Trading in financial instruments is not about you and the markets; it’s about you and yourself. The saying goes that your worst enemy is yourself and this can become very clear once in the trading arena. Mastering the psychology of trading is one of the most difficult challenges for a trader, as poor management of emotions can often lead to misjudgment and great losses.
Many traders from time to time have a feeling of an invisible force reaching into their trading account and stealing their hard-earned money. It doesn’t seem to matter how skillful they are or how many years of experience they have on their backs, they just cannot seem to stop it from mugging their money.
So, the main question is how do you prevent this inexplicable force? Regardless of whether you are an experienced trader or a novice investor, the ability to prevent the theft of your money is associated to how well you overcome the five sins of trading. For each sin represents an element of the force that ravages your trading account. A clear identification of them enables the intelligent investor to stay out of trouble, by lighting the way to combat his individual weaknesses.
We shall, therefore, take a look at these five dreadful sins and demonstrate how they affect a trader from following a logical and systematic approach to trading.
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Fear of taking losses can lead to even further losses. A trader, for example, may enter a trade and set his stop loss 20 pips away according to his trading strategy. However, if he senses fear, he may overreact and close the position too early, just because the price movement has temporarily gone against him. In the event that the trade proves to be successful, then the investor has converted a winning transaction into a failed one, simply out of fear.
Another situation of experiencing fear, is when a trader closes his position right after it becomes profitable and not letting it run its full course, because he is afraid to lose that profit. In case that the transaction moves towards his profit target, then he sentenced a great win to a much smaller one. These reactions eventually transform a money-making strategy into a failed one, as the trader minimizes the amount of successful trades or decreases his overall profit, because he is afraid of losing.
When feelings of greed overtake a trader, he diverges from his initial trading strategy in his quest to harness all the profit he can get. This emotion causes him to hang on winning positions too long, trying to get every last pip. This trait can be devastating in terms of returns, as the trader is always running the risk of getting blown out of a position.
Normally, a trader places his profit target to a certain point, based on a fundamental or technical reasoning. When he experiences greed, he does not close the trade when his strategy indicates to do so, and goes for more profit. In that case, there is a great possibility that the trade can turn against him, ending up with less gains, or even worse, a loss. This implies that he actually reduced the profitability of his strategy in his attempt to increase his profit out of greed.
A trader who is trading just for the sake of trading or just for the excitement of being in the game, is simply gambling. The key difference between trading and gambling is information. The less information you have, the more likely the odds are that you are gambling your money. A person who is trading without a trading strategy and without any sound information, is completely exposed to the random whims of markets.
A fundamental trader who responds instinctively to the latest economic news, without looking at the previous market forecasts and counterpart data on the other currency, is gambling his money. Likewise, a technical trader who only considers five minute charts to estimate his support and resistance lines, is also gambling. Whereas, a trader who examines the economic calendar, scrutinizes the hourly, daily, weekly and monthly charts, estimates Fibonacci retracement positions and only takes action when multiple time frames endorse his analysis, has a much greater chance of success.
#4. Lack of discipline
A lack of discipline to follow your trading plan is a major ingredient of the crash and burn recipe. If the way you look at a chart or assess a prospective trade entry is different from the way you did it a few weeks ago, then you have either not defined a methodology that works for you or you lack discipline to follow the strategy you have developed. The formula for trading success is to religiously follow a proven strategy.
The reason that following a solid trading strategy is so important, is because prices make rapid movements towards either direction on short notice and force the traders to react quickly. To make a good decision, you need discipline, so that you stick with your formerly defined trading plan and know when to take profit and losses. Improvising or following your gut instinct, simply can’t work for trading.
#5. Lack of patience
As trading is an inherently exciting activity due to its money-making nature, it is easy to feel like you’re missing the thrill, if you don’t place a trade. This lack of patience results in spreading yourself too thin by placing trades of lesser and lesser quality and thus over-trading.
In order to overcome your lack of patience, you have to remind yourself that every week, there is another trade of the year. In other words, do not worry about missing an opportunity today, because there will be another great one tomorrow, next week and next month.
Trading with success is not an easy endeavour. It requires hard work. But this hard work can be very rewarding, as large profit is attainable and the sense of fulfillment one feels after a few good transactions is absolutely priceless. To get to that point, however, you must first fight your own worst enemy that holds you back and steals money from your trading account. Once you acknowledge and master the particular mind-traps you tend to fall into, you will find your trading results significantly improved.