Trading Psychology and Emotions

Trading Psychology and emotions play the biggest role in your daily trading. Let me elaborate on this more in this article.

Dr. Van Tharp, a leading psychologist, is very well known for breaking down the trading process into three categories that affect traders. He categorises them by importance as follows:

  • Trading strategy (10%)
  • Money management (30%)
  • Psychology (60%)

The fact that trading strategy is the least important factor in Dr. Van Tharp’s trading process above, this suggests that regardless of how successful your trading strategy is, your psychology is the key to being successful in trading.

In one of my previous articles we looked at Fear of Missing Out (FOMO) and how it can affect your trading. Fear & Greed are the two emotions that have a negative impact on your trading journey. Experienced traders know that the greed makes you to try to take too much profit (when it is not there) and you end up with less profit or loss. Similarly, fear causes you to cut your positions quickly in loss or less profit where you could make much more.

Another important psychological factor is the ‘Ego’. We all have an Ego. We all want to be right. A trader highly influenced by his own ego will never admit that he/she is wrong. This means that, he will never be able to learn from his/her mistakes as he is unable to see those mistakes in the first place. This will ultimately result on more losses and get him/her out of the game all together.

Another aspect of emotional trading can be summarised as ‘revenge trading’. In revenge trading, the focus of the trading shifts from finding the best trading setups (according to trader’s own strategy) to fastest way of recouping losses. The trader focuses on winning the losses back (very similar to a loser gambler attitude) and ends up losing more money.

The final aspect of emotional trading is over trading. This mainly happens after big wins and the trader greed kicks in for more profits. The whole situation ends up with losing the previous gains or accumulating big losses in the process. This is a Greed based human behaviour that can be seen in experienced and inexperienced traders. Difficult to control but not impossible.

So how can we cope with our own Psychology and Emotions? You heard the trading term: “be like a robot” that comes to mind. Easier said than done! The trading algos are much more profitable than humans (when they are using a profitable strategy) for one reason only, they cut out the emotion from the equation!

As a human trader, your only weapon is discipline. You might know about what to do but applying discipline to your trading will require time and experience. As good old Warren Buffet says: “You can’t make a baby in a month by getting 9 women pregnant”.

My personal advice is as follows:

  1. The start point should be working on your ego. When you are wrong, admit that you are wrong. This will be difficult at first, but in time you will see the benefits of doing so. You will be able to see your mistakes. What went right and what went wrong with that particular trade.
  2. Have a trading diary. We are humans, we forget! My suggestion to especially new traders is having an excel sheet and note down every single REAL trade that they have done (not interested in paper trades as they do not reflect the emotion of losing real money). Make sure to have a separate column for your notes, note down everything why you entered in that trade, why you exit? did you follow your initial plan (this is very important), if not why not? Take as much notes as possible so you can go back and see what happened to your trade. What went well and what went wrong. The pattern will start to emerge when you have at least 100 or more trades, you will be able to see the bigger picture. I Cannot stress this enough, HAVE A TRADING DIARY (even if you are an experienced trader).
  3. Be DISCIPLINED! Once you have a working strategy, follow it to the letter! It is not always easy to do so, but you will get better in time if you apply discipline. Also make sure to have some trading goals (my article on setting goals can be found here)
  4. Set your expectation accordingly! Trading is not easy, do not expect easy money. Know that you will have to work for your money. A lot of hard work needed to be a successful trader.
  5. Find out what works for you. Be honest with yourself. If you are overtrading, what is the best thing to do? Some people can control themselves in front of the PC, some simply cannot. After a successful trading session, I often take a coffee break to clean up my mind and more importantly my emotions. If it is a particularly good trading day, I go for a drive in my car. Whatever works for you. Perhaps go dip in the water, have a coffe, drive, call a friend, etc.
  6. Enjoy what you do! Yes, trading is hard work but there is nothing more satisfying then knowing your strategy works, you were disciplined and executed that trade according to the plan (or avoided that big loss successfully).

I hope it helps. Have a great weekend.

MT

 

 

 

Trading Psychology – FOMO (Fear of Missing Out)

There are number of ‘Fears’ that a trader will experience in his/her career. The most important three fears that often manifests themselves are: Fearing of Missing Out (FOMO), Fear of Loosing Money (FOLM) and Fear of Being Wrong (FOBW). In this article, I will specifically focus on FOMO, what it is, how it can affect your trading and how to prevent it (as much as you can).

Fear of Missing Out (FOMO):

Fear of Missing Out is a well researched psychology topic that is not only true for trading but also for every day life. Most scams (and well scripted marketing) work due to recipients’ FOMO ‘triggers’.

If you want to understand FOMO better, I strongly suggest reading two research paper by Kernis (2003) and Ellion (2007). They argue that self-determination theory (SDT) a macro-theory of human motivation provides a useful perspective for framing an empirically based understanding of FoMO. According to SDT effective self-regulation and psychological moods are based on the satisfaction of three basic psychological needs:

  • competence – the capacity to effectively act on the world,

  • autonomy – self-authorship or personal initiative, and

  • relatedness – closeness or connectedness with others.

Today’s retail investor is a social animal. We are following each other on social media (twitter, facebook, instagram, etc.) and also bombarded by emails and other media channels. We are being sold ideas and concepts every single minute of the trading hours (and pre-trading and after-hours). What we are really trying to do is to feed the three psychological needs above and/or try to get confirmation (and comparison).

We follow each other, we hear news that this is the must have stock (or the stock that needs to be shorted immediately). We see so many people are doing the same thing and we feel left out (the feeling is: everyone will make big bucks and if I am not doing anything! I will simply loose out on a great trade!) or worse,  in some circumstances, you might be already in the trade but you start doubling your position (just because everyone else is doing the same) and pay the price later. We all know that if everyone is doing the same thing, the trade becomes crowded and thinks start to turn for the worse…

Realization and Action

As traders, we need to realise something very important as early as possible  in our trading career. We simply can’t catch every stock move and we can’t trade stocks every minute of every day. This is a fact! If you can accept this fact then you have ultimately accepted that you will miss some trades (this is perfectly OK!). The real rule to be successful in trading is to have a working strategy. Everyone trades differently, no two traders trade exactly the same way so your strategy will be different then my strategy however there might be similarities that puts us on the same set (i.e. short trader, long trader, momo trader, stock trader, fx trader and so on..). Don’t feel like an outsider or feel being wrong just because you are trading differently to someone else or to a group of people. Don’t forget there is money to be made  in so many different ways from the same stock.

All traders struggle with FOMO time to time. If someone is saying they don’t struggle, they are simply lying to you. Trading experience of course helps with this immensely. My simple rules that help me to stay in check are:

  • The Action Plan: Always have a plan before entering in a trade. Ask yourself what is your edge for entering in this trade. You need to KNOW why you are entering, what size you will be using,  when you will be exiting and what you will do if the trade goes against you. You are not going into this trade just because some guru or a friend thinks it is a good idea. KNOW your trade and KNOW what you want from it EVERY SINGLE TIME YOU TRADE!

  • Be Disciplined: As you now have an action plan, the truth is executing that action plan is more difficult than to have an action plan in the first place. This requires discipline and determination. Don’t forget that HFT algo that you are trading against doesn’t have emotions and will follow rules to the letter. You should try to do the same (as much as you can).

  • Learn to be happy with your achievement: We all want to make a killing from a trade. Reality is trading is extremely difficult. Once you have executed your plan effectively, either you made a profit or a loss. Either way, you have done what was necessary for the trade and successfully filtered out the noise – well done on that. Even though it was a loss, you cut it on time as per your action plan. This is great news. If your trading strategy is profitable, in the long term you will make serious money from trading. As you are following your rules, you WILL be consistent and you will achieve consistency in trading.

I hope this helps. Have a nice weekend.

MT