Assume you’ve just closed a winning trade and want to quickly double those earnings by initiating another trade in the same direction. Fear of missing out on a good opportunity may cause some traders to undertake bigger trades. When making a decision, these emotions are anticipated and considered. Understanding how your psychology influences your trading is critical to your success.
Despite our desire to be rational and intelligent, our emotions dictate our decisions especially when it comes to trading. Emotions like anger and sadness etc., may influence decision-making. Let’s examine the impact of trading psychology on your trading success.
When it comes to trading, psychology is the emotional component of an investor’s decision-making process that explains why certain decisions seem more rational. Fear and greed are two of the most prevalent emotions and acts associated to trading psychology. Emotional trading is typically defined as taking decisions driven by greed, fear or other emotions in the markets, and may lead to increased risk exposure.
Both successful and unsuccessful traders feel strong emotions. Emotions frequently impact a trader’s decisions. They might affect your trading by leading to illogical judgements. It doesn’t matter whether the emotion is present or anticipated; what counts is that you acknowledge it and understand its implications. Fear and greed have been discussed extensively, but other emotions may also be harmful.
How each emotion affects your trading?
When panic strikes you when you’re on your screens, you can end yourself attempting to avoid making judgments. If you’re worried, you could close winning transactions early and do nothing with your earnings. When a transaction is losing, we may elect to delay terminating it, resulting in an even bigger loss.
Greed may also lead to poor trading judgments. In the dot-com bubble and bust, as well as in the rise and fall of Bitcoin, greed was a component. People tend to be selfish when the expected reward exceeds the expected time and expense of investment. They want rapid wins. Greedy traders are more prone to overlook goals, stops, and other elements of their trading strategy. Our confidence may sometimes override us, leading to bad trading and significant losses.
We don’t really think critically while we’re pleased since we feel there’s no danger. It’s simple to make snap decisions while we’re feeling well. We’re more likely to think about the advantages only we’ll obtain if we take those decisions, and avoid considering disadvantages (this is called the saliency bias). Intense emotions drive us to misinterpret complex information (like market signals) as a chance to profit.
To celebrate a profitable transaction, we may trade recklessly and blame bad luck if we lose money. We can’t learn from our failures because we’re so self-assured. As well as it’s hard to accept mistakes while you’re happy. As a consequence, even if we study our trading activities, we will not learn and improve as traders.
On the other hand, we become cautious and lower our expectations when we are sad. We usually set a lower objective than usual on bad trading days. We’re more likely to trade too small, missing out on the chance to profit.
Anger does the reverse. Trading when enraged increases the risk of losing a lot of money quickly. High-risk situations like these may spin out of control. Loss enhances a person’s fury (at both ourselves and the market). In our rage, we make even more harmful choices. Revenge trading is the quickest way to lose all your money.
Why you should remove emotions entirely from trading?
1) To align your goals and actions
To trade based on emotion is to trade blindly. In this mindset, you run the danger of misaligning your goals and activities, which might harm your wealth development efforts. As a consequence, you make investments without fully comprehending the risks and rewards of each trade. You’ll miss your targets and there’s no time to fix it. So controlling one’s emotions is critical.
2) Avoid unreasonable risks
Emotional trading usually involves high-risk trades, placing you at risk of significant financial loss. The trouble for a newbie is that they don’t know how to solve it. A disappointing start in your trading career due to emotional trading may persuade you to give up on long-term wealth development and inflation-beating
returns. By avoiding trading based on emotions, you avoid risk and can plan appropriately.
3) Avoid overtrading
Emotional trading forces you to overtrade. For example, the current Bull Run may cause FOMO, which may lead to overtrading. Your trading expenses will skyrocket if you overtrade, making it hard to preserve your capital and trade consistently.
Trading based on emotions may lead to over-trading, whereas trading objectively lets you know when to stop. So you may trade for longer periods of time while lowering the chance of losing money.
4) Avoid revenge trading
When you lose money due to emotional trading, you’re more prone to participate in revenge trading. If you do this kind of trading, you try to make up for a previous loss. Revenge trading may result in incorrect decisions, severely harming your money. This kind of trading is illogical and pointless, and it raises the risk of financial loss.
We all have feelings, however, trading requires more discipline as well as controlling and monitoring your emotions, to raise the possibilities of long-term success.