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The Psychology Of Trading: How To Manage Your Emotions


April 2023

The psychology of trading is one of the cornerstones of success, ignoring it can lead to disaster. For example, Nick Leeson single-handedly bankrupted the 200-year-old Barings Bank (where even Queen Elizabeth II kept her money, she lost 2 million pounds), and the inability to control emotions in trading led to such a disaster. Psychology in trading is important for everyone without exception – both for a beginner with a couple of hundred dollars and for a pro with a million-dollar deposit.

Trading psychology is what determines a person's behavior in the context of trading in financial markets. By behavior, we mean all activities related to trading. Beginning from finding the entry point and ending with profit taking.

William Eckhardt, a famous trader, managing funds, said that success in trading is practically unrelated to intelligence. According to his observations, people of average intelligence, but assiduous, with the ability to maintain discipline and self-control were consistently trading successfully. It is directly connected with psychology; only full control of one's actions lets one earn stably, not occasionally. The psychology of trading can be developed over time. Beginners are inclined to make the same type of mistakes, but self-controlling can and should develop these qualities. All you need is the ability to learn from your own mistakes.

How Do I Handle My Emotions As A Trader?

The tools for dealing with psychological problems come down to constant practice and controlling one's actions. These are good recommendations, but they are too generalized, a more detailed description of the recipe for solving problems is needed.

Learn To Rest

Trading is associated with stress. Psychological stress must be relieved, no one can withstand the constant pressure of worrying about open trades or missed opportunities. Many sportsmen agree that in preparation for the final games or competitions one should pay attention to sports, daily routine, and diet. In trading, the same principle applies; physiology affects a person's psychological state.

You need a schedule that includes the activity necessary for a person's comfortable life. Set aside time for the gym, walks, and other activities. Do not turn trading into the meaning of life.

Don't Focus On The Problem And Find Unconventional Solutions

Trading is rarely a hassle-free business. Even profitable strategies lose relevance over time, and their effectiveness decreases. The market also changes, and the old analytical methods may stop working. There is a risk of getting hung up on a local problem, and there are no guarantees that you will find a solution. An example is an optimization of the trading strategy. The trading strategy may fail, and the trader gets hung up on its optimization and spends days and weeks, but all attempts are in vain.

The trader must be able to stop in time and find a non-standard solution. You can't optimize the old strategy? It is time to find a new one or change your trading style in general.

Fearless Analysis

This term was used by Brett Steenbarger. He drew a parallel between the analysis of his trading and the Alcoholics Anonymous Club. Both require courage to admit the problem. Most prefer to blame external factors instead of accepting their mistakes and accepting that the problem is in themselves. You need to be able to mentally say to yourself "I made mistakes, and that's why I lost money, the market, the market makers, and the indicators had nothing to do with it."

Acknowledging the problem is the first step to solving it. This rule works in any area of life, including trading.

Evaluation Of Hypothetical Scenarios

A trader must be prepared for all scenarios. It means that it is impossible to be bound to only one scenario and rely on it 100%. If, for example, a pronounced downtrend is developing, the pair breaks out one level after another, and the trend is likely to continue. But it is impossible to guarantee it 100%.

The probability of reversal is not very high, but it is necessary to evaluate this scenario as well, to consider what levels may stop the decrease, and where the potential targets may be.

Due to this, the trader always has at least 2 scenarios. If one does not work out, the trader just switches to the reserve variant of action. There is no panic, no misunderstanding of what is happening. This is good both from the emotional point of view and from the point of view of getting out of the drawdown. If a loss is incurred according to the first scenario, the reserve plan allows to quickly compensate for the loss.

Detached Attitude To Trading

It is unlikely that you experience intense emotions at your main job every day. Most likely, the work process has turned into a routine, and at least part of the actions are performed automatically. The same should happen with trading, positions should not cause a storm of joy or regret of losses. This is the so-called psychology of the quiet trader - the absence of strong reactions to trading.

It is impossible to develop this skill in advance. At the initial stage, any trader will experience emotions and it will interfere with trading. But with constant practice, there will be nothing surprising in trading, and placing orders will turn into a routine.

Larry Hite, who was featured in Jack Schwager's book, Stock Market Wizards, said that all his trades were utterly boring. Hite said that in all his trading there was not a single story that interested his colleagues. That is the art of trading – you have to strive for all trades to be similar to each other.

Keeping Track Of Your Actions

Keeping a trader's journal is ignored by the vast majority of beginners. It seems to be unnecessary, as everything is clear anyway - there is a signal, and it is necessary to trade instead of wasting time on some notes. This approach deprives the trader of the basis for future trade analysis.

You can download a trading report from the terminal, but it cannot be considered an analog of the journal. The report contains only trades, time of entering the market, a result of closed positions, expenses on spread, commission, and swaps. In the journal, the trader specifies reasons for placing an order and assesses their emotional state.

Besides the journal, it is recommended that beginners check the fulfillment of all rules on the checklist. It is necessary to write out all of the filters for assessing the signal on a sheet of paper, assign points to each of them, and assess entry points. These techniques work, with time you can check them mentally.

Regular Practice

We mentioned above the importance of breaks in trading, but this does not mean that you should periodically give up trading. It is important to be measured, the practice should be constant. If a bad streak has begun, it is necessary to take pause, but it should not turn into a long-term refusal from trading. Time is needed only for the normalization of the psychological state. After that, the work on mistakes is carried out and trading is resumed.

It can be compared to sports. If weightlifters do not practice it on a regular basis, they will lose their form. It is approximately the same as trading.

Trading Will Be Unprofitable From Time To Time

This is an important point, and it should be realized even before placing the first order. Starting to trade, a beginner must realize that any order can be unprofitable. But statistics of their strategy show that it will be profitable due to the greater number of profitable trades and/or a take that is much higher than a stop. It is impossible to earn in every trade, there is no trader in the world who could work in this mode for years. The maximum is a series of profitable trades throughout the day/week/month.

Attention should be paid not to the result of a specific trade, but to its compliance with the rules. If the trade was closed by a Stop Loss and it was correct, then everything is fine.

Possible Failure Is Not Related To Your Personal Qualities

If the first attempt is unsuccessful, it has nothing to do with your intelligence or lack of talent. Moreover, famous traders noted that intellectually developed people find it more difficult to trade, among them there are more of those who lose their deposits. Most likely, there were mistakes, probably the wrong decision-making methods were chosen. This is not a disaster, everything can be corrected. Success in trading does not depend on talent, only discipline, and persistence.

Conclusion

A lost deposit doesn't mean you're not smart enough or that trading isn't for you. It's just the consequence of a mistake – a lesson you need to learn, draw conclusions and keep working. It's better to learn from other people's mistakes, but you can also use your own for your own good.

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