Trading Psychology

Often overlooked, trading psychology is an important facet of a trader’s skillset, and it can determine one’s overall success or failure in the markets. No matter your prowess in technical or fundamental analyses, your trading psychology will impact your trading decisions in the market. Psychology is the study of mind and behaviour, or simply, personality. As such, trading psychology refers to a trader’s mindset during any trading activity. Humans are emotional beings who are prone to biases, and this can be manifested in their trading activity. It is often said that a trader’s worst enemy is himself, his own emotions and his bias when trading. The purpose of understanding trading psychology is not to eliminate emotions or biases (they come naturally) but to ensure that they do not hinder objective decision making when trading or developing trading strategies.

Different traders have different personalities, which means that they are influenced by trading psychology differently. Understanding trading psychology, therefore, means that one understands one’s own personality, and particularly the negative psychological traits that can limit one’s success in the markets. It also means building the positive psychological traits that will enhance better decision making in the forex and CFD markets. Financial markets are by nature fast-paced and dynamic, offering infinite possibilities but also an imminent danger of loss. Real money can trickle in as profits as much as it can evaporate as losses. Any decision made at any given time can have a huge impact on your capital balance.

The goal of trading psychology is to condition your trader mindset. By learning about trading psychology, traders hope to gain a mental edge when trading the markets. It is a way of building awareness of oneself and committing to a positive thought process and trading behaviour that will give you a realistic chance of long-term trading success. It is a way of building and applying discipline in real-time when trading. When trading psychology is mastered, a trading plan is followed to the letter, level-headed decisions are made at all times, and emotions do not get in the way of objective trading activity.

Trading Emotions

Emotions in trading can often lead to misjudgements and loss. Here are some of the most common emotions that impact trading activity:

  • Fear
    Understanding the fear element when trading is possibly the very first emotion that you go through when you see trading graphs, tickers and information coming at you that you can’t comprehend, and it is a scary concept.  You may want to run for the hills, to not even invest just to be safe, however you will stand to lose out on potential gains.  Fear can be a limiting factor for not opening potentially profitable positions without properly calculating the risks. Understanding what fear is, would be the first step to overcome the emotion and the drawback you may experience when entering something you know little about. Trading is not a threat, there is little to be fearful of when trading, it simply takes time and knowledge to understand what you are doing, why you are doing it and how it can eventually benefit you. Fear is best expressed in the market by a phenomenon known as FOMO, a term that originated from stock market psychology to describe the ‘Fear of Missing Out’ on a big opportunity in the markets. It is emotions, primarily fear and greed, that trigger FOMO in the markets. It is the feeling that other traders are making lots of money and it creates an urgent desire to make big profits as well. This desire can lead to committing trading mistakes, such as risking too much capital or even entering unnecessary trades. FOMO traders fear that they are missing a great opportunity by not placing a certain trade, while simultaneously succumbing to the greed of making profits urgently. FOMO can be triggered by various factors, such as volatile markets, prolonged winning/losing streaks, news and rumours, as well as social media. FOMO can manifest individually or even collectively in the markets. A recent case is in January 2021 when a discussion in a popular social media forum, Reddit, triggered massive demand for GameStop stock. The stock posted abnormal gains within a couple of days before tumbling again to below its initial price levels. During the frenzy period, retail investors flocked to join the ‘party’ but many would have counted losses afterwards simply because the trade was made euphorically. To avoid succumbing to FOMO tendencies, a trader should develop and rigorously stick to a solid trading plan that has defined entry and exit rules as well as a reasonable risk management plan.

  • Anxiety
    Anxiety is also a dangerous emotion in forex trading. It is the feeling of restlessness, tension or persistent worry. When a trader becomes overly anxious, it is a clear sign that something wrong was done or he deviated from his trading plan. Efficient trading activity requires constant vigilance and heightened awareness. In a state of anxiety, a trader lacks this and is, therefore, prone to poor trading decisions that can result in devastating losses.

  • Overconfidence
    Overconfidence is a state of being more confident in your trading decisions and expectations than is logically reasonable. Overconfidence can make traders overrate their abilities and even much worse, underrate prevailing market risks, such as volatility. Overconfidence in the markets can be triggered after a series of positive trades or prolonged luck. This can lead to affected traders having a misplaced illusion of control that can lead to risky behaviour in the markets, such as overtrading, aggressive market timing, trading big lots, using inflexible strategies, and overlooking volatility risk. Overcoming overconfidence requires one to be honest with oneself about one’s trading abilities as well as to perform careful analysis and follow a strict risk management plan.

  • Frustration
    In the uncertain financial markets where there is an ever-present danger of losing real money, it is very easy for any trader to become frustrated. Frustration emanates from the anger that one cannot have one’s way in the markets. The goal of every trader is to make money consistently out of the markets, but not many get to achieve this. Frustration can come about when a trader experiences perennial loss or a period of huge drawdowns. Frustration is like a bug as it will only grow in menace. It increases self-doubt, which can consequently lead to abandoning a trading plan or even a previous working strategy. Like a bug, it is best to prevent trading frustration than to fight it afterwards. This means that a trader must become aware of (and even embrace) market risks and always commit to sticking to a trading plan. Traders should also set realistic expectations, and view trading as a long-term marathon rather than a get-rich-quick sprint. But when frustration cannot be avoided, traders should use that period to reflect on their trading activity and avoid past mistakes as well as an opportunity to build on their trading skills and techniques.  

Trading mindset

As discussed above, the worst enemy of any trader is his/hers own mindset. It is therefore important to control it in such a manner that it will not work against you. The first step to doing this is to have a trading plan and stick to it with strict discipline. A trading plan will detail your trading strategy (entry and exit rules) as well as your risk management plan. Despite the uncertainty of the markets, you will less likely be troubled by an unstable mindset if you followed all your trading rules. A trading plan ensures that you have a clear framework when performing your trading activity. By following your rules, you will stick to your defined strategy before entering any trading position in the market. No trade will be entered without due diligence or thorough research to confirm or validate any trade setup.

In terms of risk management, following your trading plan will mean having stable trade sizes, a defined strategy for placing optimal stop losses and profit targets, as well as flexible rules for managing drawdown periods. A risk management plan will also govern how and when you will withdraw your profits to continually maintain objectivity in the markets. Overall, a risk management plan aims to put you in the best condition to reap rewards from the markets without overlooking the danger of the risks involved. But even as you seek to reap from the markets, it is always advisable to only trade with money you are ready and able to lose. Also, take the time to understand your psychological profile, dominating emotions, reactions and boundaries, and ensure you exercise discipline every time you enter a trade. Risk tolerance is an important factor when trading, and it largely defines your decision-making process as you trade. Risk tolerance is, in essence, the degree of exposure per investment you are willing to take.

Managing your emotions

Managing your emotions while trading is a mature and vital approach. Trading is by nature a stressful endeavour that can trigger multiple shifting emotions, which can result in a trader giving back to the markets. Emotions cannot be avoided, but when trading, they must be managed accordingly. The best way to manage emotions is to know and learn about them. This means keeping an emotional blog, which is basically a journal of the emotions you feel during your trading activity. Pay attention to every little emotion that you feel and write it down together with the circumstances that triggered it. If you were scared to take a trade, or you are happy to book a profit, or if you felt very low after losing a previously profitable trade: write it all down, document everything. It is also important to document the outcome of every trade, and how it correlates to the emotions that were experienced before, during and after the trade was performed.

This applies to both demo and live trading accounts. An emotional blog is an important learning tool that provides a great platform for picking up cues on the positive and negative emotions that impact your trading activities. It will help you to understand your personality and ultimately, to master trading psychology.  Effective risk management when trading is also vital and the psychological benefits of risk management are endless. When you define the stop loss and target prices up front, you have a clear understanding of how much you are willing to risk in the pursuit of reaching your trading target. As such, it is vital to follow your trading plan in terms of your predefined profit/loss levels.

Other aspects of risk management involve trade position sizing and stability, conducting thorough analyses to confirm a trade setup and sticking to one’s chosen trading strategy when you enter the market. AvaTrade offers every trader, novice or expert, the opportunity to practice on our free demo account, and get in touch with our customer service team to keep your emotions at bay. The demo account will allow you to practice trading and enter the markets without any risk to your personal capital, while you are tutored by one of our customer support members. Having said that, it is only fair to mention that having a real money account will stimulate a different emotional reaction, but the foundation is always the same. ‘If you fail to plan then you plan to fail’, rings true when trading. Planning each trade will ensure your success as a trader. Second, having a trading plan in place ensures that you will not divert from the discipline that needs to be executed, even under the most anguishing market changes.

Try any of our technically advanced trading platforms, experience our outstanding multi-lingual customer support in your language to prepare yourself with an understanding of the markets. Graduating to a real account with the peace of mind that you have selected the right broker, with a positive attitude will allow you to be emotionally equipped for the markets.

Online Trading Psychology main FAQs

  • How can I develop the proper trading psychology?

    First of all understand that developing your trading psychology will take effort. It is actually hard work to understand how your brain processes the information received during a trading session, and how your emotions are engaged during the trading process. It is even more difficult to actually influence and change your emotions and psychology to set yourself up for success while trading. A few things you can do are to improve your knowledge and trading skills so you are less likely to doubt yourself, imagine both winning and losing trades to prepare your brain for both outcomes, see what successful traders do when trading, practice relentlessly, and track your progress over time.

  • Is trading stressful?

    You might not think about the stresses involved in trading, but it is well known that trading is a stressful occupation. In fact, Business Insider says trading is the second most stressful job on Wall Street, right after investment banking. If you don’t know how to handle these stresses properly you might find your trading performance slipping, your profits evaporating, and your health eroding. That makes it critically important to learn how you respond to stress and how to make your response more positive.

  • How can I improve my trading psychology?

    It was Freud who discovered that we repeat the same patterns and coping mechanisms over and over in our lives, even when this isn’t a successful strategy, or after it’s outlived its usefulness. And we repeat both patterns of conflict and stress, as well as patterns of success. So, the quite simple answer to improving trading psychology is to find the patterns of success in our trading and work on reinforcing these until they become our automatic responses. This is of course much easier said than done. One way to improve is to avoid the coping mechanisms that come up during times of anxiety, frustration, uncertainty, and fear and replace them with the skills that emerge when we are most focused and “in the zone” when trading.


We recommend you to visit our trading for beginners section for more articles on how to trade Forex and CFDs.

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