Trading psychology: how to overcome yourself and achieve success

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Trading successfully requires more than just a solid understanding of markets and analysis techniques. Oftentimes, the biggest obstacles to long-term trading success lie within our own minds. Our inherent psychological biases and emotions can negatively impact trading decisions and lead to costly mistakes. Controlling fear, greed, overconfidence, stress, and other factors are crucial to developing the mental discipline of a successful trader. In this article, we will explore the common psychological pitfalls in trading and how to overcome them.

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What is trading psychology?

Trading psychology refers to the emotional and mental aspects that dictate a trader's decision-making process, influencing their behavior in the market. It encapsulates a range of psychological biases and feelings which can significantly impact trading outcomes. This can be overconfidence, euphoria, fear, greed and others.

Their influence can be so strong that:

  • A trader may suffer a loss despite the correctly performed analysis;

  • A trade does not enter a position (or exit the position), when a corresponding signal is delivered;

  • A trader trades very big or very small volume;

  • A trader overemphasizes some factors and ignores the others.

Emotions do not always lead to losses. Sometimes, they help you profit, but that usually is related to unjustified risks, which is a sign of lack of professionalism.

Traders, who have been to the trading floors of large hedge funds and investment banks (for example Goldman Sachs) know that there are psychologists working there on a permanent basis; they monitor the emotional condition of the traders. If a trader displays some signs of emotional distress or imbalance, he may be removed from his work station. A trading psychology is an important part of a trading system. If you want to learn more about the basic elements of a trading system, read the Traders Union article.

The importance of trading psychology. A simple example

Do you know about the famous Stanford marshmallow experiment?

The children were left one-on-one with a marshmallow and a condition that if they did not eat the marshmallow right away, they would get another one later.

Stanford marshmallow experiment

Stanford marshmallow experiment

The majority of the participants of the experiments yielded to the temptation and ate the one marshmallow they were given right away.

This is directly related to trading, as novice traders are inclined to give in to temptation and lock in profit as soon as it is earned. Usually, beginners do not wait for the price to reach the target level. They behave just like the children from the experiment.

The reverse pattern involves formation of a floating loss. Novice traders hope that the price will move in their favor, while the loss keeps growing to critical values. This is where the trading wisdom comes in: “Cut the losses, let the profit grow.”

The described experiment indicates that in order to achieve success in trading, you need to act against your will, emotions and inborn patterns of thinking.

Fear and greed are the most dangerous emotions in trading

Controlling Greed

Greed is an excessive desire to become wealthy. Although there is nothing wrong about the desire to have a lot of money, provided you earn them honestly, the passionate desire to become rich on Forex or stocks quickly and easily is more likely to backfire.

Greed can suppress rational thinking and lead to suboptimal behaviors, for example, buying a big volume of a financial asset simply because the price is rapidly climbing.

Example of the price chart of Tesla Inc., period 2D.

the price chart of Tesla Inc.

the price chart of Tesla Inc.

Tesla stocks are the most discussed stocks online, which is why it is possible to monitor the actions of emotional investors on the price and volume charts.

The first arrow shows rapid growth of prices at high volumes.

At the end of October, the media were full of bullish headlines:

  • stocks grew 20% in a week.

  • Company’s capitalization grew to 1 trillion.

  • Tesla gets a big order from Hertz.

  • Uber to also use Tesla.

  • Analysts set the target price of TSLA at $1,300.

Do you feel like you are starting to want to buy the stocks, when you read these headlines?

The second arrow points to the actions of emotional buyers. The volumes remain high, as the news is still being discussed on social media, also the growth progression has noticeably dropped. That’s because major players who base their decisions on emotions are selling the stocks.

The third arrow points to a narrow candlestick on very low volumes – the flow of greedy buyers has ended. And then (it seems out of spite!) Elon Musk decided to sell his share package (in reality, he got stock options instead).

The prices plunged lower than $1,000, bringing the losses to those who were buying in the end of October guided by greed and reading hot headlines.

Strategies to Overcome Greed in Trading

  • Set realistic profit targets based on historical performance. Take partial profits as targets are hit.

  • Use trailing stop orders to lock in gains as the market moves favorably. Don't get greedy waiting for more.

  • Avoid euphoric overtrading when you are winning. Stick to your trade frequency rules.

  • Scale out of large positions over time rather than trying to maximize every trade.

  • Maintain composure during bull markets and high volatility. Avoid impulsive overtading.

Tip. Study the trading volume indicator. With an understanding of market psychology and an ability to read the volume, you will be able to develop the skill of understanding the true sentiments and then act rationally, not out of greed, which is driven by the hot headlines.

Overcoming Fear

Next, let’s review the chart of AAPL, which is another widely discussed stock. It will help us understand another problem of the traders – fear. We will show March 2020, when the world was panicking due to the spread of COVID-19.

the chart of AAPL

the chart of AAPL

Note that the decline rates are always higher than the growth rates at the stock market. This can be explained, among other things, by the fact that fear is the strongest emotion. It helped humanity to survive in the wilderness, although fear can be a bad assistant in the financial market.

In the periods of panic, when emotional traders sell, there are great opportunities for investing.

Tip 1. Use technical analysis. Using the reference points 1-2-3-4-5-6, you can build a channel, in order to then find the ideal entry point for a long position on the line of the parallel channel (7) near the panic day. By the way, some technical analysis patterns are explained from the standpoint of emotional behavior of traders, and therefore, they will help trade rationally at times, when others are guided by fears and greed.

Tip 2. Study VIX, a financial instrument, which is sometimes called the ‘fear indicator’ of the stock market. The splashes on the VIX chart usually coincide with the market minimums.

Strategies to Overcome Fear in Trading

  • Set stop-loss orders on all trades to limit potential losses. Stick to your stop-losses.

  • Define maximum loss per day or week you are willing to take. Close all positions once hit.

  • Trade smaller position sizes to lower risk exposure and fear. Slowly increase as you gain confidence.

  • Avoid impulsive trading based on emotions. Stick to your trading plans and strategies.

  • Visualize end goals rather than short-term P&L. Focus on hitting singles and doubles.

“… Be fearful when others are greedy and greedy only when others are fearful.” Warren Buffet

Prejudice and Errors of Judgment

Prejudice in trading is inability to perform independent analysis and make an unbiased decision.

There are several kinds of prejudice:

  • Representative prejudice. For example, you will have objective conditions for buying USDJPY. However, you will reject this trade, because you suffered loss trading this pair in the past. So, instead of trading yen, you will choose EURUSD, despite that the conditions are not great at all. Still, you’ve had a positive experience of trading EURUSD.

  • Prejudice against negative things. It means that a trader pays too much attention to risks and is inclined to see danger even where there is none. It could lead to the trader closing a profitable trade, even if it is developing by the expected scenario.

  • Prejudice against the status quo. It means that a trader is inclined to continue to use ‘tested’ strategies and markets and disregard new information. It can work for some time, but the danger is that the trader won’t be able to adapt to the continuously transforming markets on time.

  • Prejudice against confirmation. This happens, when a trader seeks and overstates the significance only of those arguments that support his formed ideas. At the same time, he will turn a blind eye to the facts refuting his beliefs.

  • Player’s delusion. It means that the people are inclined to assume that if the price grows, it will continue to grow. The opposite opinion – “if it grew significantly, it must drop”, is also not quite justified. These thoughts, however, are often used as justification for the trades, which result in losses.

  • Non-acceptance of losses. Traders refuse to lock in the losses not to inflict pain on themselves. We can assume that the root of this practice goes back to the instinct of self-preservation. However, it is vital to learn not only to endure the pain of losses in the financial market, but also accept them neutrally, as the losses are inevitable. Otherwise, the hope that the ‘floating loss’ will disappear on its own can fully destroy your capital. Or, failure to accept losses can lead to the so-called disposition effect, when traders sell their profitable positions and hold unprofitable ones (which should be the other way around).

Tip. To fight prejudice, use two simple things: a trader’s diary and a trading plan. Create and maintain them in an orderly manner, be honest with yourself, when answering these kinds of questions:

“What should I have done?”

“Why have I not done it like that?”

“What should I do to act according to the plan?”

“How will I fix the mistakes?”

The path to solving the problems will be unique, because every person is an individual with a unique experience, knowledge and skills. You won’t be able to find a ready formula, you will need to work on self-improvement. It is important not to blame the market for acting like that to spite you! Everything that happens in your life, including trading, depends primarily on you.

5 simple ways to improve your psychology

You have probably heard all of these many times, but that doesn’t make them less relevant or effective.

1

Take a personality test. Determine your strengths and weaknesses. You will need to answer the questions honestly and then think about how to improve your strengths and control your weaknesses.

2

Develop a trading plan. It must contain detailed instructions for any situations that may appear during trading: when to enter a position, when to exist, how to control risks, etc. it is important to regularly improve your plan. It will mean that you are improving as well.

3

Manage stress and tilt. Losses and drawdowns are an inevitable part of trading. Prolonged losses can cause frustration, stress, and tilt - where emotions take over trading actions. Use stress management techniques like meditation, exercise, and positive self-talk. Take a break from trading if needed. When in a drawdown, review losses objectively rather than beating yourself up. Understand that you cannot win every trade. Staying calm is crucial for recovery.

4

Avoid overconfidence and euphoria. Success in trading may lead to overconfidence in one's abilities. But markets constantly evolve and past results are no guarantee of future performance. Be realistic about your skills and keep practicing humility. Bullish euphoria during market runs may cause you to abandon risk control. Stick to your plans and maintain composure whether you are winning or losing.

5

Cultivate a learning mindset. Successful trading requires a lifelong learning mindset. Be adaptive and continually work on improving your process. Review both wins and losses for lessons. Maintain a trading journal and practice self-reflection. The markets will humble you. Stay hungry and avoid complacency after successes.

Books on trading psychology

Let’s continue with the bestselling books that we can recommend by the authors who are directly connected to trading and psychology.

Brett N. Steenbarger, Director of Trader Development at Tudor Investment Corp. He holds a PhD in psychology and since 2004 he’s been involved in coaching and recruiting of traders and portfolio managers for hedge funds. He is the author of several books on the topic, including Trading Psychology, Trading Psychology 2.0, Enhancing Trader Performance and The Daily Trading Coach.

Mark Douglas. Mark started developing seminars and educational programs on trading psychology in 1982. His books Trading in the Zone and The Disciplined Trader: Developing Winning Attitudes are considered the industry classics and some of the first books that introduce traders to the concepts from psychology.

Jack Schwager. Schwager is the author of the series of books Market Wizards, which are a collection of interviews with professional traders. By reading their quotes, including on psychology, you will be able to gain a better understanding of the mindset of those who achieved significant success and also learn how to improve your skills.

Alexander Elder. He is a qualified psychologist, who consulted traders at his private office on Wall Street and then started to trade himself. His famous book Trading for a Living: Psychology, Trading Tactics, Money Management is a must read.

This list of books can be expanded, but we listed those that we recommend starting with in order to learn trading psychology.

Best Forex Brokers 2024

By the way, the choice of a broker can also impact the psychological element.

For example, Roboforex specializes in providing services for algorithmic traders, those who use EAs. Clearly, algorithms do not feel any emotions; they strictly follow the trading plan. If you feel like you cannot control your emotions (especially on quick timeframes), maybe you should consider algorithmic trading.

The other option is eToro, a social trading broker that provides copy trading service. This means that the clients of the broker automatically copy the trades of successful and experienced traders to their accounts, thus avoiding the stress of making a decision.

Roboforex Benefits

Open an account
Your capital is at risk.

Licensed broker, in the market since 2009;

Over 4.5 million clients as of 2020;

Specializes in trading with EAs, as you can tell from the name of the broker;

Minimum deposit is only USD 10;

Spreads – floating, from 0 pips (depending on the account type);

Clients have access to Forex market, instruments of stock, commodity, cryptocurrency markets;

You can trade 24 hours a day, 7 days a week (depending on the markets);

Deposit bonus (to learn more contact customer support);

When you trade with Roboforex, you can download EAs to the Metatrader platform. The platform features a busy market, where you can test expert advisors for free and buy those that you like.

eToro benefits

Open an account
eToro is a multi-asset investment platform. The value of your investments may go up or down. Your capital is at risk. Don’t invest unless you’re prepared to lose all the money you invest.

Licenses of FCA (UK), CySEC (Cyprus), offices in the U.S. and other countries, in the market since 2007;

The most popular copy trading service for automatic copying of successful traders;

Minimum trade value to copy - $1;

Zero commissions in a number of markets;

Leverage up to 1:30;

Free demo account;

You can buy not only whole, but also a fraction of an expensive stock.

According to the European regulator that estimates the losses of the clients of different brokers, eToro has a high level of profits. We believe one of the reasons for that is that eToro clients do not experience the strong psychological pressure, when they copy the trades of professionals to their account.

Summary

Trading is an activity with an unfavorable psychological environment. In order to achieve success here, you will need to go against your instincts and break your regular models of behavior.

In order to improve psychologically, a trader needs to:

  • Take responsibility for their account;

  • Understand the strengths and weaknesses of their character;

  • Create a trading plan, taking into account the circumstances and unique features of their personality;

  • Keep a trader’s journal, revealing and correcting mistakes;

  • Improve by reading the best books on trading psychology.

Before you start risking real money, while trading under psychological pressure of the market, check your readiness by using a demo account of a trusted broker.

For traders who struggle to control their emotions, an effective solution might be utilizing trading algorithms and automation that provide an emotion-free, methodical approach to the markets:

  • Trading algorithms can execute trades according to predefined rules and strategies, removing emotion-driven discretionary trading. Algorithms do not experience fear, greed, or other biases that humans do.

  • Automated trading systems allow traders to mechanically follow a strategy with discipline and objectivity. For discretionary traders, automation can be used just for trade execution to remove the hesitation, second-guessing, and impulsiveness during order placement. Implementing automation forces the trader to objectively define every aspect of their strategy which can lead to refinement.

FAQs

Why is it important to understand market psychology?

There are studies that prove that greed and fear can make a person lose self-control and act irrationally. The ability to work with your emotions can help traders avoid irreparable drawdowns on their account.

Why do traders suffer losses due to the wrong psychology?

Trading involves accepting a condition in the conditions of uncertainty. When you don’t know what will happen next, expectations, assumptions, recollections, gambling, anxiety before the unknown “appear on the stage” and the mind gets caught in traps. In the end, this leads to irrational trades.

Are their traders who don’t experience problems with trading psychology?

That’s unlikely. We are not perfect. However, there are traders who acknowledge their strengths and weaknesses and work on self-improvement (thus increasing their chances for success), and there are traders who do not think it is important to study their psychology and then adapt (thus improving their chances for failure).

How does mass media impact the psychology of a trader?

Journalism and trading are two different domains. From the point of view of a journalist, the work may be carried out professionally with the facts collected, experts asked for comments, interviews, and infographics drawn. This, however, does not mean that a trader will not be misled by this information. If the media helps you find good trading ideas, then use the newsfeed, TV, blogs. We believe that it is not a mandatory thing. Mass media is a source that can carry useful information, and that can also bring emotional pressure. Be that as it may, the final decision is always yours to make!

Team that worked on the article

Oleg Tkachenko
Author and expert at Traders Union

Oleg Tkachenko is an economist-analyst and a risk manager with a practical experience of working in financial institutions for over seven years. Oleg specializes in the analysis of commodities, Forex, stock markets and non-standard investment markets (cryptocurrency, hypes, peer-to-peer lending). He holds a Master’s Degree from the Ukrainian Academy of Banking of the National Bank of Ukraine, Kharkiv Banking Institute. Oleg became an author for Traders Union in 2018; in 2020 he joined the TU’s team of financial experts.

At Traders Union, Oleg is involved in expanded reviews of brokerage companies, and in monitoring the relevancy of the information provided in them. He analyzes trading strategies and indicators, and prepares educational articles on the topic of finance. In addition, Oleg carries out expert research in the Forex and stock markets, and also binary options and cryptocurrency markets. In particular, he checks brokerage companies, studies their performance and growth, tests new services offered by brokers, software and the level of customer support.

Oleg’s motto: Information is a force that opens boundless opportunities, but requires relevancy!

Olga Shendetskaya
Author and editor at Traders Union

Olga Shendetskaya has been a part of the Traders Union team as an author, editor and proofreader since 2017. Since 2020, Shendetskaya has been the assistant chief editor of the website of Traders Union, an international association of traders. She has over 10 years of experience of working with economic and financial texts. In the period of 2017-2020, Olga has worked as a journalist and editor of laftNews news agency, economic and financial news sections. At the moment, Olga is a part of the team of top industry experts involved in creation of educational articles in finance and investment, overseeing their writing and publication on the Traders Union website.

Olga has extensive experience in writing and editing articles about the specifics of working in the Forex market, cryptocurrency market, stock exchanges and also in the segment of financial investment in general. This level of expertise allows Olga to create unique and comprehensive articles, describing complex investment mechanisms in a simple and accessible way for traders of any level.

Olga’s motto: Do well and you’ll be well!

Mirjan Hipolito
Cryptocurrency and stock expert

Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO). Mirjan is a cryptocurrency and stock trader. This deep understanding of the finance sector allows her to create informative and engaging content that helps readers easily navigate the complexities of the crypto world.