Any experienced trader will tell you that in order to succeed in the tough environment of trading, you must develop a mental framework that allows you to trade your strategy dispassionately, like a machine. 80% psychology and 20% skill, that is the ratio that I found is the key to trading. Talking with many other traders in the industry, this ratio varies, but all agree that psychology is important.
Considering that trading is where we can win or lose money daily, no wonder psychology plays such a crucial part, the stress levels of seeing your profits turn negative when the trade goes against you can be immense. Many people quit at this point, simply saying that ‘trading is not for me’, ‘it’s just a scam to get my money’ or ‘I have no time for this right now’ and so on. Sounds familiar, doesn’t it?
It takes practice to develop mental attitude of a trader and do your best to get the emotions out of your trading decisions. As Mark Douglas, one of the best writers on Trading Psychology, said: “If you can learn to create a state of mind that is not affected by the market’s behaviour, the struggle will cease to exist.”
So let’s look at the psychological challenges of trading and ways to overcome them.
‘I have to make money quickly!’
One of the main reasons people get into trading is the promise of quick and easy money. The whole ‘get rich quick scheme’ has destroyed many trading accounts and many people prey on this in social media, selling trading signals by posing as traders ‘who made it’ and now enjoy a lavish lifestyle.
The problem here is that this type of thinking puts strain on your trading, as you set time limits on yourself and, consequently, on the market to make you profitable. Patience is key in trading as you must wait for the perfect opportunities to make money. Bill Lipschutz is a famous trader and he said that ‘If most traders would learn to sit on their hands 50 percent of the time, they would make a lot more money’. So, you must get rid of the mentality that trading will make you a millionaire by the end of the year. Instead focus on the trade and not the money. One good strategy is to find other productive activities while your trade is running so you can maintain it and let it run according to your plan. Many traders go to the gym and work off the stress, or if you have another job or hobby, focus on that. Traders who focus on getting rich quickly in trading, lose their ability to objectively read the charts and lose money quickly instead.
‘FOMO’ – Fear Of Missing Out
FOMO or ‘fear of missing out’ is a major issue for traders. How many times did you open the chart and see that you missed a big sell off? Some research shows that traders can feel more pain mentally when they miss the trade, rather than take the trade and lose on it. This causes traders to chase trades and react impulsively to any sudden moves in the market, in fear of missing out the on the next big move. Accounts suffer due to non-strategic and compulsive trading, that is based on fear and not objective analysis.
One of the ways to deal with fear is time. Not a ‘eureka’ type of solution, but it is true. It takes time in the markets to learn to focus on your strategy and not pay attention to every big move that happens. Your dedication decides on how long it will take to learn to cope with FOMO. Another way is to communicate with other traders, since they understand exactly how it feels. Since trading can be quite a lonely game, keeping a circle of trader friends will help you deal with FOMO.
‘Greed and Fear’
Greed and Fear is what moves the markets up and down because it is what determines the buy and the sell motives of all investors and traders. These are the fundamental forces of human behaviour that drive our financial decisions in the market. Another reason to train yourself in mental fortitude is to avoid getting your trades to be impacted by these two forces and be as objective as possible in the market. You may not take the profit and let the trade run because you are greedy and want the trade to make you more profit. You see a pullback in your trade and fear kicks in, and you close it too early before the trade is anywhere near your target. You increase your stop level; you increase your risk and so on and so on.
The best way to deal with greed and fear is having a risk management strategy with a detailed plan of every trade you take. You analyse the chart and set the target and stop, determine appropriate risk and get into the trade. Once you do so, never waiver from your plan and always follow it. That is how you get the probabilities to work for you and help eliminate greed and fear. They will not affect your trades if your trades are based on your plan and you have a clear risk management strategy. While it is challenging, practice makes perfect, the more you do it and repeat, the easier it gets.
‘I have it on good authority that this is a good buy’
Another way that your mental attitude in trading gets tested is from countless other traders in the world. How many times have you seen a ‘perfect’ setup from another trader? How many times did you take the trade because another trader said it is a 100% money maker and convinced you? When 100 traders look at the same chart, you can have 100 different opinions on where the price is expected to go. While it is important to keep an open mind, your faith in your trading plan is paramount and you must NEVER take the trade you do not understand, no matter how convincing the person who tells you about it is. Traders can lose quite a bit of their capital this way.
Setting yourself trading rules is one of the ways to avoid making such mistakes. Having them written down until they become automatic. You must always trade your plan and not someone else’s. Make sure that your trading decisions are only based only on your trade plan and its parameters.
Dealing with trading psychology is all about practice and changing your trading into an automatic mental process and keeping the emotions controlled, which of course is the biggest challenge. Victor Sperandeo, a famous trader that made 300% on his money during the crash of 1987 summarised it well ‘The key to trading success is emotional discipline. If intelligence were the key, there would be a lot more people making money trading…’