Combining psychology and trading may seem like a gamble. However, the two things are perfectly connected. The truth is that psychology plays an incredibly important role that cannot and must not be neglected. The risk is, in fact, conducting a trading activity that is troubled both economically and emotionally.
In this article, we discuss the psychology of trading, explaining why it is so important and offering some advice on how to deal with two very significant events in every trader's life from a psychological perspective: victory and defeat.
Why psychology matters
Before addressing the topic from a practical point of view and offering some advice on how to deal with the ups and downs of trading from a psychological perspective, it is important to clarify the role that the psychological sphere plays in speculative investment activities.
What happens in the trader's mind
Trading activity, whatever its outcome, always has a psychological implication. This can be positive or negative, but it is always there. The reason is ultimately banal: the trader is human, with their weaknesses and fragilities. This is true despite the collective imagination portraying them, in their "winning" variant, as a kind of money-making machine, an effective and relentless technician.
Emotions, which for obvious reasons define the scope within which trading psychology moves, are the true uninvited guest of investment activity. Therefore, they must be managed in the best possible way, both to ensure good mental health and to guarantee the necessary effectiveness of one's trading.
To understand all this, it is important to become aware of what happens in a trader's mind, especially when the psychological sphere takes over.
It's quite intuitive. Everything stems from risk. Risk causes stress, stress causes emotions to come into play, and these emotions reduce clarity. Lack of clarity leads to mistakes and increases risk (perceived or not). Thus, a vicious circle is established in which the objective data, the practical outcome of one's trading activity, pays the price.
This circle can be broken immediately. It is sufficient to recognize one's psychological sphere as important and take care of it. To a certain extent, this means managing one's emotions.
General tips on trading psychology
Before delving into individual situations, it is important to provide some general advice that is useful for cultivating one's emotional sphere and, if necessary, sterilizing its impact.
Know yourself. This is the first step in approaching trading activity from a psychological efficiency standpoint. After all, every person is unique and has their own specificities. Everyone reacts to adversities and simple facts of life in different ways. Therefore, before taking the reins of an account, before starting to spend money, before committing to an always challenging project (such as a career in trading), do some work on yourself. Establish a good relationship with your inner self. This is always helpful advice when starting a long-term project, and trading is no exception.
Understand market dynamics... And relate them to your emotional sphere. To work on your emotions, you need to know your way of reacting. To know your reactions, you need to know... The reagent. In this case, the market dynamics, the most common phenomena, the most frequent events. In other words, everything that can have an emotional impact. Once again, knowledge is a prerequisite for the wise management of the psychological sphere. Moreover, knowledge of an environment contributes to radically reducing the emotional consequences. This is not a prerogative of trading, let's be clear: it is human nature that works this way.
Practice effective Risk & Money Management. This is a step that is often overlooked, at least from a psychological perspective, yet it is precisely so: the practice of Risk and Money Management is fundamental to ensure the necessary peace of mind. It's not just a matter of effectiveness and technique, of limiting losses. It's also a matter of control and, as such, of psychology. Again, human nature in general comes into play. When a person has control over what happens around them, they are calm and do not suffer from anxieties and so on. Now, absolute tranquility in trading does not exist, just as absolute control does not exist. Certainly, practices that limit risk and the consequences of risk, capable of providing a perception of control, can help.
Psychologically managing losses in trading
Defeat is always a negative event, in trading as in life. In trading, however, when you lose, it's not just your pride that you have to manage but also your wallet. Even in this case, though, to start over, you need to learn to manage negative events. It's not at all easy, especially from an emotional point of view. Here are some practical tips.
Train yourself to accept. It's a necessary step, albeit a painful one. To live with defeat, to overcome it, to mitigate its effects, you need to understand that it is part of life. In this case, that it is part of trading. This is true, then, not only from a philosophical point of view. It does not reveal a fatalistic conception (however useful in an overcoming perspective). Defeat, in trading, is a technical fact. There is no trader in the world who has not lost, big names in history included. The inevitability of defeat is a concept intimately connected to trading, part of its nature.
Understand the mistake. Understanding defeat, in a sense stoically enduring it, is not enough. It is not sufficient to process it. Also because the risk is to postpone the resolution of the problem. So, what to do? Simple: understand the mistake and don't make it again. Of course, in the future, you will make other mistakes, but it is still an important step. Firstly, because it gives you confidence and self-esteem. Secondly, because if you learn from your mistakes, you will have the impression that you have not suffered in vain, that the pain has not been all for naught. Therefore, always record your moves and retrace them when necessary. Understand where you went wrong and remedy it. Actually, easier said than done, but you have to try.
Suspend the activity. This is a controversial aspect, a particular solution that should only be adopted in extreme or serious cases. If you keep losing, and if with each defeat you feel worse and worse, if you feel you can't react, simply... Don't react. That is, take a long break. Suspend trading activities. It is evident that you have entered the vicious circle we described at the beginning of the article. All your efforts, if you do otherwise, will be in vain: you simply do not have the necessary clarity (in that specific moment, let's be clear) to immediately pull yourself out of the quicksand. Therefore, it is better to rest, avoid causing further damage, and use the time to recover your emotional energy. The detachment may seem brutal, but there is no denying it: for extreme ills, extreme remedies.
Psychologically managing wins in trading
Managing victory in trading is a little less intuitive. Above all, it is not very intuitive why one should manage a victory. After all, it is a positive event... What could go wrong? Instead, if you don't manage victory well from an emotional point of view, you run very big risks, which have to do precisely with the emotional and psychological sphere. For example, you can enter a vicious circle in which greed and recklessness take over. You can get carried away, perhaps in the grip of euphoria, and lose the right path, which in trading means a balanced propensity for risk and discipline towards one's plan. If you abandon this path, the consequences at this point become truly intuitive. Here are some tips to avoid this drift.
Don't get carried away. We have already said it, but we use this space to reiterate and explore the issue further. There are no doubts about why one can get carried away following a win, especially a big win. Trading is a very complicated activity, and the awareness of having succeeded certainly gives a boost to one's self-esteem. The problem is when this boost is too powerful. Obviously, some people are more predisposed than others to rest on their laurels, but the risk is still common to everyone. How to avoid getting carried away? In a sense, the solution is similar to that indicated for managing defeats. It has to do with acceptance.... Of defeat. Actually, with the awareness that defeat is always around the corner. If you develop this awareness at an intimate level, the risk of getting carried away, the feeling of "having already arrived," is greatly reduced.
Don't change your trading plan. When you win, especially when you win often, you run a risk. That is, developing the conviction that all those tiring and demanding precautions you take are, if not useless, then excessive. Moreover, there is a tendency to become self-confident, perhaps too much so, to increasingly trust your abilities, especially with regard to intuition and improvisation. In short, the risk is to change your habits, to derogate from the rules of your trading plan. This is a huge mistake that must be avoided at all costs. It should be avoided especially when you are in a state of euphoria and extreme happiness. Therefore, resist the temptation, resist the urge to take undisciplined actions.
Bring everything back to the numerical data. This advice is a corollary of the previous one. If the problem is greed, euphoria, at times a sense of invincibility that (certainly for limited periods) follows an important win, the solution could be precisely to put the event into perspective. After all, there is a need to "deflate," so it might be useful to "deflate" the meaning and scope of the victory. How to do it? It's simple, the dynamics of trading offer valid help in this sense. Bring everything back to a numerical figure. Think of your gain only from this point of view. Unless you have achieved an extraordinary result, the numbers will always be less exciting than the concept of victory itself, or the way in which you, as a winning trader, have psychologically processed the event.
