How to best manage your psychology and control your emotions?
In my opinion, psychology is by far the most important and difficult to master.
It's often said that you can give the same strategy to two different traders, one will be profitable and the other one will not. It's all down to psychology.
From this blog you're going to learn the four most common psychological emotions that we experience as traders and how to deal with them:
#1 The fear of losing
The first emotional state that it's probably to find when coming into trading is the fear of losing money.
In the conventional working world, people go to work, give hours of their time to someone else (in many cases, doing something that they'd rather not do) and in return, they get paid. I understand that losing hard-earned money at the click of a mouse is not a nice feeling. This is why most new traders find it hard to pull the trigger in the first place.
So how do you combat the initial feeling of fear when trading? Start very small, so you're not going to be overly concerned about losing it.
I think everyone heard the disclaimer “Only risk money that you can afford to lose”. But be careful and don't confuse this with apathy (when you don't care to throw away your money) because you'll end up blowing small accounts.
Therefore my advice would be to drop the trade size and basically reduce the leverage. The trade should not be too big, even if it fits your strategy.
Next, we're still on the subject of fear, but in a slightly different context.
We all know money is an emotional commodity. It feels good to strike the market right and see a profit. Although, often, because of the ebbs and flows of the market, some of the trade profits will erode.
So, the common emotional mistake is to take profits too soon, before the profit targets were hit. However, is this emotion causing you to take snap profits that result in messing with your risk-reward profile? Yes, you'll end up to see only small profits on the profitable trades, but bigger losses on the losing trades.
Also, the fear of giving back is related to the practice of moving stops to break even. From my point of view, if you move stock to break even too quickly, at the end of the month you will see big losing trades and not so big profitable trades.
How can you combat all this? I would recommend doing the analysis, set the profit targets and the stop-loss levels and leave it alone.
Not watching every gyration of the market, it'll reduce your emotions. Set and forget and let the trade do its thing.
Often traders find themselves in a situation where they fear a profitable trade could turn into a losing one.
Another common emotional state that many traders fall into is the fear of giving back the profits. And what happens? Usually, when we see a bit of profit being eroded away, we snap and take that profit. Basically this is messing with our risk-reward ratio.
Of course, sometimes it might be right to lock in the profit just before it ends up with a losing trade. But in the long run, doing this is going to mess with your risk-reward profile. You will be in risk to have small profits on your winning trades and the bigger losses on the losing trades. This eventually will lead to an erosion of the account.
So the best thing to do to avoid the fear factor is to set the trade, the profit target and the stop-loss level and walk away.
The greed mentality is very dangerous, especially for rookie traders. Most of them want to see big profits right away so they can go out and buy the nice things that they crave for. This will actually cause excessive use of leverage.
How do we avoid this emotion of greed? Simple, get back to earth and set realistic expectations.
Can you make a trading career with a small account? Yes of course you can, but it's going to take time. If you're greedy and you want a $1,000 or $2,000 trading account, chances are you will blow it. So realistic expectations of 2% to 5% in a month is a solid target.
Many traders fail because they stay in trades too long in the hope that they will strike it rich. 10 to 1 risk-reward ratio do great when it comes in, but far too often, it doesn't.
You have to be emotionally stable to accept the losses. And remember the emotions are those that kill traders. Of course, we are all unique, but I haven't met many traders in my 30 years career who can stomach 10 or 20 losses before the winner comes in.
A solid strategy that has a 50% win-loss ratio can be very profitable if you take more than a 1 to 1 risk-reward ratio. You can start with a 1.5:1, 2:1 or 3:1 risk-reward ratio.
So be realistic and take what the market is going to give you.
Haste is one of the biggest emotional traps that rookie traders fall into.
Many traders take the trade before the rules of their strategy have even applied. Because the trader that acts in haste enters the trade just for the feeling of excitement.
If you find yourself in that category, you have to stop, otherwise, you will end up losing. How to do that? I would recommend having a checklist with all the rules of your strategy. Also, make sure your list is ticked off before you enter the trade.
The final emotion traders need to master is learning to switch off.
Trading is all about getting the correct work-life balance. You need to get away from the trading screens because 12 hours a day is not good for your health.
Personally, I like to enjoy some time with my family on the beach. This way I stop paying attention to news and price charts.
I hope you have found this valuable and if you would like to learn more, join me in the Trading Room. I hope to see you there!