Updated: May 16
If you're reading this, there are 100s of emotions troubling your trading activities, and you have realized the psychology of trading is one of the most crucial aspects of trading.
Successful trading is neither magical nor mysterious. It is the natural consequence of consistently applying the simplified trading approach.
But most traders face a tough time deploying one trading system in the long run as emotions take over logical mindset. Hence, trading psychology is equally important as compared to technical analysis and money management.
What is Trading Psychology?
Psychology means the mental factors or emotions governing a situation or activity in a person.
So, when we say trading psychology, it implies cognitive factors governing trading.
In simple words, trading psychology is all about the thoughts, emotions, and feelings a trader encounters while trading.
As compared to any animals, human beings have two additional qualities – 1) Vivid Sense of Memory and 2) Imagination.
When we don't have control over these two aspects, we get many life problems (and in trading). Lack of control over these two aspects is the main reason for all our problems in life.
Do you agree?
Scenario 1 - A trader buys some shares of a company. The price starts going upside. Every day holding this profitable trade is a difficult task for him.
So, one day he sells all the shares and makes some profit. The price moves further on the upside in the next few days.
Scenario 2 – A trader enters a trade when the price is at 100. He thinks 95 is the stop-loss for his trade. The price starts moving upside for some time. Later it starts trading between 97-99.
He thinks it is a good trade, and it needs more cushion; hence he pushes SL of the trade to 93. To cut short the story, he keeps on trailing the stop-loss on the downside until he makes a significant loss.
Scenario 3 – A trader is confident in a trade. He takes the position as per the rules of his trading system.
The price starts moving in the expected direction. At the exact moment, he came to know that one famous trader has taken a trade on the opposite side in the same stock.
Now he thinks he is a renowned trader and hence he is definitely right. So, he closes his trade. But the price moves in the expected direction and reaches the original target.
Scenario 4 – A trader has done detailed backtesting of a trading strategy.
He defined all the rules for his trading, including money management and position sizing. He starts to make decent profits every day using his trading system.
But one day, he saw a tweet from a Twitter trader who has made massive chunks of money in one day.
The next day, he wants to make the same amount of money (similar to the Twitter trader) and take a massive position.
Unfortunately, markets take his stop-loss, and he loses all the profits he has made.
I am sure most of you have gone through these kinds of situations. Besides, we can list some more scenarios.
However, I want to highlight two crucial aspects:
The existing trading psychology caused all the issues as mentioned above
All these issues again complicate the trading psychology files in our subconscious mind
Do you agree?
How to Improve Trading Psychology?
Four primary emotions revolving around stock market trading are greed, fear, regret, and hope.
A trader has to log all his trades, and when he analyzes all his failed trades, the reasons will appear automatically.
Most people come to the stock market intending to make money. Well, this is not wrong. But most traders set high expectations from the market and that too in quick time.
Trading is like any other profession, demanding focus, dedication, and hard work from traders for some time.
For example, a trader makes Rs.1,000 from one intraday trade with a capital of Rs. 1,00,000. But he feels the profit of Rs.1,000 is a minimal amount to feel good.
However, what he doesn't realize is Rs.1,000 is 1% returns on the capital in one day, and repeating the same success for 1 month gives over 20% of returns on the capital.
If he progresses at the same pace, he can double the capital in 5-6 months!
But many traders don't calculate the returns on a % basis on their capital. Hence, they end up taking big position size or many unwanted trades to lose massive share in the capital.
A trader can survive in markets without profits but not without capital. Protecting capital is pivotal, and the next important aspect is consistent profit-making.