Market psychology, also known as trading psychology, refers to how traders and investors approach and feel about the market. Emotions play an important role in trading and can often be a crucial factor that decides whether the trade will be successful or unsuccessful.
In addition to other important aspects which generally decide one’s success in the market, such as experience and skill set, having the right trading psychology is also just as important as well as being able to control various emotions such as greed, fear, and anger, among others.
On the other hand, there are also positive emotions that can help traders boost their success but experienced traders know that making trades based on feelings and biases should be avoided. This is because being composed and learning to control emotions improves chances of success in the market, and helps minimize potential losses.
Things to Avoid
Do Not Overtrade
This is one of the most common mistakes among inexperienced traders and investors. Two main factors that lead to overtrading are usually impatience and overconfidence.
Learning when to be patient and composed in the market is difficult but also crucial in order to become successful. New traders often make reckless trading decisions because they believe they need to make a profit each day or because of some external factors.
There is nothing wrong with buying security if you are confident it will rise in value but looking for an excuse to buy an asset will likely lead to overtrading.
Similarly, overtrading can happen if a trader becomes overconfident. This typically happens after an inexperienced trader makes a few successful trades, making them believe that they can not make a mistake.
Be Wary of Emotional Trading
Emotional trading refers to trading based on personal feelings and emotions that affect a trader’s decision-making process. While this can sometimes be a good thing, it is more likely to affect your traders negatively.
The main reason for this is that emotions can often make us make irrational decisions in our everyday lives and we definitely want to avoid making irrational moves in the market. While shutting down your emotions completely is impossible, traders should learn what is known as emotional discipline.
In other words, you need to be able to control your emotions as a trader and that is one of the most important traits in the trading world.
Some of the common examples of unfavorable emotional trading include selling a security because of a few lost points or being too arrogant to close a loss-making position.
One of the most prevalent emotions that can negatively affect trading is fear. One of the examples is the fear of trading too big. Executing trades with improper size increases volatility, resulting in making mistakes that you wouldn’t make if you hadn’t been afraid of risking bigger losses than usual. The simplest way to deal with this would be to lower your trading size to a more convenient level.
Other than this, traders also experience fear when they feel they are in the ‘wrong’ trade. Wrong trade is the trade that doesn’t fit your trading strategy. A good way to resolve this is by having a checklist to determine which trade is right or wrong for you.
Do Not Be Greedy
After reaping several big wins, traders tend to get greedy. It’s very important to know how to make the difference between greed and conviction. Using appropriate trading mechanics such as stop orders, profit targets, and a proper risk management strategy can help avoid greediness. Just like overconfidence, being greedy can also lead to careless trading decisions and substantial losses.
5 Tips to Improve Your Market Psychology
Develop a Trading Strategy
Regardless of whether you are a long-term investor or a day trader, and regardless of what market you want to trade, having a well-established trading/investing strategy is a must.
A trading strategy refers to a well-thought-out plan that outlines one’s trading objectives, risk management and tolerance, time horizon, and more. Before you commit to a specific set of rules and ideas in trading, you should first do comprehensive research and educate yourself about how you can develop a decent trading strategy.
Most trading strategies rely on fundamental or technical analysis or both. Technical trading strategies refer to strategies that depend on technical indicators to identify trading signals. On the other hand, investors that have developed a strategy based on fundamental analysis rely on the company’s fundamentals such as growth and profitability to attempt to pick a winning trade.
Set Realistic Goals
Setting realistic trading goals generally refers to avoiding setting extremely high profitability targets, but avoiding low and unexciting goals is just as important. Having realistic goals in trading has a lot to do with building confidence, particularly when it comes to less experienced traders who are testing their strategies.
For instance, a confident trader is much more likely to take calculated risks and be wary of all potential outcomes. However, one cannot become a confident trader without realistic expectations and proper trading psychology. That’s why many experts advise new traders to do a good amount of practice and test their trading plans on a demo account before actually entering the market with their hard-earned money.
Learn Risk Management
Risk management in trading refers to analyzing and accepting the uncertainty in investment choices. Primarily, it happens when a trader analyzes and tries to calculate potential losses of investment and acts in accordance with the objectives and risk tolerance of that investment.
Many investors don’t put much thought into risk management, which is essential for becoming a successful trader. This is because even if they manage to make a lot of money in the market, they can lose it quite easily without an appropriate risk management plan.
Some new traders tend to think that risk should be completely avoided but in reality, taking risks is necessary to become a great investor, it just needs to be managed appropriately.
Use Stop-Loss Orders
A stop-loss order is a price point at which a trader will exit the market and take a loss on that trade. This is a common occurrence when the trade doesn’t play out the way a trader anticipated. A stop-loss serves to cap losses and prevent them from escalating.
The most common way to place stop-loss and take-profit orders is by utilizing the moving averages (MAs). This is because MAs are easily calculated and widely followed in the market. Essential moving averages are the 5-, 9-, 20-, 50-, 100- and 200-day averages.
Placing stop-loss orders is typically done after conducting technical analysis, but keep in mind that fundamental analysis also plays a major part when it comes to timing.
Regardless of whether you are an expert or completely new to trading, taking breaks on a regular basis is important as it can help you avoid making bad emotional trades and stay composed in the market, particularly after a bad trading day.
Emotions can often get the better of traders, and that’s why it is important to take breaks in these moments and divert your mind to something else than trading.
Trading psychology is crucial to becoming a successful trader or investor. Even though success is never guaranteed in trading, developing the right market psychology can greatly increase one’s chances of success. In other words, it refers to making mindful trades, learning to control emotions and the way you react to gains and losses, and staying composed.