Let’ face it, no one likes losing money and the emotions triggered by such events will manifest themselves differently within each individual. Studies show that investors feel losses twice as hard as wins, potentially further influencing future trading decisions.
When trading successfully an investor may start to feel overconfident, particularly after a big win or streak of winning trades. This confidence of being right can quickly turn around!
Emotions can range between the feeling of guilt, anxiety, anger and fear and if not acknowledged and addressed will usually lead to bad trading decisions.
A losing streak or big loss may cause an investor to fear the market, not wanting to make the same mistake again it may prevent them from taking advantage of perfect trading opportunities presenting themselves in the market. On the other hand, it may cause them to ignore their rational thinking and revenge trade as an attempt to regain the losses already made (inevitably this will usually lead to disappointing results).
So, what can we do to better our trading psychology and help us to take control and manage these emotions?
Step 1 –Build a plan and follow it.
By building a trading plan, you will maintain a set of rules that you should be following with certain criteria that must be met to enter and exit trades. If the criteria of your trading plan is not met, then trades are not opened.
Step 2 – Back test your entry and exit points.
The better you understand how your trading strategy reacts to changes in the market price, which factors may boost profitability and what type of derailers can side-track your profits, the easier it can be to build a sustainable trading plan. Remember, no strategy works in all market conditions, thus practice makes perfect.
Step 3 – Risk Management.
Often overlooked this is one of the important aspect to trading. Your risk management plan should include the amount you are willing to invest, and it is especially important to not invest more money than you are prepared to potentially lose. The risk management should also include a plan limiting the amount of risk taken on each trade and overall on your account. This will usually include a set of rules to determine the trade size based on pre-determined levels which may have an impact on the distance between the stop loss and take profit used on the trade. Without a risk management plan, you could have the best trading strategy in the world and yet with only one badly managed trade you could lose your account balance.
Step 4 – Test your strategies on a risk-free account.
So now you have your trading plan and set of rules which will need to be met to open and close trades, you have back tested the trading plan and implemented your risk management on the charts and found it to be consistent giving you an edge over the market. You now need to start trading it in a Demo account. By implementing your trading strategy on a risk-free account, you become more confident on how the strategy reacts in different live market conditions. Additionally, you can test the management of your emotion and trades at the same time.
Step 5 – Go Live.
Once you’re confident in the profitability of your trading strategy, you understand how and when it works best and your emotions are in check, it’s worth considering a real trading account. When progressing to a Live account it is important you stick to your trading plan and risk management. Because trading with real money versus demo money can influence your reactions heavily, you can place a test trade to ascertain your emotions and see how you feel. Where you identify small changes required to your trading plan, now it’s the time to modify the strategy. Remember to back test it and trial it on a demo first before triggering it on a live account.
Never invest/risk more money than you can afford to lose.
Stick to your trading plan and rules.
If the trading plan is not working out, remember it’s ok to stop trading until you finetuned your strategy on a demo account. Review your trading to ensure you are sticking to your trading plan. If needed, take a break, as the market will always be there tomorrow.