How to Improve Your Forex Trading Psychology
One of the key pillars of successful forex trading is developing the right mindset. It’s just as important as having an in-depth technical knowledge, and it’s a skill that dedicated traders continually work on. Good trading psychology helps you to manage your emotions, make more rational decisions, and trade to a consistent pattern.
Ultimately, the right mindset boosts your chances of making profitable trades, using forex funding well, and of avoiding damaging losses. The forex markets can be volatile, and keeping a cool head is your best defence against being battered by the turbulence. Sometimes, you will need to make decisions that seem to go against your natural instincts.
Fortunately, there are many techniques and steps that can be learnt to help you manage your emotions and behaviours when trading. Here are some of the most important starting points.
Keep greed in check
Greed is a natural human instinct, that no one is immune to. It’s down to centuries of evolutionary survival tactics, where the opportunity to stock up on supplies while the going was good meant the difference between life and death. The pursuit of wealth is still a great motivator for many people today, and it can of course lead to rewards.
However, this instinct to prioritise profits above all else will work against you in forex trading. Greed can make you double down on a losing trade, or over invest in a potential gain, and incur damaging losses. You may even be convinced that you are doing the right thing.
However, greed is a powerful and treacherous emotion that can easily overpower cooler thoughts, and to conquer it, you need to understand it. It’s a reactionary emotion, meaning that it can make you follow the herd and try and take advantage of every passing asset bubble. The problem is, bubbles will always burst in the end.
The best trading strategies tend to follow a consistent pattern, and see the bigger picture, rather than react to every possible get-rich-quick opportunity that crops up. Some super-savvy investors even take what is known as a ‘contrarian strategy’ which is to trade off the back of market panics. However, this is best left to very experienced traders only!
For the rest of us, the best way to conquer greed is to first understand and be aware that it affects us all. The next step is to toughen up your trading strategy. This means that you should manage risk and always stick to a trading plan. Work out what your risk tolerance is; that is how much money you can comfortably stand to lose on each trade.
Never be tempted to take high leverage to try and maximise a profit, if it means crossing your tolerance zone. This is no better than gambling. Guard against the urge to over-trade, which is another very common mistake that new traders make. More trades do not equal more profits; it is how well you manage your trades that matters.
Another common pitfall for new traders that is related to greed is overconfidence. This can happen as the result of a first run of successful trades, and emboldens the trader to take higher leverage, or make more trades, and hang on to them in the hope of maximising profits.
This is often the way that the markets can trip up a new trader, by inducing a false sense of confidence. The excitement of success, and making knife-edge decisions under pressure, can be intoxicating, and this can lead to you abandoning a logical trading strategy. Remember that the best route to success is to follow cool logic, and not your emotions.
If you are well disciplined in your trading routine, and stick to your strategy through thick and thin, then you are far less prone to falling prey to the power of greed.
Getting a grip on FOMO
Greed’s nasty little twin is fear, and its evil cousin is Fear of Missing Out (FOMO). Fear is another very powerful emotion, which drives the most basic of human instincts. It’s easy to understand from an evolutionary perspective; it let our ancestors know when they were in danger from predators, and stopped them from taking foolish risks.
Fear is still a necessary emotion, to let us know when we might be in a dangerous situation, and to lose touch with it completely would be a bad idea. However, most of the time, we aren’t in a life-or-death situation, yet the primal fear instinct kicks in when we think we might be vulnerable to a loss, and this includes on the financial markets.
The problem is that fear can lead a trader to abandon hard-learned lessons. This means they might cut short winning trades for fear of making a loss, hang onto a losing trade rather than cut their losses early, or make trades for the sake of it rather than leave funds sitting in their account. This last pitfall is known as FOMO in trading.
Psychological studies have shown that most people are loss averse, meaning that the fear of making a loss is more powerful than the pleasure of making a profit. While greed should be guarded against, as we have seen, fear is often the more overwhelming and complex emotion to master for many forex traders.
One of the reasons for this is that it can be entangled with other powerful emotions, such as jealousy and pride. The pressure not to miss out on a bargain can be hard to resist, because we not only fear losing the chance to grab a bargain, but we covet what we perceive others to have, and take pride in our successes and gains.
There are other types of fear that can come into play, such as fear of the unknown. This may because you have starting trading before you were ready, and have not acquired enough background knowledge about how the forex markets work, how to put together a sound trading strategy, and how to stick to a daily routine.
If you suspect that this may be the case, it’s best to go back to the drawing board, and work with a demo account until you get your confidence levels up. Trading blind is basically just gambling, and your luck will run out sooner or later. Ignorance can lead to fear, but ignorance can easily be remedied with some learning and skill-building.
Another common fear is the fear of being wrong. Now, this is not the same as a lack of knowledge and experience. Even experienced traders make mistakes, and good traders will sometimes make losses, even though they stuck to a tried and tested strategy, and didn’t make any serious errors of judgement.
The thing is, losses are part and parcel of trading, and even seasoned traders take the occasional loss. This is because the nature of the markets means that there is no way of being right 100% of the time. There is no correlation between winning percentage and profits, because what matters is trading within your limits, not being right all the time.
Therefore, a good forex trader is constantly on their guard against letting their ego cloud their judgement. Remember that there is no one single way of doing things. The need to be winning all the time, and to make huge profits, will lead to taking higher leverage than you can handle, over trading, and not cutting your losses.
Planning is key to being a good trader
Failing to plan is planning to fail, as they say, and this is never truer than when trading the forex markets. The single best defence that you have against making emotion-led decisions when trading is to arm yourself with a well-informed trading strategy. Every move that you make should be guided first and foremost by this plan.
Set out your risk management parameters, by putting a limit on the amount of money you are willing to lose on each trade. Read up on the technical aspects of trading before you start making live trades. Understand how to read the charts, and grasp the basics of support and resistance levels. Use stop losses on your account to help manage risk.
Know when the best times to enter the market are, which currency pairs react to which economic news. Read up on how data releases influence the forex markets, and study how they react to macroeconomic events and geopolitical announcements. Keep a journal so that you can track your progress, and review it on a regular basis.
Finally, it is important to keep a good work life balance, and not constantly think about your trades. Include some activities in your daily routine that allow you to clear your mind, such as meditation, exercise, or socialising with non-trading friends. Keeping a sense of perspective will help you to relax and enjoy your trading more.
It is perfectly normal to have fears and anxieties around trading, or to sometimes become overconfident. The key is to keep these emotions in check, and follow your head, not your heart.