When we trade or invest in stock markets, it’s guided by a certain psychology. Apart from the trading plans and analysis, this psychology is one of the principal guiding forces. Known as trading psychology, this mental state of mind plays a vital role in determining success and failure. So, what is trading psychology, and what are its various aspects? Let’s find out.
Trading psychology refers to the different aspects of an individual’s character, mental state, and behaviour that affect trading. It represents an aspect of your behaviour and characteristics that affect your trading. Stock market psychology differs across traders and is influenced by one’s biases, emotions, and various other factors.
It is as important an attribute as knowledge, experience and skill, among others. Trading successfully depends a lot on trading psychology with discipline and risk-taking being two of its most critical aspects. Fear and greed are two common emotions associated with trading psychology.
In general, trading psychology is associated with certain specific behaviours that act as catalysts for market trading. There are two distinct subjects here - trader and market. As said, greed and fear are the two most widely regarded emotions that are likely to decide the success or failure of a trade. Along with these, hope and regret also play a vital role in devising a sound trading strategy.
Greed refers to the excessive desire to earn profits that cloud your judgement. It results in undertaking trading actions that are too risky. Greed-driven trade may result in buying stocks of companies that don’t have sound fundamentals or buying shares without understanding. Because of greed, you can take a position in the market for far too long. It often happens at the end of a bull run in financial markets when traders try to take risky and speculative positions to book profits.
On the other hand, fear drives you to avoid taking excessive risks, thus generating lower returns from your investments. It makes you act irrationally and avoid taking risky positions due to the fear of suffering losses. This kind of emotional trading is usually seen in the bear market when there is a significant sell off arising out of panic selling.
Successful traders keep a balance between trading psychologies, are more aware of their emotions to handle market fluctuations and volatility better.
Trading psychology is important to approach a trade smartly. Striking the right balance helps achieve the desired goal with ease. It prevents taking unnecessary risk and at the same time ensures you don’t lose out of a market opportunity due to fear. By developing a healthy trading psychology, you, as a trader, can effectively navigate a volatile market by keeping emotional buying and selling under check.
When you improve your trading psychology, you create a routine that puts forward a defined way of starting at trade. You can devise charting techniques through which you can identify patterns for buying and selling opportunities.
Bias is one of the biggest deterrents to trading. It hinders proper decision-making and prevents one from taking an appropriate judgement. This results in you acting under emotions rather than logic. There are two types of biases that affect trading - negativity bias and gambler’s fallacy.
In negativity bias, you are more inclined towards the negative side of a trade instead of considering both the positive and negative sides which could result in forgoing the entire trading strategy. In gambler’s fallacy, there is a belief that a particular event is less or more likely to happen because of previous events. This despite being established that the probability of such an event doesn’t depend on past ones.
Status quo is another bias that can affect your trading. It occurs when you assume that old trading actions and strategies will continue to remain relevant even today. It doesn’t allow you to explore new relevant opportunities in the current market situation.
Now that you know psychology in stock market, let us see ways through which you can improve it. You can improve it by:
For improvement, know your personal traits and devise a plan to overcome negative ones by formulating a solid trading strategy involving fundamental and technical analysis. Also, identify positive traits that can help you make prudent decisions.
Create a solid trading plan that serves as a blueprint for trading and highlights the goals you wish to achieve. Make a plan that helps you improve trading actions, set specific targets and stop loss to weed out emotions. Also, you must spend enough time researching and reviewing the available opportunities. Apart from online materials, attend webinars and conferences to interact with peers and industry professionals.
As evident, if you understand trading psychology well, you can better keep your emotions under control and make rational decisions that can help you in the long run.
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