In trading, what happens inside your mind is just as important as what happens in the market. Ask any successful trader how they got where they are and it’s likely they’ll mention the importance of trading psychology. They are able to control their emotions, overcome their biases, and cope with loss among other things. This mastery of their psychology allows them to make rational decisions that net them large profits. So to reach your trading goals, you need to be able to do the same. However, there are many psychological pitfalls you need to avoid. This post will show your five pitfalls of trading psychology and how to overcome each of them. Let’s dive in.
Pitfall #1: Lack of Discipline
This is the first trait that separates amateur traders from serious traders. Discipline means sticking to your trading plan. Without discipline, you are essentially allowing the market and your emotions to dictate what you should do..
Granted, it can be tempting to go against your plan when you see what seems to be an opportunity or a risk. But if you get into the habit of ignoring your plans and trading on a whim, you will only end up losing money and confidence.
How to overcome this pitfall:
This is common advice, but it’s important to stress it: have a clear trading plan in place and stick to it. Your strategies will not always work, and that’s okay. You should reevaluate them regularly and adjust them according to the market conditions. It’s only right to completely let go of your plan when it’s obvious it’s going to fail.
Also, you need to have your own rules and always respect them. This could be sticking to your target profits, trending with the market, or being patient — which is the next pitfall.
Pitfall #2: Lack of Patience
Patience is crucial to a profitable trading performance. It means knowing what you need to do and waiting for the right time to do it. Unfortunately, this is where many traders falter. Some exit a trade too early, fearful of losing the profit they made, while others enter too early.
Furthermore, a lack of patience can lead you to develop bad habits like revenge trading, premature exits, and news trading (which can be done right, but takes an exceptional level of trading skills).
How to overcome this pitfall:
Start by having a clear trading setup in place with a checklist of criteria for when to enter. Now, when you find a stock that seems like a good fit for it, keep an eye on it until the trading setup takes form and you see the trade trigger. You may get the impression that you are doing nothing, but that too is part of your strategy.
Pitfall #3: Emotional trading
A common saying in trading is “check your emotions at the door”. Emotional trading is when you allow your emotions to influence your decision-making. In other words, you are not in control of your emotions and that leads you to trade irrationally. You must have done this before, as emotional trading is possibly the biggest challenge that all traders must face. Luckily, you can train your mind to acknowledge these emotions so that they don’t impact your trading negatively.
The most common — and potentially harmful — emotions in trading are greed, fear of loss, fear of missing out, frustration, hope, and euphoria. Be mindful of when you experience them to keep your decisions rational.
How to overcome this pitfall:
You should write down your feelings and emotions in your trading journal. This will help you identify your emotions and how they impact your trading. By doing this, every time you are considering executing a trade, whether it’s buying or selling, you will ask yourself if your emotions are potentially impacting your thinking. Doing this helps you keep a rational outlook on the market and what you should do.
Pitfall #4: Inability to Deal with Losses Properly
In trading, you need to learn how to cope with losses properly, because they are unavoidable. When you allow a loss to affect you too much, you might do something impulsive like overtrading to make up for the loss, or lose your confidence and start wondering if you’re even cut out for trading in the first place. You might also abandon an effective strategy because of one loss. Either way, not dealing with losses properly will open a path for even more losses in the future.
How to overcome this pitfall:
No trader wants to suffer a big loss that is hard to recover from, both psychologically and emotionally. To prevent that scenario from ever occurring, don’t invest more than you can afford to lose. Accept that loss is part of the game and that you’ll live to trade another day.
Second, set a specific stop loss for each trading strategy and stick to it. Don’t let the hope for a bounce back keep you holding onto a losing streak. Cut your losses, review the trade to determine the causes of the loss, and move on.
Pitfall 5#: Biases
Last but not least is another huge element of trading psychology. We all have cognitive biases that influence our thinking and decisions in daily life. The same goes for trading: a trader may invest in a stock simply because others are doing it, or attribute a good performance to their ability when it was purely a stroke of luck.
Common biases include:
- Confirmation bias
- Bandwagon effect
- Post-purchase rationalization
- Loss aversion
How to overcome this pitfall:
Just like emotions, self-awareness goes a long way to help you avoid poor decisions. You should educate yourself on the various biases that influence traders and identify the ones that you have. This self-awareness will allow you to catch yourself before making a bias-induced decision and rectify your course of action.
Understanding Your Trading Psychology Is Key to Mastering It
Understanding your state of mind and emotions is necessary to stay rational in your decision-making. And the first step to master trading psychology is to learn as much as you can about how your mind works and the psychological pitfalls you need to avoid or overcome.
In this post, we have covered five major pitfalls of trading psychology you need to be aware of. Remember to always be disciplined, patient, able to control emotions and cope with loss, and aware of your own biases. As you develop these traits, you’ll make better decisions that net you more profits.
