The Four Demons of Trading Psychology
Forex Trading Psychology
The Four Demons of Trading Psychology
It is clear that a lack of knowledge or expertise wasn’t the cause of LTCM’s demise. Instead, too much confidence, enthusiasm, a lax attitude to risk controls were the main culprits behind the firm’s demise, and it is possible to tie these factors to emotional faults with ease. To understand these emotional problems, and trader psychology, we’ll introduce you to the four forex demons in this text whose lies and deception ruin the careers of many beginners. The harm done by them is far greater than anything caused by faulty analysis or neglect of important information. While the results of one simple mistake can be readily corrected in time, the damage done by these beings is chronicle.
But let us remind you that the rewards of a successful battle with these troublesome beings can be unlimited. The trader who masters the psychological aspect of trading has walked two thirds of the way to riches, and all the rest is just a matter of patience and study, before the inevitable outcome of wealth and prosperity is attained.
The greed demon is the number one enemy of forex traders. This demon has a long and spiky tongue which constantly whispers to our ears that the opportunities in the market are going away unless we act quickly to profit from them. Its feet are on fire: it screams “faster, faster” to the trader, stressing him, causing him to lose focus. It has an empty belly, is emaciated, weak and hungry, because none of his exhortations for speed and greed lead to the slightest profit in the end.
It is perhaps natural that the vast majority of forex traders are money-oriented, profit seeking individuals who attach great importance to financial success. It is also true that without a strong drive for making money, no trader will be able to withstand the pressures of trading the forex market. In moderate amounts the drive to achieve monetary gain, and focus on financial success are healthy and necessary. But these healthy impulses become unhealthy when they direct our trading decisions: the greed demon needs to know his place, and he must not interfere in trading practices which must be formulated by logic alone.
This fiend has a fearsome sight, and a sharp voice, bellowing, growling all the time, trying to intimidate us into indecision in everything that we do.
Fear has the opposite role of greed in our trading decisions. Instead of inspiring us to trade like a machine gun, opening and closing positions with the speed of lightning, fear convinces us that nothing that we do will be profitable in the long term, regardless of the power of our analysis, and the amount of study and consideration gone into perfecting our method. In this case, a fearful trader will be unable to wait for the realization of a profitable position, and he will be unwilling to act on the basis of rational expectations. In addition, the fearful trader will be unable to realize losses that result from mistaken assumptions, and the red ink in his account will keep spreading everywhere as a result. The result is usually ruin: as fear leads to more and more irrational decisions, and few trades are profitable, a few long-held losing trades will eventually wipe out the account.
Traders experience a feeling of wanting “revenge” on the market when they suffer a losing trade that they were “sure” would work out. The key thing here is that there is no “sure” thing in trading…never. Also, if you have risked too much money on a trade (starting to see a theme here?), and you end up losing that money, there’s a good chance you are going to want to try and jump back in the market to make that money back….which usually just leads to another loss (and sometimes an even larger one) since you are just trading emotionally again.
The queen of forex demons, Euphoria, is a creature that promises unlimited wealth, and delivers unlimited misery and destitution. Euphoria works hard to ensure that wherever we look, we see nothing but wonderful prospects for limitless profits. It is as if the trader has somehow been blessed with the Midas Touch, with success being the natural consequence of his routine behavior.
Under normal circumstances, euphoria has little relevance for most traders, because most are aware that success in forex trading is not child’s play. While magnificent profits in a short time are sometimes possible, such gains are usually the result of a period of study and practice during which the false promises of euphoria are proven repeatedly to be meaningless. In the case of the beginner, who doesn’t possess this background of hard work and study, euphoria may result from a string of profitable trades, as the trader comes gradually to believe that his understanding of the markets is impeccable, his analysis, flawless.
To deal with the problems associated with trading psychology, we must minimize the role of emotions in our trade decisions. To minimize the role of emotions, we must understand that success or failure are not related to luck, but are the logical consequences of our own choices. We discussed before that it is almost impossible to have an unleveraged account wiped out as the consequence of a single trade. If the trader succeeds in realizing an empty account as a result of a string of losing trades, it’s hard to speak of luck or chance as being the causes of the disaster. Leverage is entirely in the control of the account owner; he can set it at any value provided that he can live with the consequences. Leverage amplifies the profit/loss potential of a trade, but it also intensifies the emotional aspect of trading too. Eventually, this intensification of emotional pressures may prove to be the most dangerous and negative impact of leverage.
The best way of dealing with emotional problems is acquiring a logical approach to trading. The best way of acquiring that attitude is understanding the market mechanisms, and the forces that direct economic activity. In this website, we have attempted to give you a basic understanding of those factors upon which you can build your own edifice of knowledge to improve your own potential for success in the forex market.