Forex investors influence the market activity; therefore, investor psychology will influence and be influenced by the market activity. You can see traders’ psychology influencing the market through personal psychology studies, interdisciplinary behavioral studies, and market sentiment.
When you trade, you will see forex psychological effects in market sentiment versus the studies. Newscasters influence how traders perceive the market. World news affects your perception and all traders. Sudden market movements occur after news or forum discussions on market stability due to the changes in market sentiment.
There is a consensus regarding forex psychology. Emotions lead to mistakes; therefore, adopting proper emotions and avoiding the “four demons” of trading psychology is imperative to your success. To win against your emotions forex psychology tells us to set goals and make decisions based on facts - not emotions.
How to Combat the Negative Aspects of Forex Trading Psychology
Understanding your emotions, setting goals, and making decisions based on facts, not supposition, are the three ways you can combat the negative side of forex trading psychology.
Set a trading strategy and master it
Manage your risk properly
Avoid over trading
Making Decisions Based on Facts
Leave your gut behind
Study and research the market
Assess the global big picture
Narrow your assessment to the timeframe and currency you want to trade
A short analysis of each psychology topic and the supporting bullet points will help you create a solid forex trading plan that increases your profit and limits your losses.
Why Emotions do not Belong in Forex Trading
Emotions affect your analytical skills. Emotions can override your reason, and increase your leverage. Your emotions can lead to false calculations for profitable trades in the market. Many expert traders have fallen victim to their emotions, starting with a brilliant career and ending with an inability to work in the trading market ever again. While, you are an independent trader, trying to earn a little extra income or trying to make it a career, you still need to be aware of your emotions.
Any emotion can affect your trade, whether it is euphoria or fear. Fear, greed, and panic are negative emotions. Euphoria is a good feeling, one that comes from making successful trades, but it can turn into a negative emotion because it causes you to trade more. Trading more, taking bigger risks because of your happiness, usually ends in more losses than wins.
Euphoric Downfall Euphoria can appear in a trader’s psychology in two ways. One, the trader can become extremely happy after a hugely successful trade, such a trade that earned the trader over 100% in profit. For example, if someone enters a trade expecting to earn 30 pips, but ends up with 100 pips in profit for $100k profit, it will feel wonderful. The second way is for a series of successful trades, without any losses. The trader can believe in a special touch or ability to trade in forex when it is only a good strategy that worked for the current day or current market. The assumption that their trading strategy does not have errors or they cannot lose, increases the risks the trader takes until significant losses occur. Gone is the euphoria and in its place, is misery, panic, and fear. Greed Greed is one of the seven deadly sins for a reason. Greed is powerful and makes people do things they will regret. In forex trading, greed is a powerful enemy because it keeps you in a trade too long or tells you to continue making trades even when the situation does not warrant it. You want financial success. You want to change your financial circumstances; however, trading incorrectly is not the way you want to do so. Greed is something you will need to combat before you can have true success in forex. If you have struggled with trades since you started trading, then you need a strategy that does not have a foundation set on emotions, but on reasoning and analysis.
Fickle Fear Fear is definitely an emotion that causes people to act rashly. Fear can cause you to do two things. One, you may never open a trade because you fear the consequences. You continue to research and research, finding various worthy trades. Two, you place trades, but fear the loss so you set up a strategy that is causing you to lose. Fear can drive you to place your stops too close to the opening price, which causes you to sell out of your position too early. It can also keep you in a position too long. You decide you will not sell to try to recoup the losses you suffered because you fear the loss.
Panic Panic is when you act rashly, but in a different way than fear. Fear usually holds you back from making a move, so you hold a position too long or never enter the market. Panic happens when you are already in the market, and you continue to see losses. You lose large sums of money on your trades, you try to trade the same pair over and over, and eventually you no longer have the capital to trade. You want to make a profit, so you can also hold out on a pair that is not providing you anything, but losses. Most people’s instincts with panic tell them to sell out immediately, which may create even larger losses. If you sell out because the market is moving back and forth, with little change in the currency price, you sustain losses. This constant movement is usually a sign of market volatility where other traders are getting in and out to get their profits. It can also relate to a pattern that is not changing, where traders are just waiting to see if a breakout will occur. However, it can cause you panic. You start to think you chose incorrectly, sell out of the trade, and sustain losses because you didn’t ride the breakout like the rest of the traders.
Setting Goals Helps You Fight Emotions
Trading psychology, when discussing emotions, is often negative, but there is a positive side to psychology that can be of help to you. In psychology courses, you learn how to analyze, listen, and develop a strategy to help correct the problem. For example, dealing with panic is about assessing the situation. What happened when panic set in? What could you do differently to avoid panic in the future? How will you act next time?
Rather than allowing emotions to take over, you can already have a system in place that helps you answer how to enter the market successfully, and how to avoid emotions during your trades.
The first thing you need to do is design a trading strategy. Designing a trading strategy allows you to have a firm position for that trade with acceptable risk. Your trading strategy may vary slightly from currency to currency because not all currencies move in the same way. For example, you will establish a risk aversion level. At what point is the loss too much? If you have $1,000 to trade per market entry, are you willing to lose 10%, 20%, or more? Ten percent would be a $100 loss if the market moves against you.
If you are unwilling to lose more than $100, then your trading strategy needs to include a stop set at your risk aversion level. It requires finding out the value of each pip, setting a correct volume of each trade and setting the stop to ensure you sell out of the position if the market moves against you before you lose more than 10%. Always make sure that you never suddenly change your risk appetite based on emotions and that you fully adapt with your Stop-Loss to current market conditions.
Your strategy also needs to incorporate a time when you do not trade. Over trading occurs when a person continually gets into the market, even when there is nothing to trade. There are times when the forex market is not performing well. All traders may be holding out for news or the global economy to strengthen. Accept that there are times when you cannot trade because there is nothing to trade. Lastly, your strategy and goal setting to avoid emotions overtaking your trading style, is to have orderliness. Organizing your life, your trades, and your records will help you succeed.
Make sure you can focus on the trades by having a routine.
Choose a time to trade when you will be home and can conduct proper research.
Record your strategy for each trade.
Summarize each trade, whether it was successful, what went wrong, and what you can do better next time.
Modify your strategy a little at a time to fine tune it for the currencies you will trade.
Another way to ensure success is to stick with currencies most traders are trading. The G20 currencies are popular because of their long history with stability and market interest.
Make Forex Trading Decisions Based on the Facts
Leave your emotions, gut, behind. You already know that for a change in your trading psychology for the better, you need to stop focusing on your emotions and start focusing on an organized plan to trade.
Now, you can understand how studying and researching the market can help. There is such a thing as over analyzing the market and taking too much time gathering facts. Again, it is where your emotions take over. To stop your emotions, have a plan for research.
Start by assessing the global picture. Is the global economy stable? Are there things happening in the world that could affect the stability of the economy? Do you see trades occurring?
Examine the top currency pairs; these are the G7 pairs, such as EUR/USD or GBP/USD. Are any of these pairs moving? Are there concerns about the national economy for these pairs? Is there any news report of large companies making deals that could create a breakout trend?
Narrow your research to one pair that has positive indicators.
What occurred in the last year for the pair?
Are there any repeating patterns?
Narrow the graph to six months, to three months, and finally to one month as you assess patterns.
Finally, once you know, the larger pattern, determine what the pattern is for the week and then the day you want to trade.
What happened when the market opened? What occurred in the last four hours? Are the patterns the same or was there a reversal during the four hours?
Assess what the patterns mean.
Take a last look at the news and decide if it is time to place a trade and for how long and time your trades perfectly with our Forex Indicators and other tools.
You want to narrow your assessment of the market to the timeframe and currency you plan to trade before you enter a trade. It is important that your focus assesses the bigger picture before you narrow your study to one currency pair. You do not want to have surprises because you missed the bigger pattern.
The current pattern for the day matters greatly to how you are going to enter and exit the trade. If you plan to enter a trade, make 100 pips profit in an hour, and exit the trade, you need to know the pattern supports this plan.
For example, in a support and resistance trend, it is possible to see a currency pair fluctuate to certain known points. As you probably already know, you can trade on these fluctuations with near certainty of the profit you can make. Setting up a trading plan with a clear timeframe ensures you stay in the pattern you are trying to make a profit on.
For success in forex trading, you need to understand your own trading psychology. What pitfalls do you make? What losses occurred due to panic, greed, euphoria, or fear? Were there mistakes in your trading plan? Did you have a trading plan?
Before you make another trade, assess who you are and your patterns of behavior. If you need to seek a professional to help you figure out your patterns of behavior and help you decide who you are. Once you know yourself better, you can create a trading plan that helps you reduce your emotions.
High Risk Warning: Please note that foreign exchange and other leveraged trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved, seeking independent advice if necessary.
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