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Trading Psychology I

Trading can sometimes be hard to master – but if you succeed the rewards can be fantastic. It is a hobby or job where you can easily see how good you are – simply by looking at your account balance! When people ask what makes trading such a unique and challenging business, the answer more often than not is: Psychology. To prepare you as much as we can, here are five simple rules of thumb, as you seek to make your fortune in the world’s markets!

1. Avoid Over Analysis

As you are probably new to the market, it is natural and indeed advisable to read, learn and try and soak up a lot of information. There are many sources to do this, such as books, magazines, blogs, forums, seminars and of course the Skilling Academy. Also, your personal background and views on the economy and finance in general will naturally feed into this.

Once you start actually trading, however, you will face a lot of challenges. You will win some and you will lose some. Still, a problem that a lot of newbies often don’t understand is this element of trading; it is natural to have losses, as this is part of the learning curve. All traders experience this regularly, even those who have been trading for years.

It is important to not become too scared to trade through over-analysis. Accept that trading is a tough pursuit, and is likely to involve both profits and losses.

2. The Market is random

One of the ways to accelerate your development is to accept that the market is random. No matter how much analysis and preparation you do, you will see time and time again the market react in a totally different way as to how you saw things! This can obviously be extremely frustrating.

What makes it possible to profit is your ability to second-guess what the other traders (i.e. The Market) are also doing. People will tend to react in the same way over and over, even though they are operating within this random environment. Don’t become disheartened though with the randomness of the market. In fact, once you accept this, you will likely see your trading improve significantly

3. Look at your balance

Often traders will spend a lot of time looking at what went wrong or right on individual trades and analysing what happened. This is a good idea. However, when looking at trades over a longer period, it is very hard to determine why some are successful or not. This is because over the longer term you are likely to have changed many aspects of your trading.

Therefore, whilst important, it is much more important to look at the bigger picture. And the bigger picture in trading is your account balance as it can’t lie! If you find your balance does not match what your expectations were, then it is time to alter your trading approach.

Equally, you may find that when you surpass certain benchmarks in your account balance – say whenever you approach an account balance of EUR 10,000 - you have some losing trades and your account size decreases again. This might tell you that you are becoming too risk averse. Either way, watching your account balance is critical to your psychological success as a trader.

4. Accept risk

When you enter a trade and it doesn’t move much, often traders will then start to analyse the position. A common mistake that many make is they start to change their stop loss orders. They sometimes think ‘I initially risked 1000 euros but the market hasn’t moved much so I now want to only risk 500 euros’. The trader has started to analyse the trade (too much) and is now changing the risk that he or she was comfortable with when they first entered the trade. And once they change this to a new tighter stop loss, more often, the price ‘rockets up to your initial target’.

The lesson here? If you were happy with the risk initially…then learn to be happy with that risk and don’t adjust positions unnecessarily.

5. Take profits

When entering a trade, you will most likely have a take profit level in mind. These are often based on key technical levels. Whilst this absolutely makes sense, one should also be prepared that the trade may pan out in an entirely different manner.

Therefore, one should always be prepared to look at taking profits depending on how the situation unfolds. Sometimes you could let your profits run, other times it will become clear that this is not a good idea. Either way, never ‘fall in love’ with a position…

Read more in the sequel: Trading psychology II