Trading Psychology

What is Trading Psychology?

                   Trading Psychology simply refers to the feelings and emotions of a trader experiences and the associated actions the trader takes as a result. Just like in any other aspect of life, understanding how our mind works can improve our ability to trade better, take more informed, rational decisions and calculated risk.

                   For instance, you might have seen people take emotional investment decisions. So even when the price of a stock in their portfolio is declining, they might keep holding on to it because they regularly use the products and services of that company and trust the company enough to take the risk. In this case, admiration leads them to overlook the evidence. It is therefore crucial to understand how to identify such emotions and to control them to prevent losses. Traders with better control over emotions tend to make more rational choices and thus often end up with more profits.

Some Prominent Emotions Faced by Stock Traders

While we experience a range of emotions on any given day, there are some prominent ones that affect trader psychology that we would like to talk about today.

Fear

One of the first emotions that comes to mind when talking about stock trading is FEAR. It is a natural emotional reaction to a perceived threat. When you place a trade, you expect the market to move in the anticipated direction. Fear starts creeping in when the movement is in the opposite direction.

The potential loss instils fear in the mind of the traders and causes them to make sudden decisions to square off their positions without a plan. Since human beings are designed to combat fear is ‘fight or flight’, most traders opt for the flight (or redeem) option since they cannot fight the direction of movement of the stock price.

Some common situations where traders face stock market psychology fear are-

Not initiating a trade due to the fear of not getting it right

Not selling a losing trade since they have to book the loss and the possible potential of recovering losses if the price starts increasing

Selling too soon due to the fear of losing profits, etc.

Greed

After fear, GREED is the most common emotion that stock traders have to battle every day. In simple terms, it is a disproportionate desire for profits. This is a tricky emotion since traders are there in the market to make profits. So, how much profit is too much profit?

If the markets are performing as per their expectations, then why should they exit the position? Why not continue holding the position and make more profits? 

These are typical thoughts that GREED drives in our minds. This is more common if the markets are bullish and prices are rising. It pushes traders to hold on to winning positions much longer than advisable and throw caution to the winds. While optimism is good, there is a thin line between greed and optimism that each trader must identify and ensure that it is never crossed.

Hope

The only thing that separates stock trading from gambling is mindless HOPE. While ‘hope’ is a positive emotion, when it is not embedded in logic, it can lead to heavy losses. 

Imagine purchasing a share since your analysis suggests that the price will increase during the day. After an initial hour of a surge, the stock price starts dropping. You are unable to understand the reason behind the drop in prices. This is when HOPE walks in and forces you to believe that if you hold on to your position for a little longer, the price will start increasing again and help you recover your losses.

Traders who don’t know how to control mindless HOPE tend to destroy their trading capital with a few wrong decisions. It stops them from cutting their losses and/or booking profits even when the markets are in their favour since they HOPE for more. If GREED attaches itself to HOPE, the results can be akin to gambling – disaster!

Regret

Let’s say that you plan to purchase stocks of ABC Limited since you think its price will increase during the day. At the last moment, you decide against it and hold back. Within an hour, the stock price rallies and doubles in value. This is where you start feeling REGRET.

WHAT IF I would have placed the trade? I missed out on a golden opportunity. I knew this was going to happen. Such thoughts cloud your mind, and to make up for the lost opportunity, you might buy the stock at a double price after convincing yourself that the price will increase further. While this might seem like a logical decision at the time, it will be based on REGRET and not analysis. Hence, more often than not, you will find yourself on the losing side of the trade. 

On the other hand, there might be a position that you might take even though you are not sure of it. Say that you are unsure about the price of ABC Limited rising but invest in it nonetheless since many experts are banking on it. As the day progresses, the stock price starts falling. This is another place where REGRET can step in, making you sell the stock without analyzing its performance and potential recovery during the day.

While trading in stocks, it is important to remember that you will miss some opportunities or have a few bad trades. Accept this reality and calm your mind whenever you face any such event.

Fear of Missing Out (FOMO)

A term that gained popularity due to social media, FOMO has existed long before we even knew computers. FOMO is a social anxiety that starts from the thought that others are benefitting from an opportunity that you are missing out on.

It is an anxiety that causes traders to take positions much after the window of opportunity has closed. 

Ego

When you trade in stocks, it is important to remember that you will probably lose more trades than you win. While this might seem demotivating, once you understand and accept this possibility and create robust risk management to maximize your winnings and minimize your losses.