Trading is not what most people think it is.
The Hollywood version of trading, where huge sums of money are made effortlessly by smiling traders in a matter of seconds, can often seem alien to anyone who trades for real.
It’s also changed structurally too, with trading now making a huge impact online. It can be done from home, with the same results the Wall Street guys get being available to the guy sitting in his living room in his jeans.
The Ups n’ Downs
One aspect that can prove to be especially traumatic is the ‘rollercoaster’ nature of trading.
This is true for home traders as well as the professionals on the exchanges. The psychological aspect of trading, where your brain has to deal with losing as well as winning, often within a matter of seconds, is the hardest part to get right.
Knowing how to manage your trading psychology and becoming a winning trader is vital. If you can’t take the pressure, you won’t get far. And this is true no matter what your trading strategies are.
Your first step in gaining a trading mindset involves you, and mastering your own emotions. Once you step beyond yourself a little and look at trading objectively, you’ll have a better chance of surviving … and thriving.
There are a few things you need to master to become a consistently profitable trader:
Out of all the mentioned tools, trading psychology is perhaps the hardest thing to get right in trading.
Trading is not an exact science, it’s rather art. While you can create and follow rules with your trading strategy, it becomes quite hard to have strict rules with trading psychology and controlling your emotions. How will you control fear and greed – some of the most devastating emotions in trading – in your next trade?
In the long run, your trading success might depend exactly on the answer to that question.
Do Your Homework: Analyse the Markets
Analyzing the markets and having a good background for each trade that you’re taking can make wonders in controlling your emotions. The more you actually research the markets, the less you have a gambler’s mentality. This will also help keep your emotions under control.
The markets are fascinating things. If you spend time researching industries and companies within them, you will start to understand the context price moves. You’ll also be better placed to manage the rollercoaster of emotions, profits and losses.
For example, if you know things are bad in a certain company, you’ll be confident about short-selling that company or exiting out of your long position.
This should allow you to think more sensibly about markets and trades, and eventually come up with a trading plan. This is where you work out and articulate how you will act and what you will think when you trade.
A good trading plan allows you to work out what your expectations are, what you are like personality-wise as a forex trader, and what to avoid. Knowing the markets and currencies through deep research is a great way to build a foundation for a good trading plan.
Do Some Research into Successful Traders
Knowing how the most successful FX traders work can only give you full and deep insights into the best way to trade. Pretty soon, you’ll understand the objectivity involved in solid trading. Many successful traders treat what they do like running a business.
They don’t let emotions get involved, ever.
The aim is still to make money, but to manage risk at the same time. Studying successful traders will help your own trading in a huge way. You can really benefit from someone who has ‘made it’.
Many traders often talk in terms of absolute returns when they’re asked about their trading performance. However, a much better measure would be to talk in terms of risk-adjusted returns and Sharpe ratios.
It’s not about how much return you can make in absolute terms, but how much you’re risking to achieve those returns. Following and learning from successful traders can show you how to manage your emotions the right way, both when making money and when losing.
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Intraday Trading Psychology
Day trading (or intraday trading) is tough.
It is perhaps the one area where fear of loss can have the most devastating effect.
Everything happens on the day, whatever you trade, therefore the minutes and hours can be almost unbearably stressful. The trading psychology behind the life of successful day traders is quite simple though, and once you get the main principles down, you should be better equipped to deal with the roller coaster.
Losing money is OK
First up, remember that you are going to lose money. This is going to happen, and it cannot be avoided in the long term no matter what you do. There are factors outside of your control, and this means that you can prepare as much as you like, something will still go wrong.
Keeping that in mind, remember also that this doesn’t have to be a bad thing. If you lose money, so be it. The nature of intraday trading is that things move very fast. If you actually expect to lose some of the time, but make larger winning trades when you do win compared to when you lose, then you are making progress and profit.
Remember that business analogy?
If you win, say 60% of your trades, you’re doing well. And because you’re often making big and small trades, your big trades will also come up trumps too. Over time, and with your business mindset, you’ll see that ‘profit and loss’ are perfectly natural partners.
Traders can’t control the markets. The only thing we can control is our risk and our mindset. Even the best traders out there don’t have a success rate of 100%, and the key isn’t necessarily to increase your success rate.
Profitable traders make more on winning trades than they lose on losing trades – that’s it. In fact, many of the most successful traders take a large number of losses along the way until one winning trade makes their month or quarter.
Remember: The key is to make more than you lose, with losses being an integral part of the game.
Only Trade With Money You Can Afford to Lose
This is one of the principles that are part of true trading success.
Everyday, no matter which mood you happen to be in, or what’s happening in your life, you should only ever trade sums you can afford to lose.
Obviously, no one can really afford to lose money, but if you have a certain percentage of your money that you are prepared to lose in the pursuit of large gains, then you should feel better as the day moves on.
Stepping over the line and trading more than you can comfortably afford to lose will simply make you feel more stressed and then this will force your emotions into the driving seat. You’ll make bad decisions, and they can become catastrophic. This applies to all trades, whether on the foreign exchange (forex) or traditional stock trading.
You will feel better if you know the world isn’t going to end if a bad trade happens. This is again all about staying objective and maintaining your business mentality.
The concept of “risk per trade” fits perfectly into this discussion.
To limit your losses and grow your trading account, you should only risk a fixed, predetermined percentage of your trading account on any single trade. Depending on your trading account size, this can be anything from 0.1% to 3%. Each trader has his own rule how much he’s willing to risk on a single trade, but the key is to keep that percentage low.
Imagine risking 10% of your trading capital on a single trade. A losing streak of 5 trades will wipe out 50% of your trading account! In this situation, you’ll need to make a return of 100% only to get back to your previous account size.
As a rule of thumb: The larger your trading account the less you should risk on a single trade, in percentage terms. A trader with a $5,000 account could risk 5%, but a trade with a $500,000 would be better off by risking up to 1% of his account size.
The 6% Rule
If you aren’t controlling your risks effectively, your emotions could kick in and devastate your trading day. It’s important that you focus on making sure that your loss limit is sensible, and one that keeps you able to manage your financial situation effectively.
Most successful traders set a loss limit on all open trades at around the 6% level. This keeps them both afloat and ready to fight another day. It’s a vital part of money management.
If you’re risking 1% of your trading capital per any single trade, you may open up to 6 trade simultaneously. The 6% rule avoids that piranhas – or many losing trades – wipe out your trading account.
This is a crucial principle to make clear.
Sitting back and cutting your losses is actually part of a successful trader mindset. Ignoring this makes no sense.
Set a sensible loss limit and leave it there. Then get on with your trading. This way, no matter what happens, you’re not going to lose the farm even if you have a bad day.
Benefits of Technical Analysis
This point relates to the necessity of analysing the markets in order to control your emotions.
If you look at the biggest traders of all time, people like George Soros, for example, you’re sure to spot the one thing that links them all together. They developed strong technical analysis skills.
By knowing what the markets are like on a daily basis, point for point, and seeing trends over time, you are in a much better position than the vast majority of traders out there. While some traders are flying by the seat of their pants and hoping for the best, you’re picking stocks that you know have some value and clear prospects.
Technical analysis takes time though, and this is something that you need to be aware of. It will help your trading mindset if you’re able to put in the hours and understand technical analysis at a competent level. You don’t have to be a Soros, but you do need to know the basics.
Trust us, having an understanding of technical analysis and being able to apply it to your trading on a daily basis will make you feel less stressed and more able to handle your emotions.
Avoid these Common Mistakes of New Traders
The following areas are the biggest ‘traps’ a trader can face as their career progresses. Take a look at them and bear them in mind as you work to master your emotions.
Fear of missing out (or FOMO). A common problem with inexperienced traders, and perhaps especially new day traders. This is where you see some traders making a big win on a stock or option, and you jump in. You’ve jumped in at the wrong time though, and you end up making a big loss. This can all be avoided if you’ve followed your own rules, and focused on making informed decisions. Never chase the market for trading opportunities. Good setups form over and over again, and your job as a trader is to strictly follow your trading strategy. The FOMO effect can often lead to big losses. Beware of that.
Pace yourself. If you’re doing really well one month and you’re taking a decent amount of money, don’t make the classic mistake of doubling trade amounts in the second month. Graduate your investments, always. This is the best way to build up a business mentality, and to protect your finances. Markets are notoriously volatile, don’t let your finances be the same. Always raise investment levels after careful consideration, and incrementally.
Cool down after a trade. If you have a great trade, relax and read the newspaper. If you have a bad trade, relax and read the newspaper. The best way to let emotions take over your strategy is to keep piling into new trades. This is to be avoided. Take it easy, and focus on each trade as being an individual matter, not an extension of the previous one. Markets are different each day, and what worked yesterday doesn’t have to work in the future. Each trade needs to be a well thought out trading decision, underpinned by macro-fundamentals, technical analysis, and risk management.
The ‘good day’ trap is our last one. This is where you have an exceptional run of good trades and it feels like everything is going rosy. If you’re lucky (and you’ve worked hard to research and analyse) you will see that continuing perhaps right to the end of the day. You may not. Whatever happens, don’t think a run of good trades means anything. There will always be things that are out of your control. Play each trade ‘as it lays’, and focus on making an overall profit. If this means backing off, that’s what you do. When traders experience a series of winning trades, they start to feel invincible in this game. Greed takes over the rational decision making, which often leads to high losses down the road (sometimes higher than the earlier profits made on the string of trade).
The psychology of trading is not as complex as it sounds. Focus on running your trading as a business, and bear in mind that you should always focus on having a clear and sensible stop loss amount, and you should be able to make it a lucrative career.