An introduction to psychology in trading

A big mistake that beginners make when first learning to trade, is to assume that developing technical or fundamental analysis skills alone will allow them to become successful. In fact, learning to control emotions is the most important skill that allow a trader to become successful, because emotions have the biggest impact on your results.

The role of psychology in trading

Successful trading is not down to any single trade, but a number of trades using a strategy. This means that a trader must be disciplined enough to stick to their strategy, even throughout a losing streak. However, human beings often do not behave in a logical way and there are many times that emotions influence us and we act differently to normal.

A trading strategy's success is determined by a number of trades. A successful trader must stick to the rules of their strategy and not allow emotions to get in the way.

Do you remember the last time you were very angry? Maybe you did something and you were surprised by your actions. As much as you regretted it afterwards, at the time you probably couldn't help it and furthermore, you are likely to act the same way again if you become angry in the future.

This is because the psychology of a person is made up of thoughts and feelings that are an incitement to act, and so psychology shapes our behaviour in every aspect of our lives – trading is no exception.

Emotions are inevitable – especially for a new or unskilled trader and they can prevent you from making an objective decision. For this reason, learning how to control emotion becomes paramount to successful trading over and above everything else.

The zone

When a trader is thinking clearly and is uninfluenced by emotion, they are said to be in the zone.

When a trader is thinking clearly and uninfluenced by emotion, he is said to be in the zone. When you are in the zone, you are in control of your behaviour and are able to follow a trading strategy in a logical and systematic way.

Some traders find it easy to get into the zone, but even those who struggle can learn to control their behaviour and become emotionally detached from trading.

Tharp's chart and the importance of psychology

Dr. Van Tharp is known for breaking down the trading process into three categories that affect traders. He categorises them by importance as follows:

• Trading strategy (10%)
• Money management (30%)
• Psychology (60%)

According to Dr. Tharp, the psychological outlook and an individual’s way of thinking towards trading is the most important factor for success.

The fact that the actual trading strategy is ranked the least important by Dr. Tharp, suggests that regardless of how successful a strategy is, psychology is the key to being successful.

Emotions that influence trading

The emotions in trading that have a negative impact on results are greed and fear. These emotions cause a trader to deviate away from their plan, which can lead to further issues, such as ego and revenge trading.

The following are examples of these emotions and how they can negatively affect trading results.

Fear of losing can lead to further losses

Fear of taking losses can ultimately lead to even more losses. The typical behaviour of a trader will be to close trades early, either when the trade has temporarily gone into a loss or a small win, and not letting the trade run its full course

When a trader has a fear of losing, they try to avoid them. This can actually increase losses.

For example, a trader may open a trade and place theirstop loss, say, 20 pips away – based on the strategy they use. In other words, there is a technical or fundamental reason for it being placed where it is.

However, a trader that is influenced by fear may close the trade prematurely, simply because the trade temporarily goes against them. So if the trade goes against them by, say, 10 pips, then the trade results in a 10 pip loss. If the trade turns out to be a winner, then the trader has just turned the winning trade into a losing one out of fear.

Another scenario is when a trader closes their trade as soon as it has gone into profit, out of fear that they can lose that profit. If the trade then goes on to hit the profit target, then the trader has reduced a full winning trade down to a much smaller win.

This behaviour ultimately turns a profitable strategy into a losing one, because the trader reduces the amount of winning trades and/or reduces the profit overall because of fear of losing.

Greed results in trying to take too much profit and end up with less.

A trader under the influence of greed will try to go for more profit and will not close their trade when their strategy dictates that they should.

When a trader experiences greed, it means that they try to go for too much profit and deviate from their strategy. For example, a trader may place their profit target in accordance with their strategy. This means that – as with placing a stop loss – there is a technical or fundamental reason for doing so.

However, when greed influences a trader, they do not close their trade when the strategy has dictated they should – they try and go for more. What can happen is that the trade can turn against them, ultimately ending up with less profit, or worse, a losing trade. This means that they actually reduce the profitability of a strategy because they try to increase their profit through greed.

A trader influenced by ego will never admit they are wrong

Ego can affect a trader, causing them to not close trades when their strategy dictates they should or continues to trade on the same analysis after their trade has been stopped out, because they believe they are correct in their original assessment.

A trader under the influence of ego does not want to admit they are wrong.
For example, if the trade does not go well, instead of closing their trade according to the strategy, they carry on taking a bigger loss than necessary because they cannot admit that they are wrong.

Another scenario may be that after taking a loss on a perfectly good trade, they do not go on to look for the next setup according to their strategy. Instead, they continue taking trades based on their original analysis because they believe they were right in the first place.

Revenge trading is chasing the money you have lost on a trade

Revenge trading is when a trader chases the losses they have made – they are so focused on winning the money back that they fail to realize that they are not trading with a set of rules and each trade ends up resulting in another loss.

The importance of discipline when trading

To avoid emotionally influenced trading, you will need to build discipline that will allow you to think as objectively as possible. There are several ways in which you can do this:

Trade with a tried and tested strategy

You are much more likely to remain calm under pressure if you have confidence in your trading plan. If a strategy has not been tested enough, it may lead to doubts that could allow fear to overwhelm the trader.

Demo-account trading

Having confidence in your plan will help keep you calm under pressure. Test your strategy with a demo account and accept the risk, because a 100% winning ratio is unrealistic.

Testing and further development of a strategy should be done on a demo account first before using real money. Using real money creates an additional pressure that is likely to amplify negative emotions that are involved when trading, which can lead to further losses.

Accepting the risk

A strategy with a 100% winning ratio is unrealistic. You must be prepared to accept losses. It is normal to hope that every trade turns out to be favorable. However, inexperienced traders are likely to experience a stronger emotional impact when they take a loss. In contrast, a profitable trader is able to accept losses as part of the trading strategy and move on to the next trade, without allowing greed or fear to affect future decisions.

Summary

So far, you have learned that ...

• ... new traders make the mistake that skills in technical and fundamental analysis is the most important element in trading.
• ... controlling emotion is actually the most important skill that a trader should focus on.
• ... Dr. Van Tharp has broken down the trading process into three categories that affect traders: strategy, money management and psychology.
• ... psychology is ranked as the most important element, followed by money management and then the strategy. This highlights that regardless of how profitable a strategy is, psychology can impede the ability of a trader to make money.
• ... fear of losing can cause a trader to close trades early before the trade has run its full course, which can lead to further losses.
• ... greed can cause a trader to leave trade in and not close at the specified profit target when their strategy tells them too. This can run the risk of taking smaller profits if the market then turns against them.
• ... ego is when a trader does not admit they are wrong and can influence them to either not close their trades when their strategy tells them they should or keep trying to trade in the same direction after their trade is closed.
• ... revenge trading is where a trader tries to chase the money that they have lost without any regards to a strategy.
• ... having confidence in your trading plan and trading with a demo account ultimately helps with learning to control emotion.
• ... a strategy with a 100% win rate is unrealistic, you must be learn to accept the risk on each trade.

Credit:Tradimo

The Next Big Thing Seminar !

Want to Learn How to Trade? 

ATTEND OUR Seminar

>Learn the basics of trading currencies, commodities, and indices
>Know the difference between fundamental and technical analysis
>Understand why the currency market is the next big thing in trading

Don't miss it!

3:00 PM Saturday
October 26, 2013 
9th Floor, Marajo Tower, Bonifacio Global City. 
Dress code is smart casual

Happy Trading Hours Monthly Finals !

1 Hour Demo Challenge - Monthly Group Finals

(XAUUSD, GBPJPY, EURUSD, SPX500)


This Friday we'll see how far the finalists can go as they test their TRADING SKILLS, 

LEADERSHIP, and ability to work under PRESSURE! 

Qualified For the Monthly Finals:

1. Gabriel Vergara

2. Robert Escano

3. Joanne Atienza

4. Daniel Gempesaw

5. Juan Gaspar Cabaero


--------------------------------------------

Mechanics:
1. The leaders/finalists must choose 3 other members to trade with him/her. 

2. Each team member (including the leader) will open a PHP 100,000 demo account - for a 

total of PHP 400,000 per team. 

3. Trading is restricted to only 4 tradable instruments - October 25, 2013 finalists can only 

trade XAUUSD, GBPJPY, EURUSD, SPX500. Strictly one instrument per person.

4. Competition runs for 1 hour

-------------------------------------------

Prize: The winner will receive an HTH Trophy along with other exciting prizes, and a ticket 

to compete for the next rounds.

*Onlookers are invited to watch and feel the thrill of this exciting event on October 25, 

2013 Friday here at MetisEtrade's head office. Please RSVP by messaging us your name and 

contact number.


See you there!

Where: MetisEtrade Office 9th Floor, Marajo Tower, 26th Street, Corner 4th Avenue, Fort Bonifacio Global City, Taguig

When: October 25, 2013

Time: 6:00 pm to 9:00 PM

Part 3 – How to Become a Pro Trader: Taking Off the ‘Training Wheels !

Taking Off the ‘Training Wheels’

Last week, in Part 2 of this mini-series we discussed how to test your skills in the market.

Here’s a quick review of the points we covered last week:

Step 4: Creating and using a Forex trading plan

Step 5: Creating and using a Forex trading journal

Step 6: Demo trading your Forex trading strategy

In this week’s lesson we are going to pick up where we left off last week by getting you mentally prepared to “take off the training wheels” of demo trading. Trading with real money is significantly more intense than demo trading, thus it requires that you are aware of and accept the reality of real-money trading before you take the plunge. Most beginning traders simply dive in to the markets head first, risking their hard-earned money with no real plan in place. Hoping that you will somehow “figure it out” on the fly is not a plan; it’s what gambling traders do. Thinking that you will somehow parlay your trading account money into a small fortune within a short amount of time without any plan or strategy in place puts you on a fast-track to failure as a trader.

The truth is that reaching a point where you can honestly trade for a living without having any other job is a result of not trying to get rich quick, and of accepting the reality of what it takes to become a consistently profitable trader and doing those things consistently.

Step 7: Making the jump to live trading – Preparing yourself for the emotions

When you are demo trading the markets you naturally have no emotional problems to battle with, because you have no real money on the line. Thus, many traders do exceptionally well when demo trading only to find that their fake-money success goes out the window when they switch to real-money trading. That’s because there are drastic psychological differences between demo trading and live trading that you need to come to grips with prior to switching to a live account. Here are some points to consider before you begin risking your hard-earned money in the markets:

• How to trade like you did on demo – As I mentioned previously, traders usually do better on demo than they do on live accounts as a result of the fact that there is naturally no emotion in the mix when you aren’t risking real money. While it is certainly easier said than done, what you need to do on your live account is forget about the real money you are risking, here’s how you do this…

• ONLY trade money you are OK with losing – In order to not get emotional while trading with real money you need to never trade with money that you need for anything else in your life, as well as never risk more than you are truly OK with losing. If you can manage to consistently do these two things, you will experience little to no emotion on any one trade. Most traders end up trading with money they really shouldn’t be trading with, or they risk more than they are OK with losing per trade, thus they become emotional.

• Understand you CAN lose on ANY trade – You are much more likely to have a calm and objective trading mindset if you always remember that you can lose on ANY trade you take. Even if you see what you think is a “perfect” price action strategy  in a very strong trending market, it can still fail. The truth is that you can never know for sure what is going to happen on any given day in the market, so if you truly accept that and believe it, there is no reason to ever risk more than you are comfortable with losing.

• Don’t get caught-up over-analyzing the markets – If you want to become a professional Forex trader you are going to have to learn how to accurately read and trade off of the daily charts first. Most traders end up taking the opposite approach; they start by trying to trade off of lower time frames like 5 minute or 15 minute charts, and then after they lose enough money they eventually figure out the daily chart is a lot more conducive to trading from a relaxed and objective mindset.

• Not every trading opportunity is created equal – Understand that you shouldn’t stray from your trading edge once you start trading live. You probably traded your edge very consistently on demo, because you didn’t feel any “urge” to make money, try to recapture that same feeling when trading live and forget about the money. Over-trading is a result of feeling “pressure” and greed to trade. The more you feel these emotions the more likely you are to trade when you shouldn’t and thus lose money.

Ultimately, there is a fundamental difference in how amateur traders think vs. how professional traders think. The difference lies mainly in the amateur’s “need” to make money from their trading as well as their inability to trade emotionally undetached from any one trade. Essentially, professional traders do not become emotional from any one trade because they know their success is defined over a large sample of trades, not by one or two. Professional traders also know that the key to keeping the emotional trading demons at bay is to consistently control their risk in the market. Your trading psychology is what dictates how you interact with the market, and this psychology is almost entirely a result of how well you manage your money as you trade.

Step 8: Managing risk effectively – The KEY to successful Forex trading

As I just mentioned, risk management is the “key” to managing your emotions correctly; and thus it is also the key to becoming a successful trader and eventually a professional trader. If you practice proper risk management on every trade, it will make managing your emotions and maintaining the proper trading psychology a very simple task.

However, most traders do not manage their risk effectively, and as a result they experience huge emotional swings in their trading, as we all as in their equity curves. To avoid the account-destroying emotional trading mistakes that most traders make, there are some specific forex money managementguidelines that you can follow:

• Trade with only disposable income – I mentioned this in the previous section, but it’s worth mentioning again because it really is your first line of defense against becoming an emotional trader. If most traders would only take the time to honestly decide how much truly disposable income they have to trade with and ONLY trade with THAT money, there would be a lot more successful traders in the world.

• Understand risk / reward and position sizing – It really is amazing how many traders start risking their hard-earned money in the markets without a thorough understanding of risk reward and position sizing. If you take the time to understand the math behind the power of risk to reward ratios, it will allow you to see that you can actually lose on the majority of your trades and still make money, to learn how this is possible see this article: Case Study – Random Entry & Risk Reward in Forex Trading

Position sizing is equally important, yet many traders seem to have no idea that they can still trade a their ideal risk amount even if they need to place a large stop loss on a trade. I get questions about this everyday; “Nial how can I trade the daily charts with a small account, am I not better off trading the smaller time frames?” The answer is you simply need to reduce your position size down to meet the larger stop requirement of daily chart time framescompared to smaller time frames. There are no advantages to trading 5 minute charts on a small trading account or on any account really.

• Know what your risk-per-trade tolerance is and STICK TO IT – Professional traders know before they enter a trade how much they are going to risk on it and how much they are emotionally OK with risking on it. If you are staying up all night watching your trades, you are risking too much. You should risk an amount that truly allows you to set and forget about each trade you take, because being preoccupied with every trade you take all the time is a sure sign you are risking too much.

• Avoid taking on more risk from adding positions – Some traders like to trade multiple markets at the same time, and they will actually double or triple their normal risk while doing so. This is basically trading account suicide. First off, if you are a shorter-term swing trader like me, you are only in the markets for 1 to 3 days on average, sometimes a bit longer depending on the trade. But, there’s really no reason to be in 5 different trades at the same time unless it’s part of a long-term diversified investment strategy. If you do see a good reason to trade multiple Forex pairs at the same time, make sure you divide up your risk amongst them so that your pre-defined risk tolerance is always maintained.

• Measure risk and reward in dollars, not pips or percentages – If you are still calculating your risk and reward by percentages or pips, you need to stop. Think about it for a minute; if you risk 100 pips on a trade that doesn’t really mean anything because you can trade many different position sizes for that amount of pips. One trader might have $10 at risk on 100 pips and another trader might have $1,000 at risk on 100 pips. Thus, through position sizing, a trader can risk different dollar amounts than another for the same stop distance. So, the point is that you calculate your risk and your reward in terms of “R”, R is the dollar amount you risk per trade. Check out this article later on how to measure your trades in dollars not pips or percentages to learn more.

Finally, as you progress from the early stages of learning your trading strategy, building a trading plan, and demo trading, you will move to the “big leagues” of real money trading. I hope that the points discussed in today’s lesson provided you with some insight to get you ready. In the end, no amount of advice or insight can substitute for real trading experience, but it can help you to accept the realities of trading and let you know what to expect.

In part 4 of this mini-series, we discuss trade management and exit strategies. These are probably the two most difficult aspects of trading, so make sure you tune in next week for some solid training on these two very important aspects of becoming a professional Forex trader. If you want more help with making the transition from demo trading to live trading, check out my members’ trading forum. There you will find a genuine group of price action traders all helping each other and discussing potential setups in real-time market conditions, for more information check out my Price Action Trading Course page here.  If you have any questions or feedback you can contact me here.

Credit: Nial Fuller