This is a short overview of trading psychology and the way it affects the traders’ profits or losses.
Good academics are not often as successful as traders. Why the Forex market doesn’t see many successful traders of those who were very successful during their education? Just one example of this state is mentioning a couple of Nobel Prize winners who are heads of LTCM, who gave so much to the theory of economics with their long-lasting dedicated work to economics, Robert C. Merton and Myron Scholes, and who could not achieve much by trading at the Forex.
In this particular case, it wasn’t the lack of experience that caused LTCM to have high losses. It was the lack of carefulness, and presence too much self-confidence, as well as not paying much attention to controlling the risk. The reasons to have these issues while doing a job with too much risk are easily linked with emotional preparation. This particular article is going to present the four major psychological problems a Forex trader can encounter. We will see if the psychological problems can do more damage than false analytics and or lack of information, and what is the difference when recuperating from the damage resulted from psychological problems and analytical mistakes.
The psychological problems being discussed here are of the kind that is permanent threat for a trader, not something that can be overwhelmed once and for all. These problems can wrap traders and hold to them firmly, it is not just lack of focus or a headache that distracts you from straight thinking for several days.
It has been discussed many times at many places; some even say a small dose of greed is good for a trader. And that might just be the case. But let’s see what kind of greed is that bad enough so that it can be listed as a psychological issue number one for a trader. This problem is a huge one first of all because if greed is our companion, we will never see the end of our path, not even a break. Greed is something that will make us pace fast by the break time. If you ran a marathon, greed would not let you slow down in order to take a bottle of fresh juice from the table by the running track, even though you are about to stumble dry and thirsty.
Of course, the goal of every trader is money. That is not the issue, and the more money we get, that means the more successful we are. And the marathon runner has to have something to push him forward. But that something is actually stopping for taking a sip of water. Those who say a little bit of greed is necessary are not wrong, but it has to be put in the frame of the trader’s goal. The goal is being set by knowing your own capabilities, by knowing how much can be risked, when it is possible to risk with rising leverage, and just at the end, it is important to leave assumptions behind the trading plan and replace it with calculations. We only might need the greed to push us “into” the race, but after we do our math (get to know the map of the track), we don’t need greed to lead us forward.
Speaking of fear as a psychological obstacle for progressing into the world of successful Forex trading, let’s not forget that as in everyday life, it is something that makes us think twice before everything we do, but that further prevents us doing it. Reason as well makes us think twice, but when the thing to do is going to be in our favour, reason tells us to continue doing it, fear doesn’t.
Fear has the opposite effect than the greed. It doesn’t motivate us to trade without control, it rather slows us down and we don’t see even the “junk time” plays. Fear makes us think that whatever we do is not a good plan, again disregarding our good planning and thorough analysis. When trading with fear, the wins we get will go unnoticed, because fearful traders can’t see the reasons for wins. It is the same with losses. If a fearful trader loses an investment, he or she will think it is because bad strategy and fully cross that method, even if the reason for a loss was a mistaken assumption. The result of that sort of behaviour will eventually lead to crossing out every strategy that sometimes “prove” bad.
Cautious and frighten trader are not the same thing. Conservatism is good, because a conservative trader, even though he doubts everything, he is still willing to follow the rational lead. Regardless of the state of mind, he does what his statistics-based reason tells him. In comparison, fearful trader doesn’t believe even in his own calculations. Fear brings a trader into a position where he or she doesn’t know what to do anymore, but has to do something, and out of fear everything seems wrong, so the investments are usually just blind shots, because everything is the same to those kinds of traders.
In order to overcome fear, we must know and be assured that good strategy is what brings success, and we need to focus on developing a good strategy. We must truly understand that there is not any more luck in trading than there is in any other business. Before we achieve that, we might fall into greed or fear. So, we must make sure that we control our choices. We must have plan and a firm strategy that we use to get us there. And if we don’t make it “there”, we have to logically analyse why. It is, therefore, good to prepare and patiently study the market and get to know every aspect of it. That is the way to make sure that we understand that fear makes no favourable difference. Something we can learn from the example of psychological problems in trading is to mention that we must make sure to not overload leverage, especially if we know that fear plays a role in our trading decisions. So if we clear our account, we don’t lose more than we can really afford.
This is an issue that many traders encounter and it is probably the worst thing that can happen when in a good run. In the euphoric state, traders see no other outcomes but wins. Not like greed where we desire wins, euphoria makes us truly believe that we can’t really lose. This obviously happens after a couple of wins that the trader can’t explain. He or she then believes that it is a stroke of luck, but as mentioned in two of the previous parts, the only reason for success is good planning and good preparation with calculated investment. Investing is not throwing dices. Most successful traders don’t really go into euphoria, because they know exactly the chances to have their investments returned, so every outcome is perfectly reasonable. Even if the trader’s assumption was wrong, the outcome becomes reasonable. It goes for the successful investment as well. Therefore, a successful trader knows that there is no reason to “celebrate” in a loose way or to let his or her chances to pure luck believing euphorically that the success wasn’t the result of hard work only.
Euphoria gets trader into a state where he or she can’t think straight anymore, and even the good aspects of their trading becomes lost, so every other investment might – but won’t – be a successful one. It then only lets time to eat the account.
The way to avoid falling into euphoria is to know that success only and only comes after hard work, and not by luck. A trader has to know greed won’t make account grow, but regular motivation will; fear won’t protect investment, but caution will; and euphoria is not something to build the strategy on.
Opposite of the previous psychological problem is panic. Usually occurs after a series of losses that a trader can’t follow and analyse. As it is important to analyse the market for investing, it is also important to analyse moves and trades made in order to follow their outcome. So when a trader gets hit by a series of bad trades, and can’t realise the reason for any of those trades, or can’t make a connection, he or she then can panic and believe that the reason is lack of luck.
Again, it is not true that a lucky series can bring any success, but a series of strategically made moves can. There is actually no place for panic with real serious traders, but it can be seen with majority of average traders that they can fall into panic. Let’s remind that if one trader is having a bad series with large sums on a long currency trade, there is somebody on another end who is maybe having a series of large profits on a short trade on the very same pair. But for some reason, this very logical fact doesn’t seem to help those who panic about their losses, especially those who panic after a series of losses.
One big problem with panicking traders is that they mistakenly cross out streaks. And streaks can be good. But probably the reason these people are panicking is because they don’t plan and they can’t analyse their losses. So they simply quit a trade, escape, and irrationally change and switch their strategies.
A way to avoid huge blowouts by panicking is to avoid leverage. Actually, whenever a trader is unsure of outcome (which can only be if the trader is not prepared and the strategy was built by wrong factors), he or she should not raise leverage.
The best way to overcome the problems with trading psychology is to make sure to know that the success comes with hard work. Emotions don’t play a favourable role in trading, so they should really be put aside. The will that made a trader do the first step should be enough. For knowing what trade to take, a trader doesn’t have to have a gut, but he or she has to have the knowledge and a reasonable explanation of why that particular trade was taken. It has to be clear that not every trade would end up in traders favour, but a trader has to be able to explain every move he or she makes. Not just in order to recognise mistakes in a possible loss, but in order to avoid falling into psychological traps such are greed, fear, euphoria or panic.
Leverage is a great way to multiply chances, but a trader has to keep in mind that leverage can also amplify the loss. So whenever for some reason a trader is not sure whether his or hers investment was made upon thorough analysis, it is important to leave leverage out and invest only affordable. Relying only in reason and using emotions only to be happy about something should not let a trader down. Losses and wins happen, but the trader should know why and why any particular loss occurred and how a particular win was achieved. As long as losses and wins are possible to be mathematically calculated, psychological problems shouldn’t occur. When the trader looses track, then things like euphoria, fear, panic or greed come into play.