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Psychology in trading

This time, we will speak about the psychological aspect of trading and psychoanalysis of retail investor’s behavior.

Psychology of market participants gives insight into the developments in financial markets. You could be an excellent technician, who estimates prices and time with precision up to a pip or hour, and an inefficient trader in parallel. Indeed, all personal feelings and emotions are exposed under tough market conditions. Common human traits like fear, greed, hope etc. make a profound impact on a trader’s behavior in a hectic trading session. Weak and self-confident, greedy and sluggish people are doomed to become victims of the market. Besides, a herd can influence a trader unexpectedly: a mediocre person could turn into a winner in Forex and a lucky one could make heavy losses in trading. Understanding your own abilities and preferences, positive and negative qualities can shield you from big losses. If you develop an ability to assess adequately your psychological condition and analyze herd behavior in the market, you will achieve fire-sure success.

So, greed is the main driving force which prompts you to speculate in financial markets. You may doubt the truth of this statement. If your personality lacks this trait, you are likely to make few deals missing a lot of opportunities. On the contrary, if your personality is marked by unlimited greed, you will try to make lots of deals risking your money. If you belong to the first type of people, you will cope well with a quiet business. If you are an adventurous person, you can try gambling. It would be wise to take care of your ambition as a home plant. You should be able to deal with your greed. Importantly, it should not disrupt your decisions when you make deals. Then, it will turn out into motivation.

There are two types of motivation.

  1. Rational motivation.
    As a rule, it is a feature of beginner traders before their first entry to the market as well as trading practitioners. It is a practical approach to making sensible decisions.
  2. Non-rational motivation.
    It is displayed as a drive. All people are influenced by subconscious motivation. However, someone can deal with their emotions. Someone is driven entirely by their emotions and doomed to failure.

The other factor encouraging a trader to make a deal is hope for gaining a profit. Obviously, any job aims to provide income. However, if hope dominates common sense, you run a risk to overvalue your own capabilities when analyzing a market situation. Hope should always be less important than greed and common sense. If a beginning trader is driven by fervent hope, it might lead them to heavy losses.

A trader living in hope has a zero chance of succeeding in Forex.

As a rule, hope determines the trader’s behavior in the following cases.

  1. At the moment of entering the market.
    Only hope for making a profit can prompt a person to do something in the financial market.
  2. At the moment of losing money.
    In this case, a trader is full of hope for the better.

In the first case, everything is clear. In the second case, hope passes three stages. When a trader incurred minor losses in the first stage, he obviously hopes for improvement on condition that he follows a plan. In the second stage, losses increase if stop loss is cancelled or not set yet, so hope reaches its peak. At this moment, it is very difficult to differentiate between hope and real market conditions. A solution could be either closing a losing position or inactivity.
Outcome depends on how trader’s mind can tame emotions and how a current situation is assessed. In the third stage, losses are critical. A trader gives up hope and he is overwhelmed by despair. In most cases, it can happen to inefficient traders and beginners. A lot of market participants including successful investors are familiar with this desolate feeling, when the whole world seems hostile to you. In fact, most traders are unaware that you work in the market. Therefore, traders exaggerate the market’s hostility. At the same time, we have to accept the fact that the major aim of any trader is to earn at the expense of another trader. A person who experienced the final stage of desperate hope can consider oneself a full-fledged trader. Perhaps, in further trading the experience gained in the third stage could reveal itself as fear of the market.

It is necessary to take responsibility for your trading decisions to avoid despair and fears. Remember that strong market players are eager to take advantage of your weakness.

Trading is accompanied by the following risks.

  1. The human nature is often affected by the herd. As a result, a person takes a collective decision instead of individual.
  2. Herd decisions are mostly suggested by the silliest market participants.
  3. You should be suspicious of those analysts, who earn to a greater extent less than banks or large private investors.

Please be aware of the rule, which will perhaps help you make the right judgement about a current market situation.

“The absolute majority of financial analysts release a great deal of articles about an ongoing trend at the moment of its serious correction or even completion.”

It happens because most analysts are employed by financial institutions, which stick to the following principle in most cases, “A trend is the best friend of a trader.” On the other hand, traders are affected by misinformation when huge market players want to sell off a part of an excessive strong currency.

Logically, on the one hand, one should not oppose a crowd as it shapes an overall market trend. On the other hand, you should not follow blindly herd decisions as collective sentiment is likely to be wrong. Monitoring a crowd behavior, you should understand whether market participants act as winners or losers. You can recognize winners by a growing number of trades or rising ADX trend. Other technical indicators like MACD, RSI etc. make sharp one-way moves following a price. Losers reveal the opposite picture of the market behavior. Here is a rule of prime importance.

“Taking part in speculative trading, you must betray losers and join winners.”

While putting your detailed knowledge into practice, you will find out that sometimes your opinion is in conflict with other market participants and analysts. Such a difference is not caused by your false vision of developments. It is caused by psychological discomfort that other markets participants and analysts do not share your viewpoint, even though they are unaware if it. To avoid the feeling of embarrassment, do not be afraid to earn in the wrong way in the eyes of other analysts and traders.

Before we discuss psychoanalysis, please consider another important conclusion, which was made as a result of opinion polls among traders.

“We tend to risk in grave danger, but we are afraid to risk when there is no threat.”

Psychoanalysis is needed to understand our own weak points and get rid of them. Statistics shows that over 90% of retail traders complete their forex career in the very beginning with no results. In light of the law of probability, this figure is a bit overvalued. In principle, a number of unsuccessful traders cannot be more than 50%, even excluding those with zero results. Why do theoretical and practical figure differ so much? Most traders, who failed to achieve success on Forex, blame their problems on small deposits, lack of quality prompt information, evil intentions of brokers and dealers, high commissions, spreads etc. They are partly right. All these negatives do not contribute to good earnings. However, they should blame their losses mainly on themselves. They lack something important. Unfortunately, without the help of a professional psychoanalyst, it is possible to test your true qualities only in a tough market environment or other extreme situations.

“The wrong understanding of yourself is the major risk factor.”

It might take years for a person to reveal one’s personality and true qualities under ordinary conditions. A private investor lacks time for that. Therefore, one can either consult a professional psychology or enter the market without understanding one’s own strong and weak points. To define a type of your psyche, you should find out what kind of trader you are, active or passive.

All traders are equal before opening a position. Some of them are self-confident and ready to insist on their point. On the contrary, others prefer not to disclose their ideas. They listen to a different opinion, but act on their own.

After a trade is open, it becomes clear later whether it was the right or wrong decision. The right decision includes several aspects such as a long or short position, price, and time of opening. A trade can be closed three ways: at a profit, loss or zero result. Only the first outcome arouses positive emotions. Thus, in a short space of time, you can realize how you respond to positive or negative news: in a passive or aggressive way.
You can fill in the following table to visualize your response.

Trader’s response to events Passive Active(aggressive)
Winning trade
Losing trade
Zero result
Overall (dominating response)

An active response reveals itself in sharp gestures and a skittish opinion on a situation.
A passive response means inactivity and tranquility no matter what happens. After you fill in this table, you will see what response prevails.

Another thing is a reason for a particular response. So a trader can be driven by an instinct, intuition or intellect.

Driving forces of trader’s behavior Instinct Intellect Intuition
When opening position
When closing position
When holding position
Overall:

Now, let’s consider how a trader displays these traits.

Any initial move of a trader is viewed as a subconscious wish to satisfy material interests. Of course, you understand that trading is work. Therefore, a trader reveals his instinct that he should work, but not just stare at a monitor.

A trader displays his intellect as the ability to explain logically events in the market and make the simplest and most beneficial decision based on his logic. Instinct is a subconscious driving force, so a person appeals to memory such as advice of teachers, common rules etc. On the contrary, he uses intellect to digest these advice and rules on his own, adjust them to his own outlook on life and a changeable environment. Intellect will help you find a way out of a deadlock, which you could get into when following old rules. Besides, intellect provides insight into the nature of financial markets. It will enable your successful trading.

Intuition
In philosophy, intuition means a human ability to grasp essence of things as a result of instant subconscious insight, not by logical thinking. Speaking about trading, it is an ability to work and feel the market in the heart, but not in one’s mind. George Soros, a legendary investor of our century, combines wisely his intuition with technical and fundamental analysis. If his theory is confirmed, he expands his intervention following a market trend.

Filling in the table of reasons for traders’ behavior, you should ask yourself why you decided to open/close a particular position. If you cannot find logical reasons and explain your decision, you belong to the type of instinctive or intuitive traders. This trader always takes into account obvious reasons, previous experience, and market behavior. An instinctive trader cannot tell anything definite at all except that he was appealing to his vision. On the contrary, if a decision is sensible and logical, it is an intellectual type of traders. At first glance, an intellectual trader is likely to succeed. However, the sober judgement reflects fears about uncertainty and success of a deal.

After you fill in the two tables, you will be able to assess your psychological type. Make sure you get to know recommendations on each one.

Psychological type of trader Active (aggressive) Passive
Instinctive Weak points: over-emotional, sensitive to fears, hope etc.
Strong points:  stamina
Recommendations: calm down and not make hasty decisions.
Weak points: subdued emotions, stubborn, reserved
Strong points: common sense.
Recommendations: relax more frequently, close deals with determination
Intuitional Weak points: nervous breakdowns, lack of regular self-control
Strong points: adequate understanding of a current situation, ability to make decisions under uncertain conditions
Recommendations: nonstop self-control, impartial attitude to everything
Weak points: desperate after failure, accumulates negative energy, reflection
Strong points: risk-aversion 
Recommendations: active leisure, make more deals, discuss your activities with other traders, but make decisions on your own
Intellectual Weak points: gets tired soon, needs long rest, overreacts to fundamental data
Strong points: capable of taking fast sensible decisions, self-analysis
Recommendations: develop stamina, take a break as soon as attention eases
Weak points: slow-thinking, stubborn, fearful, lack of self-confidence
Strong points: double checks to be sure, persistent to reach a goal
Recommendations: calm down and make prompt decisions, be suspicious of recommendations from others

To sum up our discussion on psychoanalysis, it is hardly possible to change an adult. However, an adult is rather capable of fostering the necessary qualities to work in the market. Therefore, psychoanalysis of a trader aims to detect psychological faults, which could cause financial failures, and to correct them. If a trader is defiant to correct negative traits, it would be better to acknowledge that trading in financial markets is not his field of activities.

We have prepared recommendations which could help you avoid mistakes and wrong decisions, working in the forex market.

Realize your motivation
Think carefully about an underlying root of your motivation to trade. Contradiction between your motivation and kind of activities ruins your chance of success. In this case, a game is lost before it even starts.

Preferred trading method should correspond to your personality
The thing of great importance is to select a method which matches your personality and enables easy trading. If you cannot bear the idea to lose a big part of your current profit in an open position, you will strongly dislike even the best long-term strategy based on following a trend as you will never be able to practice this approach. If you do not want or cannot stay in front of a trading platform all day long, do not even try intraday trading. If you cannot cope with emotional pressure arising from making trading decisions, your solution is automated trading. You can design your own trading system, which suits exactly your needs and makes you feel comfortable.

Take your emotions
Sometimes, all market participants have to deal with a nervous breakdown and incur losses. Anxiety, worries, depression, and despair often accompany trading in the currency market. Risk management is partly related to the ability to tame emotions. Do not let your emotions dominate your trading. You should be focused on your steps. Make trading decisions on fundamental rational background without emotions and fantasies. Communication with other market participants is one of the ways to control your emotions. Other traders understand your problems and can provide important emotional support when you lack courage. You will see that you are not alone and other traders also face similar problems.

Your trading strategy should bring steady profits
You will not be able to earn on Forex even with the best money management skills and strict discipline, if your trading methods cause losses on average. If you have no trading advantage, your money management skills and discipline can guarantee nothing but a slow process of going bankrupt. If you are unaware of your trading advantage, it means you do not have it.

Create your own method
It is essential to create your own method to have a trading advantage. A type of method does not matter. Some highly successful traders use only fundamental analysis, others make trading decisions on the basis of technical analysis, there is also a mixed approach. Above all else, a method should yield steady profits on average. Importantly, a remarkable success requires both natural talent and hard work. Owing to the latter, your potential receives a boost.
However, if you lack inborn talent, hard work can develop professional skills. The similar principles are applied to trading. Few traders have natural talent. Nevertheless, virtually anyone can learn to trade at a profit. The realistic approach to the market will ensure your success in trading.

Discipline
Discipline is a must to manage your risks efficiently using your own method. You should not open trades at random. A beginner trader is not immune from bad trading habits. The best you can do is to get rid of them. As soon as you get lazy and neglect trading discipline, they will come back.

Be aware of responsibility
You and no one else take on responsibility for trading results. You might incur losses because of broker’s advice, wrong recommendation, or a false trading signal you bought from an analyst. Responsibility rests with you in any case because you made the decision to follow this advice and carry out a losing deal.

Independence
You should make decisions on your own. You cannot afford to get into herd panic. Never follow blindly somebody’s opinion. Even if somebody’s opinions brought good trading results in a couple of deals, you should understand it happened accidentally. Eventually, it will cost you money. Other market participants might confuse you and change your vision of the market.

Confidence
Complete confidence in one’s abilities to gain steady profits is the key to success of all prosperous traders. They believe in victory before they start a game.

Losses are part of work
High-flying traders realize fully that no one can avoid losses in trading. Being aware of this fact increases their self-confidence. As successful traders are certain they will win in the long-term prospect, they are not afraid of few losing trades, which are impossible to avoid. Fear about losses is a short way to a failure. If you cannot lose or you are not ready to lose, you will face two scenarios: either you will finish trading with big losses or miss excellent trading opportunities.

Search for advice
If you are keen to search for advice, it means you lack self-confidence. “If you feel an urge to find out someone’s opinion on a deal, it is a clear sign you should leave your position,” said successful trader Linda Raschke.

Patience is power
Anticipation of good trading opportunities increases a chance of success. You do not have to stay in the market all the time. Edwin Lefevre wrote in his book Reminiscences of a Stock Operator, “There are ordinary fools, who always behave wrong. Besides, there are fools from Wall Street who think they should trade nonstop.”

Gradual market entry and exit
You do not have to open and close the whole position at the same time. You can expand or scale down a position gradually that makes your trading more flexible and creates room for adjustments in case of unexpected market situations. Most traders sacrifice such flexibility without thinking because of their wish to be right. A lot of traders note the method of gradual market exit enables them to keep some long-term winning positions for much longer. Otherwise, they would not be able to do it.

Put priority on your gains
You should focus on your gains, not on your ambition to be a hero. Do not judge trading results by the lowest possible price you bought an asset. The good barometer is frequency of your deals with an optimum profit/risk ratio. The most important is an overall result of your trading, not perfect execution of every deal.

Do not be afraid to admit mistakes
Do not stick to your previous wrong forecasts. It makes sense to revise a situation and make the right decision.

Sometimes it is better to act than exercise caution
Waiting for a price correction to open a position is sensible. However, it is not the best solution. If your analysis, method, or intuition suggests that you should buy, but not wait for correction, take this step.

Catch at least part of trend
If you missed the first stage of a new trend, you still have an opportunity to earn in the middle of a trend, but you should determine and place a sensible stop order.

Faithfulness is not good on Forex
Never be faithful to an open position. A rookie trader often keeps an open position for long. Hoping for the better, he will neglect signs of changes in a market situation, so he will drive his deal to big losses. A seasoned trader understands the importance of risk management. Thus, he will exit the market promptly as soon as he makes sure he opened a bad deal. However, a smart trader is ready to make an opposite decision reversing a position if a market behavior suggests this move.

Place take profit
Take a part of your gains setting take profit order.

Hope is obstacle
Hope makes a trader hesitate to close a losing trade and also prevents him from entering the market. A trader is waiting for correction when the position could be opened at a better price. It often happens that hope for correction cancels potential profits from further market moves. Do not hope and open a position following a trend as soon as you can determine a reasonable stop loss.

You cannot win if you feel you have to
Wall Street speculators think that a trader is doomed to failure if he is scared to lose money. The reason is obvious: you run the risk of losing the money, which you cannot afford to lose. In this case, all emotional traps are much more dangerous. The market always punishes careless traders who make deals in despair.

Adventures in Forex cost too much
Trading in Forex is somehow related to adventures spirits, but this attitude has nothing in common with success.

Recognize stress and practice stress management
If you feel stress when trading, it is a worrisome sign. If you realize you find yourself in a stressful situation, think about its causes. You should act immediately to remove a problem. For example, you understand that a question about closing a failed position is not solved yet. One of solutions is that you should always start opening any position with a stop order.

Do not reject intuition
Intuition is your experience accumulated in your subconscious. Unbiased market analysis could be spoilt by irrelevant thoughts. Subconscious is free from pressure. Unfortunately, people find it difficult to appeal to their subconscious. However, when your subconscious sends you signals in the form of intuition, it makes sense to take notice.

Price is not formed by chance
Some scholars insist that market prices are formed in an erratic manner. Monroe Trout is a top futures trader, who has achieved one of the best risk/profit ratios. He said that the business of scholars is to advise, but I earn money doing what I can.

Do not focus your time entirely on market, there is life beyond trading

To sum up the whole course of the forex lectures, successful work in the market is possible only if it combines four crucial elements

Price forecasting
This task is needed to determine a market direction. This is the first and essential step before you make a trading decision. Forecasting prices, a trader can assess his further moves. In other words, a trader decides whether to earn on a bull or bear trend. If you foresee further market moves, you can answer the main question about a market entry: whether to open a short or long position. However, if the forecast is wrong, all your previous and further efforts are in vain.

Trading strategy
Owing to trading strategy, you can determine the exact moment of a market entry and exit. It is the thing of prime importance especially in the forex market as equity is rather small, accordingly a leverage effect is high. As a result, a trader can afford just minor mistakes. Sometimes, a trader made the right decision on a market direction, but he did not open a position in a timely manner. So he makes losses due to bad timing. A trading strategy is based mostly on technical aspects. Thus, if a trader prefers fundamental analysis, he has to use technical indicators in some questions, for example to determine exact points of a market entry and exit.

Money management
This aspect includes a variety of issues about traders’ investments such as optimum content of an investment portfolio, diversification, evaluation of investment into a particular market including risks, stop orders, precise assessment of a profit/loss ratio, a choice of a strategy after a winning and losing streaks, and a trading style (aggressive or conservative).

Psychological training
Every person is marked by individual traits, habits, and an emotional type. A quest inside yourself, streamlining and adjusting your personality for market requirements contribute to your success in trading. A trader can cope well with precise forecasts, develop a good trading strategy and money management strategy. However, lack of discipline, fear of the market, and lack of confidence will bring all efforts to zero and minimize chances of success.

“The virtue of achievement is victory over oneself. Those who know this can never know defeat.”A.J. Cronin. It makes sense to follow this wisdom in trading.

Dear friends, we have completed our final class. We wish you success in Forex! May you achieve all your goals!


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