Trading Psychology, Discipline, and the Importance of Overall Balance

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Trading Psychology, Discipline, and the Importance of Overall Balance

Oftentimes, the biggest hurdle any trader has in becoming successful at the pursuit is overcoming himself. The ability to manage one’s own mentality is instrumental in determining whether one can become successful over the long-run. You may have heard the assertion that trading is “1/3 strategy, 1/3 money management, and 1/3 psychology.” It gets the general point across that the ability to attain competency in those three aspects is essential in order to have trading success. But psychology is so often the part that plagues many traders. By this, I don’t mean having the raw intellectual talent, but instead the capacity to manage one’s emotions and general mental state and overall health. It can certainly stem from having issues in the other two, but trading starts with the individual.

1. Self-restraint and self-discipline are the key elements that befall many. Emotions run high after losses, trading decisions become sketchier, and eventually the individual is on a path that ruins their account.

2. But going off that primary point, understand that wiping out a trading account itself is often not what leads to so many traders failing. It is often possible to simply re-deposit the funds that were lost or save up the money to gear up for another go. But the issue is not necessarily the money lost, but the extreme drop in self-confidence that can accompany what happens when an account has been totally blanked. I know the feeling, as I was there multiple times before finally getting my ducks in a row. It’s a feeling where you doubt your ability to trade effectively at all and really question whether you’re truly cracked up for the whole trading thing.

But instead of inescapable self-doubt and vanquishing all hopes of believing I had what it takes, I considered it as a springboard to coming out of my delusion and understanding that I simply need to learn how markets actually work and learn how to trade them. In trading, you need to have a “short memory” of sorts. Forget past failures and focus on improving yourself for the sake of the present. Forgetting past successes is important as well. When I first started out, I recall that I got 11/16 ITM (11 wins, 5 losses) the first two days. Naturally, I thought I was pretty good. So I became greedy and overconfident, began increasing my trade sizes and within a day I was right back to where I started. The next day I ended up wiping out my account entirely.

These failures helped me to learn that I need to truly educate myself on what it takes to do well. But most importantly, it’s absolutely imperative to understand that these past failures do not represent your quality as a trader going forward. They can either bog you down permanently or help you realize that you need to improve and educate yourself in order to obtain the results you want. My blog is one such informational outlet that can help traders achieve this, by logging my trade results and explaining exactly what goes into each trade.

So it genuinely is not about financial ruin in the vast majority of cases, it is the associated psychological and emotional damage that transpires from the occurrence of poor trading results. And it is so mindful to always be aware of your mental and emotional state and how this is, or can be, affecting your performance.

3. If at all possible, try to trade at the same time each day. The human brain responds well to routine. In terms of having a trading schedule, I believe it’s important to have that period during the day when you can trade at a point in which you are focused and your mental energies are high. This, of course, takes self-discipline.

4. Having passion for the art of trading itself is imperative. Many people look toward financial trading as a means to attaining wealth. That is, in large part, the allure of financial markets. They represent the potential for upward mobility and the chance to create a better life for yourself. But you must certainly have a genuine passion for it, not simply an all-out money-seeking mindset.

If trading is an extremely distressful, nerve-wracking endeavor, then it’s probably not the best choice of a vocational pursuit. And that’s entirely okay. I know for a fact that I would be a “failure” at many other professions, but I find that with trading I have a passion for it – which develops a positive and diligent work ethic – so this is what I’ve chosen to do.

At first, going through the initial stretch of trading is rough because the learning curve can be very steep. It really can be disheartening. But it can also be very rewarding for those who put in the sheer amount of work required to be good at it, like any other pursuit in life.

5. Have a support network. It’s always nice to have people in your corner who support your ambitions and those you can listen to, learn from, bounce ideas off of, and discuss various facets of a particular subject. That is the nice thing about the Internet and sites such as – a resource for traders looking to improve at their craft and learn about the diversity of the trading profession and all that it entails.

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It reminds us that we are not alone in this pursuit that very few other individuals may understand or be able to identify with. It’s always nice to realize that others share our particular passion in life and we can follow them on their trading journey and share our own in addition.

6. The easiest way to overcome emotional trading is to simply make trade investments that are small enough to obviate the potentiality of emotions running amok. This might not seem like an appetizing option considering that we trade to make money. But your trade sizes should be so small such that it does almost seem like a paltry amount. It helps to limit emotional trading decisions, and trading smaller can certainly help you to come out ahead in terms of profitability over time.

7. It is important to understand that trading will often represent a part of how you make a living and earn income. Even many if not most successful traders earn money from a type of job or undertaking that pays them a fixed salary for the stability that it brings to their life. I have confidence in my ability to trade well now and into the future, but even so I feel attracted to the idea of having a line of work that brings in an additional and stable source of income. It might even be trading related. I simply do not know at this point. But that is far and away the best route for most to take and also for me personally.

8. Understand the benefit of having other pursuits in life. Trading is like a hobby to me in that I enjoy doing it. But there are also other things that interest me outside of trading and I enjoy those as well. In many respects we trade not only because we enjoy it because it offers the potential to create a good life for ourselves. But if one’s eyes are glued to a screen all day watching prices move up and down all day, it is hard to enjoy other aspects of life, whether this mean friends, family, other hobbies, recreation, proper nutrition, exercise – whatever it may be.

Understanding the common psychological pitfalls in trading and the need for some semblance of balance in life outside of trading can greatly assist in attaining a more broad-perspectived nature of the profession and even manifest in greatly increased positive trading results as they did for me.

The Importance of Trading Psychology

Containing emotion and exercising discipline are key to making money

There are many skills required for traders to be successful in the financial markets—the ability to understand a company’s fundamentals and the ability to determine the direction of a stock’s trend are two of them. But neither of these technical skills are as important as a trader’s mindset: the ability to contain emotion, think quickly, and exercise discipline—what we might call trading psychology.

The psychological aspect of trading is extremely important. Traders often have to think fast and make quick decisions, darting in and out of stocks on short notice. To accomplish this, they need a certain presence of mind. They also, by extension, need discipline, so they will stick with previously established trading plans and know when to book profits and losses. Emotions simply can’t get in the way.

Key Takeaways

  • Market psychology refers to the prevailing sentiment of financial market participants at any one point in time.
  • Investor sentiment can and frequently drives market performance in directions at odds with fundamentals.
  • Understanding what motivates fear and greed can give you the discipline and objectivity needed to be a successful trader and take advantage of others’ emotions.

Understanding Fear

When traders get bad news about a certain stock or the general market, it’s not uncommon to get scared. They may overreact and feel compelled to liquidate their holdings and go to cash or to refrain from taking any risks. If they do that, they may avoid certain losses, but they also may miss out on gains.

Traders need to understand what fear is: a natural reaction to what they perceive as a threat—in this case, to their profit or money-making potential. Quantifying the fear might help, and traders should consider pondering what they are afraid of, and why they are afraid of it.

By pondering this issue ahead of time and knowing how they may instinctively react to or perceive certain things, a trader can hope to isolate and identify those feelings during a trading session, and then try to focus on moving past the emotional response. Of course, this is not easy and may take practice, but it’s necessary to the health of an investor’s portfolio.

Overcoming Greed

There’s an old saying on Wall Street that “pigs get slaughtered.” This adage refers to greedy investors hanging on to winning positions too long, trying to get every last tick. Greed can be devastating to returns because a trader always runs the risk of getting whipsawed or blown out of a position.

Greed is not easy to overcome. It’s often based on an instinct to try to do better, to try to get just a little more. A trader should learn to recognize this instinct and develop a trading plan based upon rational business decisions, not emotional whims or potentially harmful instincts.

Setting Rules

To get their heads in the right place before they feel the psychological crunch, traders need to create rules. They should lay out guidelines based on their risk-reward tolerance for when they will enter a trade and exit it—whether through a profit target or stop loss—to take emotion out of the equation. Additionally, a trader might decide that in the wake of certain developments, such as specific positive or negative earnings or macroeconomic news, he or she will buy or sell a security.

Traders would also be wise to consider setting limits on the amount they are willing to win or lose in a day. If the profit target is hit, they take the money and run, and if losing trades hit a predetermined limit, they fold up their tent and go home, preventing further losses and living to trade another day.

Doing Research and Review

Traders should learn as much as they can about their area of interest, educating themselves and, if possible, going to trading seminars and attending sell-side conferences. Also, it makes sense to plan out and devote as much time as possible to the research process. That means studying charts, speaking with management (if applicable), reading trade journals, or doing other background work (such as macroeconomic analysis or industry analysis) so as to be up to speed when the trading session starts. Knowledge can help a trader overcome fear, so it’s a handy tool.

In addition, it’s important traders remain flexible and consider experimenting with new instruments from time to time. For example, they may consider using options to mitigate risk, or setting stop losses at different places. One of the best ways a trader can learn is by experimenting (within reason). This experience may also help reduce emotional influences.

Finally, traders should periodically assess their performance. In addition to reviewing their returns and individual positions, traders should reflect on how they prepared for a trading session, how up to date they are on the markets, and how they’re progressing in terms of ongoing education, among other things. This periodic assessment can help a trader correct mistakes and change bad habits, which may help enhance their overall returns.

The Bottom Line

While it’s important for a trader to be able to read a balance sheet or a chart, there is a psychological component to trading that shouldn’t be overlooked. Being aware of how fear and greed can impact trading, exercising discipline, developing trading rules, experimenting, and periodically self-reviewing are crucial to a trader’s success.

Trading Psychology

What is Trading Psychology?

Trading psychology refers to the emotions and mental state that help to dictate success or failure in trading securities. Trading psychology represents various aspects of an individual’s character and behaviors that influence their trading actions. Trading psychology can be as important as other attributes such as knowledge, experience and skill in determining trading success.

Discipline and risk-taking are two of the most critical aspects of trading psychology, since a trader’s implementation of these aspects is critical to the success of his or her trading plan. While fear and greed are the two most commonly known emotions associated with trading psychology, other emotions that drive trading behavior are hope and regret.

Key Takeaways

  • Trading psychology is the emotional component of investor’s decision making process which may help explain why some decisions appear more rational than others.
  • Trading psychology is characterized primarily as the influence of both greed and fear.
  • Greed drives decisions that appear to accept too much risk.
  • Fear drives decisions that appear to avoid risk and generate too little return.

Understanding Trading Psychology

Trading psychology can be associated with a few specific emotions and behaviors that are often catalysts for market trading. Conventional characterizations of emotionally-driven behavior in markets ascribe most emotional trading to either greed or fear.

Greed can be thought of as an excessive desire for wealth, so excessive that it clouds rationality and judgement at times. Thus this characterization of greed-inspired investor or trading assumes that this emotion often leads traders towards a variety of behaviors. This may include making high-risk trades, buying shares of an untested company or technology just because it is going up in price rapidly, or buying shares without researching the underlying investment.

Additionally, greed may inspire investors to stay in profitable trades longer than is advisable in an effort to squeeze out extra profits from it, or to take on large speculative positions. Greed is most apparent in the final phase of bull markets, when speculation runs rampant and investors throw caution to the wind.

Conversely, fear causes traders to close out positions prematurely or to refrain from taking on risk because of concern about large losses. Fear is palpable during bear markets, and it is a potent emotion that can cause traders and investors to act irrationally in their haste to exit the market. Fear often morphs into panic, which generally causes significant selloffs in the market from panic selling.

Regret may cause a trader to get into a trade after initially missing out on it because the stock moved too fast. This is a violation of trading discipline and often results in direct losses from security prices that are falling from peak highs.

Technical Analysis

Trading psychology is often important for technical analysts relying on charting techniques to drive their trade decisions. Security charting can provide a broad array of insights on a security’s movement. While technical analysis and charting techniques can be helpful in spotting trends for buying and selling opportunities, it requires an understanding and intuition for market movements which is derived from an investor’s trading psychology.

There are numerous instances in technical charting where a trader must rely not only on the chart’s insight but also their own knowledge of the security that they’re following and their intuition for how broader factors are affecting the market. Traders with a keen attention to comprehensive security price influences, discipline and confidence show a balanced trading psychology that typically contributes to profitable success.

6 Trading Psychology Books to Improve Market Strategies

Market Psychology Books Can Improve Your Trading Strategies

Trading is as much about psychology as it is about developing a solid strategy. Without the mental fortitude to stick to a plan, the most well-conceived strategy in the world won’t do you any good. Successful traders not only develop and master a strategy, but they also take become more familiar with their own psychological traits (such as discipline and patience) and cultivate them, which allows them to be more effective in implementing their strategies.

A variety of books can help traders take steps towards understanding psychology from an investment perspective.

Trading in the Zone

Written by Mark Douglas, this is a must-read for anyone who is struggling to attain consistency in the market. The author provides a roadmap for overcoming many trading issues.

While this is a book about trading, the author does not provide strategies.

This book includes addressing personal inclinations to seek short-cuts, being easily swayed by fear or greed, and getting distracted. These traits often cause traders to act irrationally even when they know better. In simple language, the book explains why and how these issues occur, and how to approach them to keep them from happening.

If you’d like to learn about the psychology of trading, you should first work to understand trading practices, techniques, and lingo before reading this book, so you can fully grasp the topics covered.

“The Disciplined Trader” is another popular trading psychology book by the same author.

Reminiscences of a Stock Operator

Even classic books can maintain their relevance over several generations. First published in 1923, this book by Edwin Lefevre is based on legendary trader Jesse Livermore. Combining rich storytelling with a deep insight into what it takes to trade successfully (and actions that can ruin a trader), the material can be read over and over again, offering new or different insights each time as you build familiarity with the subjects.

If you are an experienced trader already seeing positive results, not trading well, or just starting your trading journey, this book has something for you. In it, you’ll follow the trading career of a life-long trader, whose experiences might just be the insight you need to help you through the struggles you are facing, or have yet to encounter.

Sway: The Irresistible Pull of Irrational Behaviour

Written by Ori and Rom Brafman, “Sway” is a rare page-turner in the non-fiction genre.

In the book, the authors tackle problems many traders are aware of yet seem powerless to prevent. They include why it can be so hard to get out of a losing trade—even delving into why people stay in personal relationships, relating it to the trials of trading.

The book explores issues of which traders are often unaware. The authors examine how danger and risk affect the decision-making process and their relevance in facing the risks of the financial markets.

The material also addresses such concepts as diagnostic bias—an inability to see beyond an initial hypothesis despite evidence to the contrary, and the chameleon effect—a person’s habit of taking on traits that are assigned to them. All of these psychological quirks can have a substantial effect on traders.

The research and anecdotes in this book can also teach the reader about hidden motivators that drive decision making, which in turn may help them make more informed decisions as a trader.

How important is psychology in trading?

Maintaining the right mindset is one of the most important factors in being a successful trader. Find out how you can improve your trading psychology to minimise the effect of emotions and biases during your time on the markets.

What is trading psychology?

Trading psychology refers to a trader’s mindset during their time on the markets. It can determine the extent to which they succeed in securing a profit or it can provide an explanation as to why a trader incurred heavy losses.

Innate human characteristics like biases and emotions play a pivotal role in trading psychology. The main focus of learning about trading psychology is to become aware of the various pitfalls which are associated with a negative psychological trait and to develop more positive characteristics. Traders well-versed in trading psychology will generally not act on bias or emotion. They, therefore, stand a better chance of yielding a profit during their time on the markets or, at the very least, of minimising their losses.

Trading psychology is different for every trader, as it is influenced by each individual’s own emotions and pre-determined biases. Some of the emotions which impact trading are:

How to improve your trading psychology

Improving your trading psychology can most easily be achieved by becoming aware of your own emotions, biases and personality traits. Once you have acknowledged these, you can put a trading plan in place that takes these factors into account with the hope of mitigating any effect that they might have on your decision making.

As an example, if you are a naturally confident person, you may find that overconfidence and pride hamper your decision-making. For example, you might let losses run in the hope that the market will turnaround, rather than incurring a small loss on your trading account. This could lead to greater losses or the eventual collapse of your trading account.

To counter this, you might use stops as a way to minimise your losses and to make the decision about when to close a particular trade before you open the position. By doing this, you have become aware of your own biases and emotions as you have made a conscious decision not to act on them but rather, you have taken steps to combat them.

How does bias affect trading?

Biases affect trading as they are, by definition, a predetermined personal disposition in favour of one thing over another. As a result, they can hinder your decision making during your time on the markets because they might cloud your judgments and lead you to act on gut feeling rather than reasoned fundamental or technical analysis.

This is because trading bias means that you could be more likely to trade an asset that you have had past success on, or to avoid an asset on which you have incurred a historic loss. It is important that traders are aware of their conscious biases as this can help them overcome them and approach the markets with a more rational and calculated mindset.

There are five main types of bias:

  • Representative bias means that you will stick to or be more inclined to replicate previously successful trades. You might do this without carrying out analysis for every trade of this type because in the past, it has paid off for you. However, even if two trades seem similar, it is important to approach every trade on its own merits rather than on historical success
  • Negativity bias makes you more inclined to only look at the negative side of a trade, rather than acknowledging what went right. This could mean that you scrap an entire strategy when, in fact, you might only have needed to tweak it slightly to turn a profit
  • Status quo bias means that you will continue to use old strategies or trades rather than exploring new ones – you will stick to the status quo. The danger arises when you fail to assess whether those old methods are still viable in the current market
  • Confirmation bias is when you seek out, or give greater weight to, news and analysis that confirms your pre-formulated ideas. It may also be that you don’t seek out, or disregard, information which disproves your convictions
  • Gambler’s fallacy is where you assume that because an asset has been increasing, it will continue to rise. There is no reason to believe that it should, similar to how there is no reason that a coin should land tails side up – rather than heads – after doing so a few times in a row

7 tips to avoid emotional trading

Identify your personality traits

One of the keys to developing successful trading psychology is identifying your personality traits early on. You will need to be honest with yourself and say if you have impulsive tendencies or if you are prone to acting out of anger or frustration.

If this is the case, it is important to keep these traits in check while you are actively trading because they can lead you to make rash and ill-advised decisions that have little analytical backing. However, it is also important to play to your personal strengths. For instance, if you are naturally calm and calculated, you can take advantage of these personality traits during your time on the markets.

Equally as important as identifying and being aware of your personality traits and emotions is recognising your biases, as listed above. Biases are an innate aspect of human nature, but you should be aware of what your individual biases are before opening or closing any trades.

Develop and follow a trading plan

Having a trading plan is paramount to ensuring that you achieve your goals. A trading plan acts as the blueprint to your trading, and it should highlight your time commitments, your available trading funds, your risk-reward ratio and a trading strategy that you feel comfortable with.

For instance, a trading plan could say that you were going to commit one hour every morning and evening to trading, and that you will never commit more than 2% of the total value of your portfolio to any one trade. This can help minimise losses and limit the effect of emotions on your trading as the rules for opening or closing a position are already highlighted for you.

Trading plans should also take into account individual factors that could affect your trading discipline such as your emotions, biases and personality traits. If you make clear what your biases are before you start trading, you might be less inclined to act on them.

Have patience

Patience is integral to discipline and it is crucial that you have patience with your positions. Acting on emotions like fear can lead you to miss out on a profit by closing a position too early. Trust your analysis and remain patient and disciplined. Equally, when looking to enter a trade, it is important to be patient and wait for the opportune moment rather than just jumping into a trade right then and there.
For instance, if you were wanting to speculate on some GBP currency pairs like EUR/GBP or GBP/USD, you may want to wait until just before a Bank of England (BoE) announcement as there tends to be increased volatility at this time.

Be adaptive

While it is important to have a trading plan, remember that no two days on the markets are the same, and winning streaks don’t exist in trading. With this in mind, you should become comfortable in assessing how the markets are different from day to day and adapt accordingly.

If there is more volatility on one day compared to the day before and the markets are moving particularly unpredictably, you may decide to put your trading activity on hold until you’re sure you understand what is happening. Being adaptive can help to limit your emotions and rule out representative and status quo biases, enabling you to assess each situation on its own merits – ensuring that you are pragmatic during your time on the markets.

Take a break after a loss

Sometimes after a loss, the best thing you can do is walk away from your trading account for a short while to gather your thoughts and compose yourself – rather than rushing into another trade in an attempt to regain some of your losses.

The best traders are those that take their losses and use them as learning opportunities. They will typically take a few minutes to themselves before going back to their platform, using this time to assess what went wrong for that particular trade in the hope that they might avoid making the same mistake in the future.

In doing so, they keep emotions like pride or fear in check by letting themselves cool off before approaching the next trade with a clear head and sound judgment.

Accept your winnings

Just as important as taking a break after a loss is to quit while you are ahead and take your winnings. A succession of wins or one particularly big win can make you feel invincible and you could subsequently rush into another position to try and do it all over again.

You might even open a succession of new positions in the belief that none of them will fail because today is ‘your day’ on the markets. This could cause you to take unnecessary risks or diversify your portfolio too quickly without doing analysis into each of the respective markets.

Happiness can be just as dangerous as anger during your time on the markets and, as such, it is important to recognise when it might be impairing your decision making or could be having a negative impact on your trading psychology.

Keep a trading log

A trading log will enable you to record all of your losses and wins, as well as the emotions that you were experiencing during that particular trade. As a result, it is the culmination of all the previous points in this article, and can be used to assess whether what you did at any one point in time was a good decision or not.

For instance, a trading log can be used to record a time when you chose to cut your losses and the eventual price that the asset hit. By doing this, you can see if you made the right decision or not. Equally, it can be used to record when you accepted your winnings and if your emotions played a role in whether you chose to close that position too early or a little late.

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