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Importance of Forex Trading Psychology
I’ve often been asked whether trading psychology is really important for a forex newbie or if it’s just overrated. In this old man’s humble opinion, sound trading psychology is what sets consistently profitable traders apart from the rest.
I believe that a person’s ability to handle and overcome stressful situations, like experiencing a drawdown, having a losing position, and managing one’s greed, plays a central role in determining a trader’s success.
If you are not psychologically prepared to handle the stress that comes with trading, chances are that no matter how good your strategy is, you will not be able to execute it properly and will most likely see your account deep in the red.
Just take a look at the Turtle Traders’ experiment run by Richard Dennis and Bill Eckhardt. A group of traders was taught the exact same system, with the same exact risk management guidelines and principles. Some were very successful, while others floundered.
The difference? Trading psychology.
Some of the “turtles” were unable to handle the system’s drawdowns, or closed their trades early and were unable to maximize the best trade setups.
This is very similar to handing over the keys to an F1 car to a student driver and expecting him to carve the racing track like he’s Michael Schumacher.
Even with a supercharged car, the student driver would probably lose a race to Huck’s broken-down Honda Fit as he lacks the mental fortitude to handle high speeds and sharp turns.
At the same time, we can’t overlook the importance of trading strategy. You may be the most disciplined and emotionless trader out there, able to stick to the plan and leave emotions at the door, but you’ll probably still end up in the red if the strategy that you’re following to a T is poor and not profitable in the long run.
The key is to find the proper balance between trading psychology and strategy.
Trading psychology may not be able to turn a losing system into a profitable one, but it can equip you with the right tools to develop a profitable system.
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Having the right frame of mind can provide you with valuable insights to tweak your trading approach and get better results. In effect, having the right trading psychology can lead to a better trading strategy.
Likewise, a lot can also be said about the positive effects a successful strategy can have on trading psychology. You may find that sticking to the plan and weathering drawdowns are much easier when you’re trading a tested and proven system.
To become a successful trader, you will need both the right mindset (trading psychology) and the right tools (trading strategy). Without either one, you’re bound to fail.
A Guide to Trading Psychology
Trading Psychology: Beyond the Basics
The psychology of trading is often overlooked but forms a crucial part of a professional trader’s skillset. DailyFX is the perfect place to learn how to manage your emotions and hone your trading psychology; our analysts have already experienced the ups and downs, so you don’t have to.
Keep reading to discover their top tips, and to learn more about:
- What is trading psychology
- How to get in the mindset of a successful trader
- The basics of trading psychology
- Trading psychology tools and techniques
Learn more about the realities of trading in our ‘ Day in the Life of a Trader ’ videos.
Unsure of what trading style to employ? Discover your niche with our DNA FX Quiz !
What is Trading Psychology?
Trading psychology is a broad term that includes all the emotions and feelings that a typical trader will encounter when trading. Some of these emotions are helpful and should be embraced while others like fear, greed , nervousness and anxiety should be contained. The psychology of trading is complex and takes time to fully master.
In reality, many traders experience the negative effects of trading psychology more than the positive aspects. Instances of this can appear in the form of closing losing trades prematurely, as the fear of loss gets too much, or simply doubling down on losing positions when the fear of realizing a loss turns to greed.
One of the most treacherous emotions prevalent in financial markets is the fear of missing out, or FOMO as it is known. Parabolic rises entice traders to buy after the move has peaked, leading to huge emotional stress when the market reverses and moves in the opposite direction.
Traders that manage to benefit from the positive aspects of psychology, while managing the bad aspects, are better placed to handle the volatility of the financial markets and become a better trader.
The Basics of Trading Psychology
Fear, greed, excitement, overconfidence and nervousness are all typical emotions experienced by traders at some point or another. Managing the emotions of trading can prove to be the difference between growing the account equity or going bust.
Traders need to identify and suppress FOMO as soon as it arises. While this isn’t easy, traders should remember there will always be another trade and should only trade with capital they can afford to lose.
Avoiding trading mistakes
While all traders make mistakes regardless of experience, understanding the logic behind these mistakes may limit the snowball effect of trading impediments. Some of the common trading mistakes include: trading on numerous markets, inconsistent trading sizes and overleveraging.
Greed is one of the most common emotions among traders and therefore, deserves special attention. When greed overpowers logic, traders tend to double down on losing trades or use excessive leverage in order recover previous losses. While it is easier said than done, it is crucial for traders to understand how to control greed when trading .
Importance of consistent trading
New trades often tend to look for opportunities wherever they may appear and get lured into trading many different markets, with little or no regard for the inherent differences in these markets. Without a well thought out strategy that focuses on a handful of markets, traders can expect to see inconsistent results. Learn how to trade consistently .
“Trade according to your strategy, not your feelings” – Peter Hanks , Junior Analyst
Debunking Trading Myths
As individuals we are often influenced by what we hear and trading is no different. There are many rumours around trading such as: traders must have a large account to be successful, or that to be profitable, traders need to win most trades. These trading myths can often become a mental barrier, preventing individuals from trading.
Get clarity on forex trading truths and lies from our analysts.
Implementing risk management
The significance of effective r isk management cannot be overstated. The psychological benefits of risk management are endless. Being able to define the target and stop loss , up front, allows traders to breathe a sigh of relief because they understand how much they are willing to risk in the pursuit of reaching the target. Another aspect of risk management involves position sizing and its psychological benefits:
“ One of the easiest ways to decrease the emotional effect of your trades is to lower your trade size ” – James Stanley , DFX Currency Strategist
How to Get in the Mindset of a Successful Trader
While there are many nuances that contribute to the success of professional traders, there are a few common approaches that traders of all levels can consistently implement within their particular trading strategy .
1) Bring a positive attitude to the markets every day . This may seem obvious, but in reality, keeping a positive attitude when speculating in the forex market is difficult, especially after a run of successive losses. A positive attitude will keep your mind clear of negative thoughts that tend to get in the way of placing new trades.
2) Put aside your ego. Accept that you are going to get trades wrong and that you may even lose more trades than you win. This may seem like all bad news but with discipline and prudent risk management , it is still possible to grow account equity by ensuring average winners outweigh the average losses.
3) Do not trade for the sake of trading. You can only take what the market gives you. Some days you may place fifteen trades and in other instances you may not place a single trade for two weeks. It all depends what is happening in the market and whether trade set ups – that align with your strategy – appear in the market.
“Trade decisions are not binary, long vs short. Sometimes doing nothing is the best trade you can make” – Ilya Spivak , Senior Currency Strategist
4) Do not get despondent. This may seem similar to the first point but actually deals with thoughts of quitting. Many people see trading as a get rich quick scheme when in fact, it is more of a journey of trade after trade. This expectation of instant gratification often leads to frustration and impatience. Remember to stay disciplined and stay the course and view trading as a journey.
Trading Psychology Tools and Techniques
At DailyFX we have a whole library of content dedicated to the psychology in trading. Take some time to work through the following topics:
- Listen to our podcast on how to create a trading plan
- Learn how to create and maintain a trading journal
- Avoid the #1 mistake traders make by adopting the traits of successful traders
- Setting a stop loss instead of a mental stop loss is a great way to avoid runaway losses.
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
The 5 Founding Fathers and A History of Positive Psychology
After the Second World War, the focus of psychology was on treating abnormal behaviors and the resulting mental illnesses.
Dissatisfied with this approach, humanist psychologists, such as Abraham Maslow, Carl Rogers, and Eric Fromm helped renew interest in the more positive aspects of human nature.
This article contains:
Inspiration in a Bed of Roses
The story of Seligman’s epiphany in his rose garden—which started the movement of positive psychology—has become somewhat a folk legend. This is how the story goes:
Seligman’s daughter, who was 5 at the time, had been trying to get her father’s attention when he turned around and snapped at her. Unhappy with this response, his daughter asked him whether or not he remembered how she used to whine when she was 3 and 4?
She told him that when she turned 5 she decided to stop – and if she was able to stop whining, then he was able to stop being a grouch!
This revelation of developing what was right, rather than fixating on what was wrong, sparked what Seligman would go on to promote during his career as APA president—that we should teach our children and ourselves to look at our strengths rather than our weaknesses (Seligman M & Csikszentmihalyi M, 2000).
Positive psychology can be viewed as the “fourth wave” in the evolution of psychology, the first 3 waves being, respectively, the disease model, behaviorism, and humanistic psychology.
This approach contrasts with how, in its early years (the second half the 19 th century and the first half of the 20 th ), the practice of psychology focused mainly on cure and treatment of psychic ailments, which is a decidedly negative focus.
Some of the greatest names in the early field of psychology were foundational, such as Freud, Adler, and Jung. But over time, psychology began to acquire a negative outlook and stereotype, with its focus on the darkest chambers of the human mind and the near total exclusion of its sunlit highlands.
Positive psychology, as the name suggests, is psychology with a positive orientation. What is the science behind what makes humans well?
It does not imply that the rest of psychology is unhelpful or all negative and, in fact, the term “psychology as usual” has been coined to denote the rest of psychology.
The Four Waves of Psychology
To understand the roots of positive psychology, we have to revisit the three waves of psychology that came before that. After all, it was not until recently that the field of psychology began expanding its research criteria to study what makes people thrive, instead of what makes people sick.
The following three sections offer a brief summary of Western psychologies waves, or movements, before introducing the fourth-wave that brings us to positive psychology.
The 1st Wave: The Disease Model
During the second half of the 19th century and the early part of the 20th, psychology was concerned with curing mental disorders, such as schizophrenia and human complexes of various kinds (inferiority, power, Electra, Oedipus, etc.).
And why not? There has always been, and will perhaps always be, a significant incidence of mental illness in all communities, irrespective of race or religion, caste or creed.
The attempt of psychologists to cure these ailments was quite natural and laudable, and the work of early psychologists, such as Sigmund Freud, Adler, and Carl Jung was indeed very effective. (Note: It must be added here that of these pioneers, the big 3 of Vienna as they were called, Carl Jung was perhaps the earliest psychologist to recognize, and be troubled by, psychology’s negative focus).
Over time, this disease focus pushed psychology towards the dark recesses of the human mind and away from the deeper well-springs of human energy and potential. As highlighted by Martin Seligman, in his 2008 TED talk on Positive Psychology, the negative focus of psychology resulted in three major drawbacks for the field:
- Psychologists became victimologists and pathologizers (they forgot that people make choices and have responsibility);
- They forgot about improving normal lives and high talent (the mission to make relatively untroubled people happier, more fulfilled, more productive), and;
- In their rush to repair the damage, it never occurred to them to develop interventions to make people happier.
The 2nd Wave: Behaviorism
B. F. Skinner of Harvard University was the originator, along with John B. Watson and Ivan Pavlov, of the behavioral approach in psychology. Skinner believed that free will was an illusion, and human behavior was largely dependent on the consequences of our previous actions.
If a particular behavior attracted the right type of reinforcement it had a high probability of being repeated, and if, on the other hand, the behavior resulted in punishment it had a good chance of not being repeated (Schacter, Daniel L., and Gilbert Daniel, 2020).
Skinner believed that given the right structure of rewards and punishments, human behavior could be totally modified in an almost mechanical sense.
This theory undoubtedly has a lot of merits, particularly the idea of operant conditioning —the influencing and eliciting desired behavior, through a well-conceived reward system .
However, the manipulation of behavior that such a properly structured reward system allows is open to gross abuse by autocrats and dictators in terms of oppressing their subjects. And not just in society at large, but in the workplace as well. J E R Staddon and Noam Choksy were among Skinner’s major critics (Staddon, J., 1995; Chomsky, Noam 1959).
Furthermore, Skinner’s total rejection of free will is still disturbing. It goes against all that human history stands for — the ultimate, and the enduring triumph of the human spirit against overwhelming odds.
Criticisms of his theory notwithstanding, Skinner stands tall as a brilliant psychologist and prolific writer. With 21 books and 180 articles to his credit, he was voted the most influential psychologist of the 20th century in a 2002 survey (Haggbloom, Steven J. et. al, 2002).
The 3rd Wave: Humanistic Psychology
This wave is known for its two major strands of thought – existentialist psychology (Soren Kierkegaard, Jean-Paul Sartre) and humanistic psychology (Abraham Maslow and Carl Rogers).
According to Sartre, every human being is responsible for working out his identity and his life’s meaning through the interaction between himself and his surroundings. No one else can do it for him, least of all a non-existent God. For this reason, meaning is something truly unique to each person – separate and independent (Jean-Paul Sartre, 1946).
One cannot quarrel with this strand of thought, particularly the responsibility of the individual for his own destiny, but the underlying atheism is dampening.
What about people who cannot find their identity and their life’s meaning on their own?
Uncontrollable anxiety would be inevitable, particularly in the absence of faith in a supernatural being, an idea rejected by existentialism . This anxiety is recognized in psychotherapy as “existential anxiety” and has been of major therapeutic concern of many leading psychologists, particularly Victor Frankl, the originator of logo-therapy.
There is a considerable divergence of views on the question of “What is life’s meaning?” and, clearly, each individual needs to work it out for themselves, with their own unique experience and surroundings.
Here is a very thoughtful quote from Kierkegaard, arguably the earliest exponent of existentialism:
“What I really need is to get clear about what I must do, not what I must know, except insofar as knowledge must precede every act. What matters is to find a purpose, to see what it really is that God wills that I shall do; the crucial thing is to find a truth which is truth for me, to find the idea for which I am willing to live and die. (…) I certainly do not deny that I still accept an imperative of knowledge and that through it men may be influenced, but then it must come alive in me, and this is what I now recognize as the most important of all” (Kierkegaard, Soren, 1962).
The humanistic movement was about adding a holistic dimension to psychology. Humanistic psychologists believed that our behavior is determined by our perception of the world around us and its meanings, that we are not simply the product of our environment or biochemistry, and that we are internally influenced and motivated to fulfill our human potential .
Humanistic psychology emphasizes the inherent human drive towards self-actualization, the process of realizing and expressing one’s own capabilities and creativity. This approach rose to prominence in the mid-20th century in response to the limitations of the disease model in fulfilling the human desire for actualization and a life of meaning (Benjafield, John G., 2020).
The 5 basic principles or postulates of humanistic psychology are:
- Human beings, as human, supersede the sum of their parts. They cannot be reduced to components;
- Human beings have their existence in a uniquely human context, as well as in a cosmic ecology;
- Human beings are aware and are aware of being aware – i.e. they are conscious. Human consciousness always includes an awareness of oneself in the context of other people;
- Human beings have the ability to make choices and therefore have responsibility;
- Human beings are intentional — they aim at goals, are aware that they cause future events, and seek meaning, value, and creativity .
It is hard to miss the significant foundation that the humanistic approach has provided for positive psychology.
The 4th Wave: Positive Psychology
As already pointed out earlier in this article, positive psychology is psychology with a positive orientation, concerned with authentic happiness and a good life.
Humanistic psychologist Abraham Maslow maintained that psychology itself does not have an accurate understanding of the human potential and that the field tends not to raise the proverbial bar high enough with respect to maximum attainment.
“The science of psychology has been far more successful on the negative than on the positive side; it has revealed to us much about man’s shortcomings, his illnesses, his sins, but little about his potentialities, his virtues, his achievable aspirations, or his full psychological height. It is as if psychology had voluntarily restricted itself to only half its rightful jurisdiction, and that the darker, meaner half” (Maslow, 1954, p. 354).
While the previous waves of psychology focused on human flaws, overcoming deficiencies, avoiding pain, and escape from unhappiness, positive psychology focuses on well-being, contentment, excitement, cheerfulness, the pursuit of happiness , and meaning in life.
The humanistic movement wanted to look at what drives us to want to grow and achieve fulfillment. However, even though their conceptual ideas of human nature did influence the development of positive psychology, they are separate. While the humanistic approach used more qualitative methods, positive psychology is developing a more scientific epistemology of understanding human beings.
Psychology may be converging— finally—with the quintessence of the world’s great religions. It may finally be discovering that the key to human evolution lies in a fine blend of the mind and the spirit. It may, at last, be recognizing and accepting the dark chambers of the human mind as well as its sunlit highlands.
Who are the passionate visionaries behind this fourth wave of psychology? Let’s find out…
The 5 Founding Fathers: Developing Positive Psychology
In 1998, Martin Seligman was elected President of the American Psychological Association and it was then that Positive Psychology became the theme of his term as president. He is widely seen as the father of contemporary positive psychology (About Education, 2020).
However, while most people see Seligman as the face of Positive Psychology, he didn’t start the field alone and was not the first ‘positive psychologist.’
There have been many influencers which have contributed to this new era of psychology.
1) William James
James was a philoso pher, physician, and psychologist, and he was the first educator to offer a psychology course in the United States. He argued that in order to thoroughly study a person’s optimal functioning, one has to take in how they personally experience something, otherwise known as their subjective experience.
He also saw the importance of combining both positivistic and phonological methodology, which is what many now refer to as ‘radical empiricism’ because he was interested in what was objective and observable.
Despite this, many consider James to be America’s “first positive psychologist” (Froh, 2004) because of his deep interest in the subjectivity of a person and because he believed that “objectivity is based on intense subjectivity” (2004).
2) Abraham Maslow
While the entire 3rd Wave of Humanistic Psychology played a vital role in providing Positive Psychology with foundational concepts, there was no greater influence from the approach then Abraham Maslow.
In fact, the term “positive psychology” was first coined by Maslow, in his 1954 book “ Motivation and Personality. ” Maslow did not like how psychology concerned itself mostly with disorder and dysfunction, arguing that it did not have an accurate understanding of human potential.
He emphasized how psychology successfully shows our negative side by revealing much about our illnesses and shortcomings, but not enough of our virtues or aspirations (Maslow, 1954, p. 354).
3) Martin Seligman
Seligman is an American Psychologist, educator, and author of self-help books. He is famous for his experiments and theory of learned helplessness, as well as for being the founder of Positive Psychology.
His work in learned helplessness and pessimistic attitudes garnered an interest in optimism, which led to his work with Christopher Peterson (mentioned below) to create a positive side to the Diagnostic and Statistical Manual of Mental Disorders (DSM).
In their research, they looked at different cultures over time to create a list of virtues that are highly valued and included it in their Character Strengths and Virtues section in the DSM: wisdom/knowledge, courage, transcendence, justice, humanity, and temperance.
In 1996, he was elected President of the American Psychological Association and the central theme he chose for his term as president was positive psychology. He wanted mental health to be more than just the “absence of illness” and ushered a new era that focused on what makes people feel happy and fulfilled.
Today he is the director of the Positive Psychology Center at the University of Pennsylvania.
4) Mihaly Czikszentmihalyi
Czikszentmihalyi was born in Hungary in 1934, and like many other people of that time, he was deeply affected by the Second World War. He was stripped from his family and friends as a child and was put in an Italian prison and it was there he had his first idea of working with flow and optimal experience.
He had an affinity for painting, noting that the act of creating was sometimes more important than the finished work itself. This led to his fascination with what he called the flow state , and he made it his life’s work to scientifically identify the different methods through which one could achieve such a state.
Czikszentmihalyi’s studies gained much popular interested. Today he is considered one of the founders of positive psychology.
5) Christopher Peterson
Christopher Peterson was the professor of Psychology at the University of Michigan and the former chair of the Clinical Psychology department.
He was the co-author of Character Strengths and Virtues with Seligman and is noted for his work in the study of optimism, hope, character, and well-being.
Influential Positive Psychology Researchers
The following positive psychology researchers deserve a special mention. However, there are so many positive psychology researchers whose work is shaping the future of positive psychology that they can’t all be mentioned in this article. Check out our full list of Positive Psychology Researchers .
Albert Bandura’s self-efficacy theory originated from his social-cognitive theory. It relates to a person’s perception of their ability to reach a goal and the belief that one is capable of performing it in a certain way in order to reach them. This concept has been of great impotence and use in positive psychology.
Seligman stated that Clifton followed a similar path that he did when he came up with Strengths-based psychology. He studied successful individuals and wanted to know what they did right to achieve top performance.
His work gave employees solid recommendations on how to find a fulfilling career that is suitable for them. He was honored in 2002 by the American Psychological Association with a Presidential Commendation as the Father of Strengths-based Psychology and he has been called the “grandfather of Positive Psychology” (Snyder, Lopez, & Pedrotti, 2020, p. 66).
Deci and Ryan
The theory of human motivation known as Self-Determination Theory was developed in 2000 by Edward L. Deci, professor in the Department of Clinical and Social Sciences at the University of Rochester, New York, and Richard M. Ryan, clinical psychologist and Professor at the Institute for Positive Psychology and Education at the Australian Catholic University in Sydney, Australia.
Their grounding work on Self-Determination Theory updated the hierarchy of needs originally identified by Abraham Maslow and found that human motivation is founded in three major needs: autonomy, competence, and relatedness (connecting to other people).
Dr. Ed Diener , aka “Dr. Happiness”, is a leading researcher in PP who coined the term “ Subjective well-being ” as the aspect of happiness that can be measured scientifically. His argument that there is a strong genetic component to happiness has led to a huge amount of data studying the internal and external conditions of happiness and how one can change it.
Diener even researched the relationship between income and well-being, as well as cultural influences on well-being.
His publications have been cited over 98,000 times and his fundamental research on the subject is what earned him his nickname. He has worked with researchers Daniel Kahneman and Martin Seligman and is a senior scientist for The Gallup Organization .
Dweck conducted research on the notion of growth vs. fixed mindset . It has been used with parents, teams, students, entrepreneurs, and business leaders. It is a positive psychology tool that is used widely and praised highly, bringing people more interest to the world of positive psychology.
World-renowned author and researcher, Fredrickson made her first contribution to positive psychology research with her theory on positive emotions , The Broaden and Build Theory, which proposes that positive emotions are able to broaden people’s minds, resulting in resources for experiencing well-being and resilience in times of adversity. Since then Fredrickson has done extensive research and produced 2 books.
Fredrickson currently acts as the Director of the Positive Emotions and Psychophysiology Laboratory, University of North Carolina at Chapel Hill.
About Education. (2020). What Is Positive Psychology? Retrieved from http://psychology.about.com/od/branchesofpsycholog1/a/positive-psychology.htm
About Education. (2020). Martin Seligman – Biography and Psychological Theories. Retrieved from http://psychology.about.com/od/profilesmz/p/martin-seligman.htm
Bandura’s Self-efficacy Theory. (2020).
Csikszentmihalyi and Happiness. (n.d.). Retrieved from http://www.pursuit-of-happiness.org/history-of-happiness/mihaly-csikszentmihalyi/
Further praise for Carol Dweck | LVS Consulting by Lisa Sansom (2020). Retrieved from http://www.lvsconsulting.com/2020/07/11/further-praise-for-carol-dweck/
Mentor Coach. (2020). BEN’S INTERVIEW WITH KENNON SHELDON, PhD. Retrieved from http://www.mentorcoach.com/sheldon/
The Pursuit of Happiness. (2020). Diener and Happiness. Retrieved from here
Chomsky, Noam (1959). “Reviews: Verbal behavior by B. F. Skinner” . Language 35 (1): 26–58. JSTOR 411334.
Haggbloom, Steven J.; Warnick, Jason E.; Jones, Vinessa K.; Yarbrough, Gary L.; Russell, et al. (2002). “The 100 most eminent psychologists of the 20th century” . Review of General Psychology 6 (2): 139–152.
Jean-Paul Sartre. “Existentialism is a Humanism, Jean-Paul Sartre 1946″ .
Benjafield, John G. (2020). A History of Psychology: Third Edition. Don Mills, ON: Oxford University Press. pp. 357–362.
Bugental, J. (1964). The third force in psychology. Journal of Humanistic Psychology, 4(1), 19-26.
Greening, T. (2006). Five basic postulates of humanistic psychology. Journal of Humanistic Psychology, 46(3), 239-239.
Froh, J. J. (2004). The History of Positive Psychology: Truth Be Told.
Hefferon, K., & Boniwell, I. (2020). Introduction to Positive Psychology. In Positive psychology: Theory, research and applications. Maidenhead, Berkshire: McGraw Hill Open University Press.
Kierkegaard, Soren. Works of Love. Harper & Row, Publishers. New York, N.Y. 1962.
Park, N., Oates, S., & Schwarzer, R. (2020). Christopher Peterson “Other People Matter”. Applied Psychology: Health and Well-Being, 5(1), 1-4. doi:10.1111
Snyder, C. R., Lopez, S. J., & Pedrotti, J. T. (2020). Positive psychology: The scientific and practical explorations of human strengths (p. 66).
Seligman M & Csikszentmihalyi, M (2000). Positive psychology: An introduction, American Psychologist, 55, 5-14. Also Chapter 1 of Positive Psychology, a publication of mheducation.co.uk
Schacter, Daniel L., and Gilbert Daniel. (2020). Psychology. (2 ed.). New York, 2020.
Staddon, J. (1995) On responsibility and punishment. The Atlantic Monthly, Feb., 88−94. Staddon, J. (1999) On responsibility in science and law. Social Philosophy and Policy, 16, 146-174. Reprinted in Responsibility. E. F. Paul, F. D. Miller, & J. Paul (eds.), 1999. Cambridge University Press, pp. 146−174.
The Trading Psychology of Your Emotions to Master Your Trades
Table of Contents
Why it’s necessary to accept and harness your emotions in order to be a successful trader
Trading Psychology – We can never be neutral in our emotions. No matter how hard we try, we will always feel something, in some mood, and in some direction. For traders who think this is a bad thing when it comes to the markets, think again. Emotions can (and to a certain degree have to) be an integral part of your trading routine.
Simply put, without emotions, you’ll end up making erratic decisions based on impulse. If and when you remove emotions from your trading, you’ll end up in a very dangerous position, left with impulsive decisions based on a whim.
The Somatic Marker Hypothesis
An important theory in regards to emotion and how we can understand it as it pertains to trading is the Somatic Marker Hypothesis. This is a theory proposed by Antonio Damasio in which he described emotions as experienced through bodily states.
Imagine the idea of following your gut. In this situation, the body is signaling an emotional reaction to a certain situation. The intuition provided by the emotional state gives us an idea of which path to follow and can help us make a sound decision. If we are empty of emotion, we lose this valuable guide. Emotions are proved to be crucial in our decision -making process.
Now apply this to trading. Imagine you have a perfectly good trading setup that has performed well in the past and shows no obvious signs of failure in the future. Your emotions towards this setup would obviously be positive and encourage you to continue operating with this fruitful setup. If there were no emotions involved in the decision to use this setup, you wouldn’t have such a positive gut feeling towards the setup. Emotions guide and encourage you to continue with this setup, rather than make a poor decision like abandoning it for something potentially perceived as more logical.
Emotional Functions When Making Trading Decisions
Doing away with the myth that emotions inherently lead to irrational decisions, researchers have shown that emotions are instead an integral part of the decision making process. Emotions are not all the same and therefore shouldn’t be treated as such. While there are certain emotions that will lead to irresponsible and ill-advised decisions, there are also plenty of emotional responses that can guide us towards the right decisions. This is not to say that emotions should be categorized as either good or bad. There is a grey area and there is room to work on both sides.
The researchers who discovered the multifaceted nature of emotions identified four primary functions of emotions. We can take these four functions and apply them to the mental aspect of our trading routine.
The first function of emotions is to provide information. That is, they help us in our understanding of situations and the possible options or alternatives to said situations. For example, when a trader finds a good setup, emotions can guide in the pursuit and implementation of the strategy. A good setup brings feelings of excitement which in turn influences trading psychology decisions.
How emotions accelerate our decision-making process
The next function of emotions is how they might accelerate our decision-making process. In the context of trading Psychology, this means that emotions can enhance a trader’s ability to make quick, necessary decisions. For example, a trader might be in a short trade when they see their trade stall. Along with this action, the trader might experience apprehension that the market is no longer moving in the direction planned. This sudden rush of emotion will help the trader make a quick decision before price can rally against them.
The third function of emotions is as a tool to focus attention. Emotions help us evaluate a situation by zeroing our attention in on the information that is most relevant to the circumstances. An example here would be if an experienced trader sees what appears to be a can’t miss trade. However, something in the trader’s gut tells them to take a step back and look at the trade over a longer period of time just to make sure everything’s in order. Emotions directed the trader to focus their attention on the larger picture and to obtain all the relevant background information.
Stick with your trades decision
The last function of emotions is to help us choose and stick with a decision. Feelings of confidence can reinforce a made decision and allow us to stick with it without fear or doubt. A confident trader is better prepared to stick with trade rather than impulsively bailing because of a slight setback.
Knowing Your Emotions and Opening Up to Them
While we can write all day about the importance of emotions in trading, it’s irrelevant unless you’ve opened up to them and embraced them. Emotions can be a force for good but if you’re not using them or acknowledging them, it won’t make a difference.
In order to familiarize yourself with and to embrace your emotions, there is a fun little exercise you can do to visualize your emotions and potential response to them. In the chart below, we’ve identified a scenario, the information associated with it, the speed at which it’s occurring, the attention devoted to it, and the commitment that comes along with it.
Map out a table for yourself and go through various situations and the emotions associated with them at every stage. Contemplate how you would react, how they would make you feel, etc. This can be a very helpful emotional preparation before you’re thrust into a position with no previous preparation.
Concluding Thoughts on Trading Psychology
While moderate, controlled emotions can lead us to make sound and wise trading decisions, strong, uncontrolled emotions will not. The idea in embracing and controlling emotions is to harness these out of control feelings so they don’t lead us down a path of ill-informed, irrational decision making. We cannot let our decision making be hijacked by extreme emotional tugs. Rather, we need to be aided by composed, controlled, understood emotions.
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