If we’re not psychologically prepared, we may make wrong decisions and risk more significant losses. Our psychology can influence everything from the trading system itself, trading decisions and analysis.
The forex market is a high-pressure environment with a lot at risk. Combine this with a highly volatile market, and you will have a market where traders feel emotions every day. When the trader feels fear, anxiety, anger, stress, or depression, it can be tough to make rational decisions and perform to their maximum potential.
What is Trading Psychology?
Trading psychology is a set of behaviors or emotions that influence how a trader thinks, feels, and acts. If a trader can master their trading psychology, they can be more successful, consistent, and reliable.
On the Internet, traders have a wide range of personalities. Some traders are aggressive and like to make quick trades; others are more cautious. Some traders use technical analysis, while others use fundamental analysis. Also, there is a set of personality traits that people commonly associate with traders, such as greed, competitiveness, and recklessness.
The Influence of Psychology on Technical Analysis
Trading and psychology go hand-in-hand. You can’t have one without the other. The psychology of trading is a vital aspect in determining whether you will achieve success or failure. Trading psychology is less tangible than trading behavior, but it plays the most significant role in the psychological aspect of trading. Trading psychology is what’s going on inside a trader’s head – how they make decisions, whether or not they chase losses, etc.
Technical analysis (TA) is easily traded by observing price action and analyzing profitable entry and exit points patterns. The market’s price is processed through a trader’s mind, where subjective analysis occurs.
Below are examples of how emotions can adversely affect trading decisions:
When traders are greedy, they make decisions based on what they hope will happen rather than what has happened. A greedy trader may think that past trends are more likely to continue instead of considering the possibility of a reversal. Greed is often rooted in fear, and what a trader hopes will happen often reflects their fears about the possible outcome of any particular trading decision. Being greedy prevents risk management from being effective because greed impairs a trader’s ability to cut their losses when needed most.
When traders are fearful, they make decisions based on what they hope will not happen, again rooted in fear of a negative outcome. A fearful trader may exit a profitable trade when it’s still reasonably early because they are frightened by the possibility of losing money. Fear leads to unnecessary losses and future trades that begin with an increased level of risk. Fear also leads to greed, as fearful traders are often tempted by the possibility of a huge win that would quickly make up for initial losses.
When a trader is over-confident, they do not adequately assess their ability to make money in the forex market. Traders who are over-confident often trade far more frequently than they should, leading to increased transaction costs and missed opportunities. Successful trading results from growing your bankroll over time through small but consistent profits, not by making big trades that could wipe out months or years of profit in one fell swoop.
When a trader is constantly doubtful, they constantly second-guess their ability to make money. It often leads to difficulty entering trades, as a trader who doubts themselves will continuously worry that any given trade may not be the best choice. Their self-doubt also manifests itself during active trading. Constantly thinking about whether or not you could have entered a trade in the past will cause you to miss opportunities for future trades.
When a trader is over-reactive, they allow their emotions to sway them from making sound decisions. As with greed and fear, being over-reactive often goes hand in hand with other psychological traps. Overreaction prevents a trader from sticking to their strategy, as they are constantly changing it based on how the market behaves in the short term. They then find themselves back at square one, without a plan or a direction for future trades.
If you avoid these five psychological pitfalls, you will vastly improve your money-making in forex.
The psychology of trading is the study of how people make decisions and act on those decisions, including when and why traders lose and make money. Trading psychology involves applying psychology to trading to maximize trading performance. Trading psychology is the study of the way traders think. Traders do not always act rationally, and as a result, psychology forms an integral part of trading.