Being new to the trading game, I’ve very quickly came to realise, one of the biggest mistakes newbies make when learning to trade is to assume that they will immediately become successful. Ask any experienced trader (as I’ve interviewed many!), if you want to become successful, first learn to recognise your emotional state and then learn to control it, it will have the biggest impact on your results.
Psychology plays a significant role in trading, similar as to when you play a game of poker. Mastering the psychology of trading is one of the most difficult elements of learning how to trade. Not only do you need to quickly grasp the world of economics and the numerous trading platform software, you also need to keep your emotions in check! Your ultimate goal is that you make money, not lose it. Controlling your emotions will have a big impact on this.
Another area where Traders go wrong is that Trading should be treated as a business, not as a hobby. It’s a personal choice but it’s normally best to separate it from our personal lives, why do you ask? Personal lives involve emotions, in the trading world, emotions are left at the door – there is no room on your trading desk for emotions. The only room in your trading environment is for calculated risk and well-planned strategies and decisions. Our emotions have a tendency to skew the decision-making process, and far too often, they cause poor decisions that lead to losses.
When trading, a strategy’s success can be determined by a number of trades. A successful trader must be disciplined and patient and not allow emotions to get in the way. No matter which way the market moves (up, down or sideways), the trader must see the strategy through until the end. Sound easy right? Wrong!
Do you remember a time when you lost your cool? You were tired, it was the end of the day, it had been a long week and something you would normally class as insignificant made you boil with anger. After a good night’s sleep you regretted your actions, but could you promise yourself you wouldn’t act like that again after a 48hour working week? Trading is similar, it takes patience and practice to keep your cool.
The psychology of a person is made up of thoughts and feelings resulting in the way we act, so psychology shapes our behaviour in every aspect of our lives – playing poker or getting angry after a long working week, trading is no exception.
All markets go through different cycles that produce different psychological effects and luckily, to help you identify, we have a 14 Stage Phycology of the stock market – cheat sheet. Understanding this cycle can help you identify and take control whilst trading.
- OPTIMISM – a positive outlook leading us to buy a stock.
- EXCITEMENT – Things start moving our way, a possible success story is in the making.
- THRILL – At this point we cannot believe our success and begin to comment on how smart we are – hey I’m getting good at this!
- EUPHORIA – This marks the point of maximum financial risk but also maximum financial gain. Having seen every decision result in quick, easy profits, we begin to ignore risk and expect every trade to become profitable.
- ANXIETY – Oh no – it’s turning around! For the first time the market moves against us. But having never seen this happen, we tell ourselves we are long-term investors and that all our ideas will eventually work.
- DENIAL– The markets don’t turn as quickly as we had hoped. There must be something wrong we think to ourselves. We begin denying either that we made poor choices or that things will not improve shortly.
- FEAR– Reality sets in that we are not as smart as we once thought. We believe the stocks we own will never move in our favour.
- DESPERATION– Not knowing how to act, we grasp at any idea that will allow us to get back to breakeven.
- PANIC– The most emotional period by far. Having exhausted all ideas, we are at a loss for what to do next.
- CAPITULATION – We have reached our breaking point and sell our positions at any price. We just want get out of the market and avoid future losses.
- DESPONDENCY – After exiting the markets, we do not want to buy stocks ever again. The markets are not for us and should be avoided at all costs. This often marks the moment of greatest financial opportunity.
- DEPRESSION – Not knowing how we could be so foolish; we are left trying to understand our actions.
- HOPE – Eventually we return to the realization that markets move in cycles, and we begin looking for our next opportunity.
- RELIEF– The markets are turning positive again and we see our prior investment come back around. We regain our faith in our ability to invest.
Do you relate with these emotions? Let us know your thoughts? Share your stories?
Stay tuned for more articles on Trading Psychology.