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Psychology and Trading

Thomas Hughes

Psychology Is The Most Important Factor For Your Trading Profits

When folks begin trading, the first instinct is to focus on the charts. After all, the charts are where all the action is. That’s where you find the Double-Bottoms, Reversals, Break Outs, and Trends that make big profits. What many traders come to realize, the successful ones at least is that there is more to trading than the charts, more than just making trades.

What you may have also realized is that finding winning trades isn’t enough. There’s something standing in the way to profits and that something is psychology.

Psychology is the study of the mind, behavior, and behavior patterns; what makes us do the things we do, how do we overcome the obstacles that are holding us back. Believe it or not, trading is mostly a head game. It’s not the market you need to beat, it’s yourself.

Trading Discipline Is The Foundation For Your Success

Trading discipline is the foundation for your success because it provides a set of rules for you to follow that will help prevent unnecessary losses. I say unnecessary losses because you can’t cut out all of your losses, as a trader, you must be prepared for it or else it will drive you mad. The root causes are Fear and Greed. Fear and Greed are the two strongest emotions felt by traders and not easily overcome.

What does discipline mean? It means coming up with a set of trading rules, rules you always follow so you don’t make decisions based on fear or greed. Rules can be as simple as only trading once per day, they can be as complex as only making trades when the asset price is bouncing from support after a bullish breakout and confirmed by a bullish crossover in MACD and rising RSI.

You may not believe me but the market will make you mad. It will infuriate you by not doing what you think it should. Your rules are intended to keep you from making trades based on the madness. Grudge-trading, revenge-trading, trying to get back at the market by making wild bets with valuable trading capital is a real thing.

Here is a list of sample rules for speculative traders. These rules can be used for Forex, CFDs, Options, Commodities, or Cryptocurrencies.

  • Every trade will always be 1% (or 2% or 3%, 5% is getting risky and 10% very risky) and no more or less (as close as can be had on your platform). Using a % instead of a fixed amount will allow the trade size to grow or shrink along with the account balance to maximize profits and minimize losses.

  • I will always trade with the trend. I will determine trend by price action, trend lines, moving averages, and MACD.

  • I will only enter on confirmed entry signals. My signals are bullish/bearish crossovers in stochastic and MACD, confirmed by a break of the 30-period moving average.

  • I will not enter if price action is within 3% of resistance (for bull trades) or support (for bear-trades).

  • I will use support and resistance targets as exits targets for my trades. If price action reaches a target I will exit to take profits. Some profits are better than no profits and infinitely more satisfactory than losses.

  • I won’t have more than one trade open on one asset at a time.

  • I won’t have conflicting trades open on the same asset at the same time.

  • I won’t have more than five trades open at the same time, that’s 5% of the account at risk at one time.

  • I will always follow my rules.

That last rule, I will always follow my rules, is the most important rule of all. It doesn’t make much sense to have rules if you don’t use them. I can say without a shred of embarrassment that I learned that last lesson myself more than once. Like I said before, the market will infuriate you and drive you to do things that are self-destructive to your account and trading capital.

Factors That Affect Your Trading Psychology

There are millions of factors that can affect your trading psychology. This list is intended to be a guide to what may drive you to make bad trades. The key to understanding your psychology and improving your list of rules is to be aware you can be driven to make decisions and recognize when that is happening. If you can do that you can take yourself out of the equation, step back from the situation, and regroup without losing money. The name of the game is consistent wins and capital preservation.

  • Fear – Fear is one of the most vicious emotions a trader can face. Fear can keep you from making a trade, it can also keep you from taking profits. Fear of losing money in your account will keep you making trades but you can’t let it, you have to make trades in order to make profits. If you keep your trades small no one loss will hurt you and you will still be able to trade again. Fear of losing profits you might make can keep you from taking profits you already have. What I’ve learned is that if you don’t take profits in favor of waiting for more, more often than not the profits you have will evaporate. You have to close your trades when the profits are showing.

  • Greed – Greed is the second most vicious emotions a trader can face. Greed is the other face of fear. Greed is the fear of losing profits you don’t have, or the desire to make huge trades and even huger profits. What takes traders by surprise is that greed rears its head when you are doing well. A string of wins can get your confidence up and that can lead to making aggressive trades and big losses.

  • Ambition – Ambition is a trait that all traders shares. It takes a certain  amount of desire to succeed to embark on the journey that is a trader’s life.The problem with ambition is when it leads you to make bad decisions, like when you compare your results to another trader’s and let that influence your trading.

  • Losses – Losses, a trader’s worst nightmare. Losses occur when trades don’t go your way. They are an inevitable part of trading but can be managed. The trick is not letting them become too large, always use proper position size (the 1% or 2% in my rules), and not to throw good money after bad. If a trade goes against you don’t double up on it and don’t reverse it. If you feel yourself getting frustrated from a string of losses the best thing you can do for yourself is to walk away from the market.

  • Hope – Hope can lead traders to do bad things just as bad as fear or gree. Hope is good but it can turn against you. It’s one thing to go into the market hoping all your hard work will pay off. It’s something else entirely to go into the market hoping this one trade with your rent money will pay off huge. That’s gambling and the worst kind, it’s desperation and that’s not a good place for a trader to be.

Understanding Psychology Is The Path To Your Trading Success

Understanding your trading psychology is the path to your trading success. To put it bluntly, you have to remove all emotion from your trading if you want to be truly successful. Successful over the long-term.

Successful in a way that means you can live off of trading. In order to do that you have to have some rules, the discipline to follow them, and the ability to take yourself out of the market when emotions overtake your decision-making process.

A Word On Algorithmic Trading Versus Human Trading

Algorithmic trading is the use of computers to perform trading tasks. The big-money algo-traders have billions in money-making hundreds, thousands, and even millions of trades a day as they try to scalp whatever profits they can while waiting for the big score.

Smaller traders use Expert Advisers (MT4) and other trading software to determine trading entry and exit points. What I have to say is that the algorithms are usually good but not something you want to rely on blindly.

Algorithms are based on rules and only work while the market conditions match those rules. When market conditions change the algos stop working and losses can mount quickly. At no time should a small trader ever let an algorithm trade their account unsupervised. 

That being said, social trading accounts allow you to tie your returns to professional self-disciplined traders. Using this service you are not blindly relying on algorithms but instead, you essentially let proven successful traders execute trades on your behalf.

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This article was originally posted on FX Empire

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