in your daily lives, it is important to acquire better ways to control your thoughts and emotions. This enhances your perspective on trading in general.
Trader, don’t give up if you don’t notice results right away; it takes time to get results from these exercises!
What are some habits of a successful trader?
Since success is highly correlated with the ability to grow and refine one’s trading mentality, it enables a trader to maintain composure in volatile market conditions. Here are some habits that you could incorporate into your daily routine:
- Trade only with money you can afford to lose!
- Accept the possibility of losing money on every deal you make, and be sure the possible gain justifies the risk.
- No matter how strongly you feel about your position or how much you trust your own analysis, be prepared to leave the trade if it turns out to be incorrect.
- Instead of concentrating on your trades’ losses, look at how well they performed overall. This will increase your confidence in your trading methods and their likelihood of success.
Trading psychology is crucial for your success in the market. Although nobody can guarantee any results, being mindful of your trading psychology increases traders’ chances of success in the market.
As time passes, you will learn to control your emotions better, without being at the mercy of your knee-jerk reactions and emotions. In a nutshell, you’ll proceed to keep going, regardless of the gains or losses you’re making.