Trading is not about you and the market. It’s about you and yourself. We are often the biggest enemy of ourselves. Understanding what goes on in your mind before and after trading is a subject that is being studied more and more of late and the results can tremendously influence financial markets across the world.
Trading psychology refers to the changes your mental acuity goes through while you are actively involved in the act of trading. Psychologists and financial analysts have been examining trading psychology using brain scans and working hand-in-hand, they have reached some interesting observations.
One of the first areas these psychologists studied was the differences incurred when trading in a demo account and when trading in a live account. As can be expected, trading in a demo account, where the risk of losing your money is non-existent, reveals a drastic reduction in anxiety and stress. You have no emotional attachment to the money that is in your demo account because you were not involved in developing it. This makes it easier to place random trades or risky trades without the worry of any dire consequences.
Still, there are those who trade in a demo account who still worry about moving over to a live account sometime in the future and this angst is picked up in changes in the brain waves. In addition, once demo traders decide they are ready to move over to a real account, they exhibit indecisiveness and uncertainty and the stress zooms up. Understanding the effects of these changes is a big part of trading psychology.
Trading psychology affects your judgment as a trader. Two emotions in particular, greed and fear, have proven to be the basis of ruin for many Forex traders over the years. Greed will cause you to work towards huge gains by making trades that are too large or too risky. Greed can also cause you to try to wait for the results of a specific move instead of letting it run its course. Fear can cause you to pull back from making a trade when the opportunity arises; or you might choose to close a trade prematurely without giving it a chance to be profitable.
Risk management is one of the best ways to avoid trouble with trading psychology. Risk management means developing a trading strategy and sticking to it. This requires a great deal of discipline on your part. The idea of successful risk management is to not let yourself get in over your head.
Another aspect of trading psychology is to master your emotions and not let them get in the way of trading. Let the other traders succumb to their passions and anxieties. Successful traders leave their emotions outside the trading floor. When you make a trade, make sure you have a reason for doing it and don’t go overboard. If your trade ends in a loss, don’t resort to revenge trading by becoming overly aggressive with your trading. No one took your money away, certainly not the Forex marketplace. Better to accept defeat for the moment and admit your mistake. Keep in mind that it is slower to bring yourself back up than it is to fall down, but the long term rewards are certainly much better.