Know the risks. Know yourself. Why trading psychology is important

No matter what your trading plan looks like, you should have a keen understanding of the trading psychology involved in making financial decisions. Trading psychology refers to your ability to handle risks and deal with gains and losses in an appropriate manner. 

Emotions can affect our decisions, so it is important to learn how certain biases and feelings can impact our trading habits. There is no single set of rules or techniques that all traders must follow, but it is important to know how to use the different facets of trading psychology to your advantage. 

Although you can never entirely eliminate the emotions of trading, understanding the psychological components involved will make your decisions more informed and reliable. Learn the basics of risk management and ensure that you are familiar with all the associated rules and regulations. You should also recognize the signs of irrational decisions that can be triggered by fear and greed. 

If you understand the risks and learn how to master trading psychology, you will have an easier time keeping your head and executing transactions strategically. Use all the available resources to stay informed and confident in your trades. Being knowledgeable about the trading environment and considering your personal tendencies will give you an edge in any market. 

On this page, we will delve into the four primary aspects of trading psychology and how being mindful of them can aid in making sound financial choices. 

What Should the Psychologically Conscious Trader Focus On?

Behavioural finance looks at how psychological factors influence investment decisions. People often use mental shortcuts, called heuristics, which can lead to biases and missteps in financial markets. These biases are unconscious beliefs that can impact money decisions. 

IG conducted a study to understand the effect of psychology on financial decisions. The study analysed 30 million trades, academic research, surveys, and consulted industry experts. Personality traits like discipline, decisiveness, patience, rationality, and confidence can affect financial decision-making and can be improved to maximize results. 

Discipline

What does 'discipline' mean in trading? 

Discipline in trading refers to following strategies, avoiding losing trades and taking profits at the right time. Discipline helps regulate a trader's emotions, attention, and decision-making. A trader can become disciplined by creating a trading plan and outlining a risk-to-reward ratio.

Patience

What is 'patience' in trading? 

Patience in trading involves waiting for the right signals to enter or exit the market and delaying gratification for future benefits. Traders can develop patience by understanding market movements, building a risk management strategy, and using techniques like trailing stop-loss.

Decisiveness

What does 'decisiveness' mean in trading? 

Decisiveness in trading means making quick but informed decisions about entering and exiting trades, learning from mistakes, and integrating new information into a plan. Traders can become decisive by creating a solid trading strategy, using technical or fundamental analysis, or automating their strategy. 

Overconfidence

What is confidence in trading? 

confidence in trading is trust in one's abilities and knowledge and is essential for identifying and acting on opportunities and bouncing back from losses. Confidence and overconfidence should be distinguished, and traders can build confidence by keeping track of their successes and learning from their failures. 

Rationality

What is 'rationality' in trading? 

Rationality in trading means making decisions based on the best available information to achieve the best possible outcome. This can involve maximizing gains or minimizing losses. To become a more rational trader, demo accounts can be useful to practice and test strategies without risking capital. This helps to familiarize with market dynamics and reduce fear.

Which emotions effect trading behaviour the Most?

The most prevalent emotions experienced by traders include: 

Fear - which can result in avoiding trades, impulsive decision making due to fear of missing out, or exiting trades too early out of fear of losing profits. 

Elation - which can lead to overconfidence and taking on excessive risk, especially after a string of successful trades. 

Greed - this emotion is often paired with overconfidence and results in disregarding trading strategies and taking on too much risk. 

Boredom - which can prompt traders to make unwise trades during periods of low market opportunities. 

Frustration - which can cause traders to abandon their strategies and seek other methods of trading, often leading to poor outcomes. 

The bottom line

Everyone is different – know yourself and your risk appetite before you make trades. Economists believe that individuals make financial choices based on maximizing profits and optimizing results. However, the truth is that emotions and biases also play a role in decision making. This can result in financial mistakes. Recognizing these biases can help prevent them and having a financial plan to follow can lead to better investment decisions.