Forex Lesson 10: Trading Psychology
Emotions are the trader’s worse enemy. As mentioned in module 9 to be a successful trader it is best to make decisions that are totally devoid of emotion. However emotions can be hard to overcome for the new or inexperienced trader, even the most seasoned trader can succumb to emotion and place an illogical trade. Emotions can be powerful especially when a trade is not succeeding or working out as expected. The emotional pressure caused by a failing trade can have an adverse effect on the trader’s psyche and influence them to throw money at a losing trade. The crucial mistake these traders make in the first instance is the absence of a trading plan that is clearly and logically planned and is devoid of emotion. A well thought out and detailed trading plan takes no account of emotion and promotes successful trading. Without a trading plan a trade can spiral out of control making the trader stressed which affects them psychologically thus increasing the likelihood of emotional rather than logical decision-making.
To avoid emotional decision-making and psychological pressure in trading you need to start as you mean to go on. It is crucial when trading to have a trading plan. To start without a trading plan is to take a first step on the slippery slope to failure. To draw an analogy, to trade without a plan is like driving without insurance. At first everything is fine and you don’t notice the effects of driving without insurance, you may have a few bumps or scrapes that raise alarm bell but you ignore them as you’re OK and have managed so far without it, until one day you have a major crash and no support leaving you stripped of everything and in a lot of trouble. This may sound extreme to you but is actually a very similar comparison. The message is to not take any risk; trading is about careful analysis and foresight not unnecessary risk taking.
It is advisable and highly recommended to form good trading habits form the beginning. Limit the number of trades you make. Good trading takes time and effort, by being self disciplined and reducing the amount of trades placed you will be more likely to plan that trade carefully rather than making rash uncalculated decisions. Give yourself to plan your trade in detail. The more you plan a trade the more familiar the process will become the more successful you will become as a trader. Good habits once formed will serve you faithfully for a lifetime of trading; bad habits will ruin you.
Other traps that are easy to fall into are the lure of easy fixes. Two common easy fixes are the short-term chart and news releases. We have covered short-term charts in more detail in the last module and elsewhere in the course, suffice to say never use them as the sole information point for your trading. News releases can be seen as an easy way to interpret the market. If a major incident occurred such as a hurricane that took out several US oil supplies it would be easy to assume that the USD would be affected and trade on the strength of this. Once again this is not advisable in the same way that the use of short-term charts is not advisable. The market will not always follow the pattern that you expect it to and the only way to accurately trade a major event affecting the currencies is to refer to charts and technical analysis to support your theory before making any commitment to the trade. Generally trading news events is not a good idea for new or inexperienced traders and should be approached with caution by experienced traders using the back up of charts and analysis to support opinion.
Successful trading strategies have invariable, intrinsic components that form a solid background to trading. Having a percent rule is one method of limiting loss. With percent rules you determine what percentage of your account funds you are prepared to waive in any one trade. This limits loss and locks in profit. For example if you had a £10,000 account and a 2% rule you would only ever lose £200 on any one trade. If you implement and maintain the percent rule technique you will never experience disastrous losses.
Most traders place trades that are realised within days or weeks of them being placed, it is rare, especially with Forex to place trades that cover a long period of time. The main aim then for trades that are realised in the short term is to preserve and increase capital. If a trade does go as planned put it sown to experience, analyse why it didn’t go well so you don’ make the same mistakes again and move on. Do not be tempted to throw money at a losing trade, this will not alter it in the slightest and will just mean that you lose more in the end. This is an example of the pressure of the psychology of trading where emotions rule your head, remember stick to your plan and your strategies and you will succeed.
Stops and limits should form an integral part of your strategic plan. Through careful use of stops you can limit your loss and lock in profit. This is something we have covered in more detail in early modules and is worth re-reading before you make a trade. Always ensure you have stops and limits built into your strategic plan.
Strategies and plans do not have to be complicated. Yes they will take time to form and implement but a lot of that time is the analysis and planning not the amount of content in your plan. Try to avoid the psychology that the only good plan is a highly detailed and complicated plan, this is not the case. Choose the strategies that work well for you and stick with them. Sometimes your strategy may not work, this doesn’t mean that it will never work again it just means that this time it didn’t. Don’t give up on it, analyse why it didn’t work and don’t make the same mistakes again! It is however recommended to have different strategies and plans for different types of market, cover all the eventualities and you won’t go far wrong. It makes sense that a strategy for a range bound market won’t work as well for a trending market. It may take time at the beginning and a lot of legwork but in the end it will be worth the initial effort.
If you find that despite having detailed plans and strategies in place that your emotions are still getting the better of you, pull back. If you are emotional you will make rash and irrational decisions and you will fail. If it does happen to you don’t worry, it happens to every trader at some point, irrespective of experience, the difference between being a successful trader and an unsuccessful trader, knows when to pull back and listen to your head rather than your heart. Look at your trades and analyse where they are going wrong, rule out emotions and move on. The same rule of thumb applies when you are successful. Don’t let the success go to your head or greed to influence your emotions. A successful trader should analyse why the trades are successful and use these strategies to inform future trades.
Finally trading is an emotional experience. There are highs when you are successful and low when you are not. The key to success is to not let your future trading be influenced by these highs or lows and to maintain a clear head for trading with a solid strategic plan.
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