Whether you win or lose in trading, at least 80% of the final results you get are the result of your psychology. trading is a huge undertaking and the reason most people fail is because of poor trading psychology. They simply approach the markets or have beliefs about what is possible in the markets that are completely false.
The real reason that traders have poor psychology is mainly that they lack complete conviction in their trading methods. Conviction is directly related to how confident you are while in a position. Knowing the reasons why you are in a trade is vital to staying calm if the market moves against you.
One of the main aims of trading is for the trader to gain complete conviction in his trading so that he will never suffer from any psychological ailment with his trading. In trading it is never the psychology that is the problem, it is the conviction. Conviction, or lack of conviction, is the root of all good or bad trading psychology.
Trader Psychology Problems
Switching
Switching is where you have a strategy, trade it and it doesn’t really work so you decide to switch it and go find a new strategy. This process repeats until your library is full of trading courses and systems.
Each and every strategy that you were sold tells you that this is the last strategy you will need and it has everything you need to become successful in the market. You quickly realize that the system is not that simple and move your search to the next latest and greatest product that will surely make you rich.
This cycle locks you into a constant stream of losing strategy after losing strategy so it will be impossible to ever make consistent profits in the markets. Even worse is that some of these systems might be decent but you never give them a chance to prove themselves. The effectiveness of any trading strategy should be measured over hundreds of trades, not a handful.
Over leveraging
Overleveraging is risking too much of your account equity before you become consistently profitable. The root cause of overleveraging is either lack of conviction, misguided overconfidence, or just not knowing what you’re doing.
A lack of conviction usually stems from not having enough faith in your trade plan or your trading edge. This could be for many reasons but the most common is a lack of experience executing trades in accordance with your trade plan. This may cause you to take trades that are not in line with your edge.
Not having an edge typically leads to losses and losses make a trader who has poor psychology tend to load up on trade size to try and make back all the losses on one trade. This type of Trading psychology behaviour might work once or twice if you are lucky but over the long run you will blow out your account.
Misguided overconfidence can happen to traders who don’t have a lot of experience having consistent winning streaks. If a novice trader has a nice winning streak his confidence seems to go up and he becomes overconfident. Overconfidence comes from the recency bias of having some nice wins in a row and the other major problem of overleveraging.
The trader gets overconfident and starts taking on larger trade sizes believing that he is invincible. As with all things in life, “A fool and his money are soon departed.” Remember before when we talked about the market's sole purpose is to remove you from your money? Well, when you overleverage you make it all that much easier for the market to take your money.
The trader may have a couple more wins as the trade size gets bigger and bigger but what almost always happens is that one trade will get away from the trader and he ultimately gives back all his prior profits and then probably most of his account balance. This is obviously a tough way to make a living which is why professional traders go for single base hits rather than swinging for grand slams on every trade.
A trader that just "doesn’t know what they don’t know" is one that should step off onto the sidelines until they have a better understanding of how to trade in a professional manner.
Sometimes traders will overleverage, not because they want to, but because they simply don’t know how to use their trading platform. Most brokers offer demo platforms where you can risk fake money in the markets. This is a great place for novice traders to learn how to use the trading tools the platform provides before they go out and risk real money in the market.
Recency Bias
As human beings, we are psychologically affected by our most recent events. In trading terms, an example would be that you could have had 30 winning trades in a row and then experience a losing streak of 3 trades. There could be nothing wrong with this system but the last 3 losing trades will have more of an effect on your psychology than the previous 30 winners. You would be focusing on the most recent trades in your mind. The 30 winning trades should clearly outweigh the 3 losing trades but the human brain will focus on the most recent events.
Recency bias can work the other way as well. Maybe you have had an incredible winning streak and your confidence is running high so you decide to double up the size of your next trade. The thinking is that you might as well make some more money while you are on a hot streak.
This overconfidence has led you into the overleveraging trap and at some point, you are going to have a losing trade. If the trade size is much larger than usual, the loss will also be greater than usual and can have devastating consequences both financially and psychologically on the trader.
Traders need to be careful to not allow the recency bias to cloud their good trading judgement. You can’t let the last trade affect the next trade whether it was a winning or losing trade. This recency bias could lead the trader down a path of switching systems even though the system they are using is perfectly suitable.
Solutions for Trading Psychology Problems
Following on from Trader Psychology Problems, we will now take a look at some solutions including:
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