Trading the forex markets takes hard work, discipline, a plan and the right personality to be profitable. You will be tested consistently and this will require a psychological mindset, which allows you to make the right decision when the going gets tough.
To become a successful trader, you need to keep your emotions in check, and have trader discipline. This will help you build confidence and allow you to execute your trading plan more effectively.
Having a Disciplined Trading Approach
The markets are made up of many participants who are at any moment experiencing a range of emotions which can generate volatile market conditions. Even the best traders fall prey to emotions such as fear and greed. There is a tendency amongst novice traders to place a trade when the market is experiencing high volatility and try to generate quick gains, based on gut feel, without a specific trading plan.
One of the best ways to promote discipline, as a trader, is to create a business plan. Generating income from trading activities is a business, and should be treated as such. You would never risk your hard-earned capital in a new car washing venture or restaurant, for example, without having a plan that shows that you can make money. It should be no different with your trading business.
Many traders realize that importance of having a checklist when making a trading decision to make sure they have all their ducks in a row, before they transact a trade. This is a great idea that will build confidence in your trading process and help you to analyze your trades better. It is very important that you have confidence in your process and approach, because if you don't, you will pull the plug quickly when something goes wrong.
Trading Psychology Explained
It's hard to completely understand trading psychology unless you have had direct investing experience. Most traders know that getting and staying in the right mindset is essential. This is especially true for the short term trader. If you are day trading the markets, you will need to make quick decisions on short notice, which can be the difference between a profitable or losing trade. At the same time, you need to be able to stick to a previously established plan where you are confident in booking profits and executing a stop loss. Your emotions need to be in check and they simply cannot get in the way of making time sensitive trading decisions.
Part of understanding forex trading psychology is to recognize the presence of fear and greed. While losing money is something you need to accept as part of the business of trading, it's very hard to learn how to tolerate the uncomfortable feeling you will experience when you are losing money. You need to have emotional discipline as a trader, but it does take time to become relaxed and take losses in stride. If you want to become successful, it is important to know the effects of losing and winning on the psychology of a trader.
What emotions should you watch for in yourself while trading?
To be a little bit more specific about "emotional" trading, let's go over some of the most common emotional trading mistakes that traders make:
There's an old saying that you may have heard regarding trading the markets, it goes something like this: "Bulls make money, bears make money, and pigs get slaughtered". It basically means that if you are a greedy "pig" in the markets, you are almost certainly going to lose your money. Traders are greedy when they don't take profits because they think a trade is going to go forever in their favor. Another thing that greedy traders do is add to a position simply because the market has moved in their favor, you can add to your trades if you do so for logical price action-based reasons, but doing so only because the market has moved in your favor a little bit, is usually an action born out of greed. Obviously, risking too much on a trade from the very start is a greedy thing to do too. The point here is that you need to be very careful of greed, because it can sneak up on you and quickly destroy your trading account.
Losing money goes hand and hand with fear. Fear can overwhelm you if the position size is larger than normal, especially if you did not plan on taking a larger than normal loss. If you are a disciplined trader, and stick to your plan, when losses come around you will deal with them appropriately.
Experience will teach you to remain calm if you have a drawdown that falls in your range of expectations. If you have a strategy that wins 60% of the time, you should expect losses. You will never be happy when the market is moving against you, but if your strategy shows losses 40% of the time, you will become more comfortable with a loss as a potential outcome. What is much harder to handle is a situation where a trader takes unplanned risks which can adversely affect their investor psychology.Euphoria
While feeling euphoric is usually a good thing, it can actually do a lot of damage to a trader's account after he or she hits a big winner or a large string of winners.
Euphoria, is a creature that promises unlimited wealth, and delivers unlimited misery and destitution. Euphoria works hard to ensure that wherever we look, we see nothing but wonderful prospects for limitless profits. It is as if the trader has somehow been blessed with the Midas Touch, with success being the natural consequence of his routine behavior.
Under normal circumstances, euphoria has little relevance for most traders, because most are aware that success in forex trading is not child's play. While magnificent profits in a short time are sometimes possible, such gains are usually the result of a period of study and practice during which the false promises of euphoria are proven repeatedly to be meaningless. In the case of the beginner, who doesn't possess this background of hard work and study, euphoria may result from a string of profitable trades, as the trader comes gradually to believe that his understanding of the markets is impeccable, his analysis, flawless.
The key here is the knowledge that the first condition for performing a flawless analysis is beginning with the assumption that no analysis is flawless. Consequently, the successful analyst or trader is always skeptical about the value of his explanations, although he doesn't hesitate to act on them because he bases his work on logic alone. The profit potential of the next trade taken is independent of how profitable the previous one was. Consequently, there's no sense in getting excited about a string of profits: the next trade may or may not be profitable, depending on how diligent our study of the market was.
Thus, the best way of avoiding euphoria is by understanding that a string of wins or losses does not impact the outcome of the next trade that we will make. The success or failure of the next trade is only dependant on how capable we are of excluding emotions from our study of the markets, and in that knowledge lies the alpha and omega of a successful trading strategy.Revenge
Traders experience a feeling of wanting 'revenge' on the market when they suffer a losing trade that they were 'sure' would work out. The key thing here is that there is no "sure" thing in trading...never. Also, if you have risked too much money on a trade (starting to see a theme here?), and you end up losing that money, there's a good chance you are going to want to try and jump back in the market to make that money back....which usually just leads to another loss (and sometimes an even larger one) since you are just trading emotionally again.
The Importance of Discipline and Trading Rules
Trading rules are very important for every level of trader experience, but most important for the novice trader. Most novice traders are eventually knocked down and never figure out how to recover. By having specific rules in place, you can help yourself fight the emotional swings you will experience while trying to make money trading. Remember, you are not the only trader out there, there are countless people trying to make money trading the currency markets. While the game is not completely zero sum, as many people are using the currency markets to hedge exposure, nevertheless you need a solid edge and focused mind in order to compete successfully.
If you are the kind of trader that tends to get overly greedy, train yourself to put an order in the market that designates your take profit point. If you find that you get antsy as a currency pair approaches your mental stop loss level, put a hard stop in the market and let the market take you out. Be careful and make sure that your take profit and stop loss levels account for market noise, which will help you avoid getting stopped out by the normal market fluctuations.
If you're a day trader, you can also set limits on your profit or loss for a day. If you make or lose a specific amount you can take a break or cease trading for the day.
You should periodically review and assess your performance along with the strategy that you are using to trade the markets. This goes beyond evaluating your returns to see if you are hitting your goals, it also means analyzing how you reacted to specific situations. By analyzing what you did right and what you did wrong you can improve upon your performance. If you see specific mistakes you can correct them. Remember, what can be measured, can be improved.
Creating a Trading Plan
Traders should try to learn about their area of interest as much as possible. For example, if the trader deals heavily and is interested in telecommunications stocks, it makes sense for him or her to become knowledgeable about that business. Similarly, if he or she trades heavily in energy stocks, it's fairly logical to want to become well versed in that arena.
To do this, start by formulating a plan to educate yourself. If possible, go to trading seminars and attend sell-side conferences. Also, it makes sense to plan out and devote as much time as possible to the research process. That means studying charts, speaking with management (if applicable), reading trade journals or doing other background work (such as macroeconomic analysis or industry analysis) so that when the trading session starts the trader is up to speed. A wealth of knowledge could help the trader overcome fear issues in itself, so it's a handy tool.
In addition, it's important that the trader consider experimenting with new things from time to time. For example, consider using options to mitigate risk, or set stop losses at a different place. One of the best ways a trader can learn is by experimenting - within reason. This experience may also help reduce emotional influences.
Finally, traders should periodically review and assess their performance. This means not only should they review their returns and their individual positions, but also how they prepared for a trading session, how up-to-date they are on the markets and how they're progressing in terms of ongoing education, among other things. This periodic assessment can help the trader correct mistakes, which may help enhance their overall returns. It may also help them to maintain the right mindset and help them to be psychologically prepared to do business.
To deal with the problems associated with trading psychology, we must minimize the role of emotions in our trade decisions. To minimize the role of emotions, we must understand that success or failure are not related to luck, but are the logical consequences of our own choices. We discussed before that it is almost impossible to have an unleveraged account wiped out as the consequence of a single trade. If the trader succeeds in realizing an empty account as a result of a string of losing trades, it's hard to speak of luck or chance as being the causes of the disaster. Leverage is entirely in the control of the account owner; he can set it at any value provided that he can live with the consequences. Leverage amplifies the profit/loss potential of a trade, but it also intensifies the emotional aspect of trading too. Eventually, this intensification of emotional pressures may prove to be the most dangerous and negative impact of leverage.
The best way of dealing with emotional problems is acquiring a logical approach to trading. The best way of acquiring that attitude is understanding the market mechanisms, and the forces that direct economic activity. In this website, we have attempted to give you a basic understanding of those factors upon which you can build your own edifice of knowledge to improve your own potential for success in the forex market.
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