Trading the financial markets is one of the most psychologically demanding ways to make money. Many traders experience failure because they fall victim to their own psychology and behaviors rather than misunderstanding the markets.
Successful traders don’t just need to understand the markets they trade; they need to understand themselves. Successful trading strategies must be systematic, and giving in to our emotions can cause a potentially profitable trading strategy to veer off course.
Trading is an emotional rollercoaster, and how you feel before opening a position, during and after, can vary substantially. Similarly, your feelings after a win or a loss will differ greatly. Overcoming emotions and irrationality are the biggest hurdles traders must overcome to succeed.
Every trader should use their journal to describe their feelings while trading. This article explores the basics of trading psychology, the emotions and biases experienced when trading and how to overcome deep-rooted behaviors.
Trading psychology
A trader’s psyche gets pushed and pulled in many different directions. Sometimes we’re worried about losing money, determined to be correct, or anxious about missing opportunities.
Understanding trading psychology is crucial as it allows traders to develop a sound mental and emotional framework to navigate the markets and make rational and profitable decisions.
Trading psychology is how we describe the mental and emotional aspects of trading, particularly how they impact the decision-making process of traders. Trading psychology defines how traders think and feel about the markets, their abilities, and their trading decisions.
Factors that impact your trading judgment
As humans, one of our greatest assets and liabilities is our emotions. Our unique ability to think intelligently and consciously can be harnessed to achieve great success, but it may also cause destruction.
Successful traders need to navigate numerous psychological phenomena that can impact our trading judgment, such as:
- Emotions: Fear, greed, anxiety, optimism, and other emotions can cloud judgment and lead to impulsive decision-making.
- Cognitive biases: Cognitive biases, such as the hot-hand fallacy, house money effect, confirmation bias, and many more, can lead you to make decisions that are not based on objective analysis.
- Stress: High-stress levels can negatively impact your ability to think clearly and make rational decisions.
- Lack of sleep: Not having enough restful sleep can affect cognitive function, judgment, and emotional control and increase stress.
Understanding trading decisions
Many professional traders and psychology experts who studied this area conclude that most traders fail to maintain successful trading systems because of psychological factors rather than technical or systematic reasons.
Every time a trader opens or closes a position, they must have a valid reason. If they don’t, they are simply gambling, and then it’s natural for their decisions to be irrational and fueled by emotions.
Your state of mind varies throughout the life cycle of a position. Before opening, you should have performed some analysis to select the trade direction, when to open, and the profit target. Similarly, you should have determined the position size, capital risk, and margin utilization.
How a trading journal can reduce the impact of emotional trading
Many traders think that trading journals are to log their trading performance to review events such as winning or losing trades and drawdown. A trading journal can be used for much more than analyzing track record. A journal can and MUST be used to note your feelings while trading, which can be essential for retrospective analysis and long term improvement.
A trading journal should be used to reflect on the emotions present during a trade and how they may have influenced the decision-making process. Reflecting on your journal can help you identify behavioral patterns and triggers that cause unplanned actions and develop strategies to manage emotions more effectively.
Combine trade history and emotions
Trading journals can be used to record the details of each trade, including the entry, target take profit, stop loss and exit points, position size, and the outcome. You may find that your negative emotions correlate to certain controllable factors, such as position size, volatility, drawdown, or margin utilization. By combining trading history and emotions, you can identify scenarios that cause discomfort and trigger irrational behavior.
Identify your biases
There are dozens of biases that can trigger strategy deviations. Thankfully, not everyone is affiliated with the same set of biases. Recording your thoughts and emotions can help identify cognitive biases that may be impacting decision-making. By recognizing these biases, you can take steps to manage and counteract them and make more objective decisions.
Maintain discipline
Keeping a written trading journal will drive discipline and help you stick to a trading plan. You should keep track of trades, emotions, and performance. Train yourself to stick to your trading strategy, be disciplined and be aware of the consequences of deviating. Define your strengths and weaknesses, reinforce successful actions and identify areas to improve.
Improve with a trading journal
Keeping a trading journal requires self-reflection, which can help you gain a deeper understanding of your emotional responses to the markets and positions to develop a more objective perspective on your trading.
Trading is a journey without a finish line. With a complete technical and emotional trading journal, you have the ability to fully harness the Kaizen mindset or 1% better philosophy and strive for continuous improvement.
There is no point in writing a trading diary if you don’t use it to reflect on your past decisions and understand your trading mindset when you made mistakes. Using a trading journal can give you a phenomenal edge. Any trader can benefit from a trading journal, no matter whether you’re trading forex, stocks, crypto, or commodities. Trading psychology is consistent throughout all asset classes.