Trading Psychology

The Mental Game of Trading

Many experts believe that trading success is 80% psychology and only 20% strategy. You can have the best trading system in the world, but if you don't have the right mindset, you are likely to fail. Mastering your own psychology is often the final and most difficult step in becoming a consistently profitable trader.

The Two Primary Emotions: Fear and Greed

The financial markets are driven by the emotions of fear and greed. These two emotions are the primary cause of most trading errors.

• Greed: This leads to chasing trades, over-leveraging, and refusing to take profits in the hope of an even bigger gain. Greed causes traders to abandon their trading plan in pursuit of unrealistic returns.
• Fear: This can cause a trader to exit a winning trade too early, or to be too scared to enter a valid trade setup. The Fear of Missing Out (FOMO) is a powerful driver of impulsive and irrational trading decisions.

Common Psychological Biases

In addition to fear and greed, traders are susceptible to a number of cognitive biases that can impair their judgment.

• Confirmation Bias: The tendency to look for information that confirms your existing belief about a trade, while ignoring information that contradicts it.
• Loss Aversion: The tendency for the pain of a loss to be felt more powerfully than the pleasure of an equivalent gain. This can lead to holding onto losing trades for too long.
• Recency Bias: Giving too much weight to recent events. For example, after a series of losing trades, a trader might become too fearful to take the next valid signal.

Developing Discipline

The key to overcoming these psychological hurdles is discipline. This means creating a detailed trading plan with specific rules for entry, exit, and risk management, and then having the discipline to follow that plan consistently, regardless of your emotional state. Keeping a detailed trading journal is an excellent tool for identifying and correcting psychological flaws.