The Science Behind Trading Psychology
Human beings are emotional creatures. Every one of us, including the “heartless” ones, have emotions. They can be good or they can be bad. But no matter what we say, emotions play a significant role in our decisions making. And all those emotional decisions can be traced all the way to our trading. Trading psychology is a part of our life as human beings.
But what is trading psychology? How does trading psychology affect us? All that and more will be discussed here. So sit back and learn all that you can with the science behind trading psychology.
What is Trading Psychology?
Trading psychology, as the name clearly suggests, is the study of the human mind and how ones emotional capability can alter their trading choices. To put it simply it weighs in on a trader’s character and emotional capacity and how it affects their trading capabilities. Trading psychology also factors in other important attributes like knowledge, experience, and skill in its formula.
The 2 most important aspects of trading psychology are discipline and risk-taking. Those 2 aspects are crucial because it determines the approach and success of a trader’s plan. Although, fear and greed are the two most common emotions that are also constantly being considered. Other notable emotions are hope and regret.
How Does Trading Psychology Affect the Market?
There are certain emotions that are considered to be the most important aspect of trade psychology. The most common emotional characterization that affects your trades the most is either greed or fear.
Greed is a constant need to earn more wealth. Now don’t get me wrong, everyone wants to get rich. However, too much desire for wealth can cloud your judgment and rationality. Which in turn leads to a behavior that is generally chasing after high-risk scenarios in hopes that it will him/her to success. Additionally, it can also cause the investor to stay too long in profitable trades because they will generally believe that if they stay they will get the most bang for his/her buck.
There are other greed related behaviors to look out for including, but not limited to, pushing for high-risk trades, buying multiple shares of an untested company or technology without checking the risk assessment just because it is going up in price rapidly, or buying shares without any sort of research on the underlying investment. The bull market is usually where folks like those lurking around.
Fear, on the other hand, is an emotion that greatly affects an investor’s decisions. It could cause a trader to quit too early. Or make a trader refrain from taking a risk due to concerns about loss. Thus commonly affecting traders to exit the market too hastily and losing potential profit. The worst-case scenario with fear is that it can morph into a panic. And with panic, it generally causes selloffs in the market that resulted from panic selling.
Lastly, regret may cause a trader to make a sudden irrational decision due to missing out on a previous better trade. For example, a trader might exit early out of fear, is then filled with regret, then jumps into a trade without the proper mindset. Vice versa goes for greed.
Emotions are powerful difference makers in our judgment. They carry significant weight in our daily and professional lives. And it could turn into a vicious cycle if not managed. Such as fear, turning into regret, turning greed and so on. However, with the proper emotional management and a level headed mind, you can trade all you can without any worries.