How Psychology affects Trading

How Psychology affects Trading

Humans are slaves of their mental boundaries!

The world has changed; from funds to fund houses to hedge funds, from money to corpus to Algorithmic trading, from pit trades to exchange trading to block trading and so forth.

Does trading psychology affect online trading, have a glimpse to know more!

God created human mind and it changed the world dramatically. Financial world is no exception which gets affected by human psychology. Rather, for participants of the financial world, who are expected to be “wealth maximizers”, psychological stability plays a vital role. Human minds place events into different mental compartments, and hence each event has a different impact on our behavior. Let us talk about the most crucial factor that affects our trading i.e. our psychology!

World is full of challenges and trading in financial markets is among the most challenging endeavors. Successful trading involves the human minds’ ability to handle complex and difficult situations in financial world and to control one’s behavior to overcome the complexities involved in trading. Success and rewards in financial trading are offered only to those who have mastered the art and science of trading and that is the biggest fascination that attracts humans towards financial trading. Trading is not just to understand markets but to develop a psychology of not making mistakes. For that put yourself in scenarios where you will make mistakes and then develop your behavior that best suits the difficult stress full situations in trading.

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Over decades, trading products have grown leaps and bounds, platforms have gone through a ground-breaking change, financial world has changed from a simple ring to highly advanced technologically driven online platforms. But what has not changed is the dependency of trader on his psychology. Where there’s money, there’s emotion and when emotions play their role, they drive traders’ minds and then, the result is dramatic.

The big question is whether it affects the overall market for good or bad.

The answer depends upon the condition!

 

Greed, fear, confidence and anger are the most protruding psychological factors that affect trading and for most of the times, tinkle with the risk management system of the trader. Amid these factors, some traders keep holding loss making positions for more than the stipulated period whereas others exit the positions too early. Many investors may get carried away by overestimating their ability to beat the market. While others instigate their trade with a long-term perspective but then make decisions based on short-term movements and ideas. If you are not God, emotions might affect your trading too. Human psychology, most of the times act as a barrier to achieve our financial goal, whether it is in trading or in investments. Although invisible, psychological barriers can be just as impenetrable as more obvious barriers like systemic risk.

Trading Account

Traders often form opinions about the market and whatever information that flows in the market that supports their opinion is always given more weightage against the information that is contradictory to their view.

Traders should always identify the barriers that are restricting them from achieving their trading goals and develop a trading plan to remove them. Before a trader begins to trade he or she must take into account the following factors:- overtrading; herd behavior; favoring the familiar stocks; disposition effect (selling winning positions and holding onto losing ones); and hyper optimism, overconfidence (self-attribution bias).

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A very basic example that comes in mind where traders succumb to human psychology is the act of excessive trading even though the trade was initiated with long term investment idea in mind.

The question that arises here is that, do we keep on buying and selling the home, on a daily basis, in which we have put hard earned money to finally stay in it? If the question seems bit funny, why do we do the same with the assets we had purchased with the same intention? The answer lies with the human psychology.

Human mind lies at the pinnacle of our body and should be the root cause of the successful trading but if used inefficiently, might pose the biggest of risks. To overcome it, a trader is expected to climb the mental ladder and exercise discipline in his trading.

Emotional challenges come in our way of rational trading making it a difficult proposition. No matter how well the trading strategy is or how well it has gone through the statistical tests, the strategy will always have an element of risk and will be open to failure in different market conditions. The essence of successful trading will lie in how a trader responds to those inevitable losing trades and how well he overcomes those situations and executes his ability to manage risk and remove biases.

Understanding traders’ logic’s become imperative to have a bird’s eye view of situations that lead to irrational decision making. As trader we need to first master ourselves before we can master the markets. Patience is a trader’s virtue and mental accounting is the first subject to master. Commitment is the foundation stone on which the skyscraper of trading ability is built. One cannot just get up and become a successful trader overnight. It needs commitment, pledge, discipline and a strong psychology to be fully engaged in trading. The last one makes the most of the difference between a successful trader and a failure. When trades go in your favor a strong psychology helps maintain calm whereas when the time isn’t that good, it provides a cushion and helps stay in the game!

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