Trading psychology involves the emotional and mental state that influences the success or failure of your trading strategy. It encompasses various aspects of an individual's character and behaviour that impact their trading actions. Just like knowledge, experience, and skill, trading psychology plays a crucial role in determining trading success.
Two critical aspects of trading psychology are discipline and risk-taking. The trader's ability to implement these aspects is vital for the success of their trading plan. Common emotions associated with trading psychology include fear and greed but hope and regret also play significant roles in trading behaviour.
To understand trading psychology, it is important to identify specific emotions and behaviours that often drive market trading. Emotionally driven trading is often attributed to greed or fear. Greed refers to an excessive desire for wealth that can cloud rationality and judgment. It can lead to certain behaviours like high-risk trades, buying shares without proper research, or staying in profitable trades longer than advisable.
On the other hand, fear can causes traders to close out positions prematurely or refrain from taking risks due to concerns about significant losses. Fear is particularly palpable during bear markets and can lead to irrational decision-making and panic selling.
Regret can also impact trading psychology, causing a trader to enter a trade after initially missing out on it due to the stock's rapid movement. This violates trading discipline and often results in direct losses.
Trading psychology is especially important for technical analysts who rely on charting techniques for trade decisions. While technical analysis and charting can provide insights into market movements, understanding market dynamics requires intuition derived from an investor's trading psychology. Traders with a balanced trading psychology, including attention to market price influences, discipline, and confidence, are more likely to achieve success.
Part of trading psychology involves understanding why individuals make irrational decisions in the market. Behavioural finance, a subfield of behavioural economics, explores the psychological influences and biases that affect the financial behaviours of investors and financial practitioners. It helps explain market anomalies and phenomena like extreme stock price fluctuations. Concepts within behavioural finance include mental accounting, herd behaviour, emotional gaps, anchoring, and self-attribution.
Fear is a natural reaction to perceived threats in trading. When traders receive bad news about a stock or the economy, they may overreact and liquidate their holdings out of fear. It is important for traders to understand their fears and why they arise. By analysing and quantifying fear before it occurs, traders can move past the emotional response and make rational decisions in line with their strategy that benefit their portfolio's health and their own well-being.
