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Your psychology is one of the most critical aspects of your trading journey. If you want to improve your performance in trading, you will need to develop mindset management skills. It’s important to find and implement ways to manage your psychology while making your trading decisions.
Without managing your trading psychology, emotions will be the driving force behind your decisions.
Imagine this scenario: you’ve made a trade with a risk of $10,000. Whether you make money or not from this investment is not as important as the impact this amount has on your trading psychology.
In other words, if you were to lose the $10,000, how would you feel? After a series of losses like this, how do you feel? It's important to keep in mind that even though we are trading money (and yes, it's only money) our emotions can get in the way of us making sound trading decisions.
It's important to keep track of what triggers your emotions while trading and to develop a strategy to deal with these situations! In this article I'll show you some examples of emotion-driven trading and how to use trading psychology to help manage your emotions so they don't end up steering you wrong.
What is Trading Psychology?
The term "trading psychology" is used to describe the emotional state and mindset of traders and the behaviors that stem from their mindset and emotions.
Psychology is an important part of trading because it affects your decision-making process. When you trade based on your emotions or beliefs instead of facts, you can make costly mistakes that will hurt your bottom line.
Traders must be able to manage stress and anxiety, which can cause them to make poor decisions when they are under pressure. They must also be able to control their emotions so they do not get carried away by fear in times of market volatility.
What is Trading Bias?
A lot of people think that trading is just picking the right assets, but there's actually a lot more to it than that. When you're trading, you have to be aware of all the different types of bias that can affect your judgment and cause you to make bad decisions.
Trading bias is a term that describes your tendency to favor one side of your trade over the other. This can cause you to make decisions based on emotions rather than logic, which can have a negative impact on your trading results. It's important to understand your trading bias because it can affect your trading strategy and performance.
These are 15 types of bias that can affect your trading:
1. Optimism/Pessimism bias
This is when you think that the market is going to go up or down, based on past experience with similar events.
2. Gambler’s fallacy
This is when you believe that if something has happened three times in a row, it will happen again. It's also called "the hot hand fallacy."
3. Status quo bias
This is when you stick with what you know rather than taking a risk in hopes of earning more money.
4. Overconfidence bias
This is when you think that you're right and the market must act the way you expect. Which leads to making costly mistakes or poor decisions.
5. Recency bias
This describes your tendency to place greater value on recent events than on older ones.
6. Anchoring
Anchoring refers to making an initial decision about something (like an asset price) and then sticking with it even when new information comes along that should change your mind about how much it should be worth instead."
7. Self-serving bias
We tend to attribute any success we have to ourselves but any failure to external factors (for example, we think we'll do better than our peers because of hard work and perseverance but think they’ll do better because they had better luck).
8. Volatility aversion
The tendency to become risk-averse after losing money, even though taking a gamble would have been better financially in hindsight.
9. Loss aversion
The tendency to become risk-averse after experiencing a loss, even though taking a gamble would have been better in hindsight.
10. Confirmation bias
The tendency to seek evidence that supports your existing opinion while ignoring or undervaluing evidence that contradicts it.
11. Bandwagon bias
The tendency to do (or believe) things because many other people are doing (or believing) them.
12. Familiarity bias
The tendency to place more trust in things you're familiar with, even if they aren't necessarily better simply because they're familiar.
13. Hindsight bias
The tendency to see past events as being more predictable than they actually were, usually due to the fact that we now know the outcome and can't imagine how things could have gone differently at the time (and therefore underestimate the role chance has played in their occurrence).
14. Survivorship bias
The tendency to focus on what has survived from an event or group instead of what was lost. This leads us to overestimate how important or influential those survivors are, when in reality they might have been completely average or below-average members of that group!
15. The law of small numbers bias
This is when we think small samples of success are representative of larger scale wins.
How Does Bias Affect Trading?
Bias can affect trading in a number of ways. The most common way is that it can result in overconfidence, which can lead to taking unnecessary risks. Another way it can affect trading is by causing traders to make decisions based on their emotions, rather than the facts of the situation. Finally, bias can also cause traders to believe that their strategy will always work and ignore it when it doesn't.
Additionally, there are two types of biases that can have the greatest impact on trading: confirmation bias and loss aversion. Confirmation bias is when traders only look at information that confirms their existing beliefs. Loss aversion occurs when traders are more concerned about losing money than they are excited by making money—so they tend to avoid riskier trades even if they would be profitable in the long run.
How Important is Psychology in Trading?
Psychology is important in trading because it affects how you approach the market. If you're not confident and motivated, you may be less likely to take risks or make smart decisions. You also have to keep an eye on your emotions and stay alert for signs that you're becoming too emotional or irrational.
Traders often have a lot of different emotions that they need to deal with. They might feel excited and optimistic. They might feel worried, anxious, or depressed. These emotions can affect their ability to make good decisions and follow through on plans.
The best traders are able to stay calm and focused when it matters most, even when their emotions are telling them something else.
How to Know if Your Psychology is Affecting Your Trades
There's a lot of psychology that goes into trading, and it can be hard to know if you're being affected by your own psychology. Here are some of the signs that your psychology might be affecting your trades:
- You're not making money anymore.
- You've started betting more than you can afford to lose.
- You're taking risks that seem out of character for you.
How to Manage Your Trading Psychology
Managing your trading psychology is all about awareness. By being aware then you are able to manage your emotions and make better decisions. Below are a few more tips to managing your trading psychology:
1. Don't be too hard on yourself—even the best traders have losing streaks.
2. Take breaks when you need to—you'll be more productive when you come back.
3. Don't get too emotional about your trades, or you'll lose money.
4. Do your research! The more you know about a stock, the better off you'll be when making decisions about buying or selling it.
5. Remember that trading isn't a game—it's a business, and one that requires strict discipline and attention to detail in order to succeed.
6. Keep a trading journal and track your progress and emotions.
7. Find a strategy that works for you, and stick with it until you've mastered it.
8. Don't over trade or make rash decisions based on flimsy information.
9. Know your risk tolerance.
10. Have a long-term perspective.
3 Traits of a Trading Psychology Master
Focus on mastering these three traits to have a good grip on your trading psychology.
- Discipline: You should be able to follow a system and stick with it, even when you don't feel like it.
- Patience: You'll have to wait for the right moment before you buy or sell.
- Confidence: You should believe in yourself, your strategy and its ability to provide a positive expectancy.
Maintain a Successful Trading Psychology
If after all this you’re still wondering how important trading psychology is, keep this in mind: a trader’s mindset is what separates the winners from the losers.
While trading is certainly a skill that can be taught, learning how to manage one's psychology will ensure that this skill is used to the fullest extent. In order to do this, as mentioned above, a trader must be aware of their potential biases. This can be done by identifying your current positions and asking yourself: "Why did I enter this trade?" It helps to have hard data ‒ information gathered through research, charts, and signals ‒ behind your positions, both before and after.
Identifying your emotional triggers is also essential in managing your risk and overall chances of success. For example, if you are enticed to take too many risks when under stress you may want to limit your trades during those times.
Getting in the right mindset to trade is critical, it can make all the difference between success and failure and it is something that a lot of people struggle with. With a little awareness, and the right tools, you’ll be well prepared and potentially able to make successful trades.
Better your chances at gaining an advantage in trading by using trading signals to help guide your decisions and help you avoid making decisions purely from emotion.
