According to research in South Africa, in many of our articles we highlight the importance of having a good Forex trading strategy, however understanding the psychology of Forex trading will also help you deal with emotions that can distract you from a clear decision-making process.
Spending the time to build a solid foundation of Forex knowledge and applicable experience is important not only because you must know what you are doing, but trading is stressful.
If you aren’t completely grounded in your Forex strategy then you will quickly and easily give into the mind games that you may allow to happen in your head.
In other words, you will trade currency with emotion and recklessness not logical and according to a plan.
You can really know your trading knowledge and STILL be affected emotionally and psychologically when you trade.
Often, it is the psychology of Forex trading and not a lack of knowledge or skill in application that allows you to make trading mistakes.
The unfortunate truth is that some people are just better at handling this kind of mental stress then others.
You can make yourself more prepared and equipped to handle the psychological side of Forex trading by being aware of what you are doing and knowing the steps that you can take to handle it better.
The danger of the wrong mindset
There’s many reasons why people that try Forex day trading lose money. One of the main ones is that they come into trading Forex with the wrong mind set from the beginning.
Most people are attracted to Forex with ideas of earning a lot of money quickly.
In other words, they start Forex trading with preconceived unrealistic expectations.
These unrealistic expectations cause a Forex trading mindset in most traders that they need to start earning profits right away and this causes a lot of pressure.
Pressure often leads to mistakes and is usually followed by losing all your trading capital.
When you begin trading with this pressure to earn profits, you trade emotionally, which is the fastest way to lose your money.
To be a little bit more specific about “emotional” trading, let’s go over some of the most common emotional Forex trading mistakes that traders make:
Greed
When doing any kind of trading the main goal is to make money. Good Forex traders need a strong drive to earn to be successful. This drive can quickly turn on you if you aren’t careful.
In healthy amounts this drive to achieve monetary gain is necessary. But this normal drive and ambition can become unhealthy when it takes over your trading decisions.
Your drive for profits most be moderated and should not interfere in Forex trading practices that are formulated by logic not emotion.
The first step for conquering greed is to develop a disciplined approach to Forex trading.
You must formulate a trading strategy and develop the mental discipline to stick to it throughout the course of a trade, even when your mind and emotions are screaming for you to do something else.
Make sure your responses to market developments are calculated and based on the principles established by your knowledge and study of the market.
Fear
Fear is a natural and healthy emotion. It keeps you safe by driving you to avoid dangerous situations. It is part of the flight or fight response that is hardwired in us.
But fear can also have a hugely negative impact on our behavior if it is not kept in check.
You will naturally on instinct gravitate to the safest option in order to feel safe but this isn’t always the best thing to do, in life or in Forex trading.
Sometimes the safest and best option is actually to go against fear and take actions that may seem to put you at further risk but are actually the best and most fruitful thing to do.
This is what it is like when you follow a carefully planned Forex trading strategy. It can seem riskier and scarier than cutting the trade early but in the long run is the best and safest option.
Giving in to the fear, however, could keep you from the profits you could have gotten and even worse, it could cause you to make rash decisions.
With the hope of turning a losing trade around fear can result in losing much more money than you would have if you had just left it to play out.
Instead of focusing on the long-term plan, your mind wants to focus on making the best out of this short term losing position.
Fear can strike at any time and at any Forex trader, no matter their level of knowledge and experience.
Of course, this fear can manifest itself in different ways depending on the person and how much trading ability and experience they have.
Fear has the opposite role of greed in our Forex trading decisions. Instead of inspiring us to trade recklessly, opening and closing positions quickly and overtrading, fear paralyzes and causes inaction instead of over action.
Fear says that nothing will work, not even with great market analysis, and a solid trading strategy and the knowledge that you have been building up.
A fearful trader won’t trust his own logic and will therefore make rash emotionally driven panic decisions that is more like gambling then Forex trading.
Fear is NOT being conservative. Being conservative in your trading decisions is a good and calculated thing because you are willing and able to act on a trade when the data, market, and patterns, confirm a profitable risk/reward prospect for a trade.
Revenge
Sometimes when a Forex trader has a trade lose that they were positive would win, then they start wanting to get their “win” back.
They want to get revenge on the market for having them lose. Sounds irrational right? Well emotional trading is irrational.
The reality is you can’t get revenge on the market because, well it’s just intangible data.
Always keep in mind that losing trades are just part of Forex trading. It happens to everyone and it’s not personal. Take emotion out of the picture.
Euphoria
Who doesn’t like to feel joy and euphoria? That feeling of elation when something goes your way is amazing and addictive.
It can also be very damaging; if you let it affect your trades in a negative way that causes huge losses.
If you make a string of profitable Forex trades, and that feeling of euphoria begins to give you a false sense of overconfidence and bravado that you cannot lose, then you’ve already lost.
Your trades will be reckless, and you will lose. This is the Forex trading version of getting a big head.
It’s important to always keep in mind that the Forex market is volatile and can change at any time and at the end of the day, you are only as good as your last trade.
Having a string of wins or losses does not impact the outcome of the next trade.
What will impact the next trade is how good you are at recognizing when to enter and exit trades in a logical and thought out manner.
Panic
Panic is the opposite of euphoria. In a panicky situation, the Forex trader feels that nothing can go right and that no matter what they do there will be losses.
This happens especially in periods of great market volatility. If the market fluctuations are volatile and increase in depth and frequency then this can effect your predictions greatly.
This can cause panic if the market condition lasts long enough.
Forex trading in a state of panic can commit all kinds of errors. For example, closing a profitable position too early expecting that it will reverse quickly.
Trading Bias
Another aspect of the psychology of trading is called Forex trading bias.
Bias in Forex trading is where an investor makes a decision based on pre-conceived ideas of what will or won’t work, without considering the evidence.
A trader might feel confident in their ability to remain calm and collected during their Forex trading sessions before the market opens, but trading live is a different thing all together.
It’s very easy for emotions to get involved when you are making hard and fast decisions during a trade. It’s impossible to suppress your emotions.
The best you can do is learn to work with them and keep your emotions in a manageable state of check.
Try and recognize if you are exposed to one of the following psychological biases of Forex trading:
These are an overlap of the emotions we spoke about before but specifically on how it creates a bias in the way you trade.
Overconfidence Bias
Humans are naturally self-centered and we are constantly looking to validate our egos by proving that we know what we are doing.
The problem is that if not kept in check, too much validation can turn quickly into over confidence.
It is common that a Forex trader gets overconfident after a string of winning trades and this will certainly end in failure if this confidence makes you reckless.
Always make sure you analyse your Forex trading sessions and look at your wins and losses in detail.
Anchoring Bias
Anchoring is a tendency to rely on what is already known to a trader because of past movement and currency patterns and letting that effect your decision making in the future.
This is instead of being aware that there can be new situations and changes in the future market.
Anchoring can cause a trader to use obsolete and irrelevant information because they were anchored to it and wouldn’t adapt to the market.
This can show itself by holding a losing position for too long just because they wouldn’t consider other options or realities that they did not see or consider at first.
You need to keep learning if you want to have a long and profitable career in Forex trading.
By anchoring yourself to outdated strategies and knowledge, and by not being willing to let go and grow, you will increase your chances of big losses.
Confirmation Bias
Confirmation bias is the most common Forex trading bias amongst professional and experienced traders. It is also the biggest bias in the academic world.
People with experience and knowledge start slipping into the mental state of only looking for information that will support a decision they have made, regardless if the data and evidence is there to support it.
It just becomes a way of justifying your actions and strategies. This is a very dangerous place to be and can cause a vicious cycle of sorts.
Loss Aversion Bias
Fear is a big motivator. A Forex trader might cut a good trade short resulting in very low profits, just because they are afraid the market might turn at any time.
In other words, the trader was more afraid of potential loss then maximizing (in a planned and intelligent way) his already trending profits.
Often people want to make the safe bet when given a choice. Rather the devil you know than the devil you don’t know, so to speak.
Because of this, we choose a lower possible loss over a higher possible reward. This is also known as risk aversion.
When you’ve overcome trading bias and are ready to take your trading experience to the next level, the best way to do it is to expand the possibilities of your trading platform by
Some other things to keep in mind
Most Forex traders trade way too much and their primary mistake is to over-trade.
Only trade according to you Forex trading plan and make sure the moves you make are logical and calculated.
Don’t trade on gut instinct and don’t trade because you feel like it or are addicted to chasing prices.
This leads to emotional Forex trading that can be very hard to stop and will cause damage to your trading habits and your trading account as well.
The only way to succeed is to be disciplined in Forex trading. Have a solid trading plan and keep a trading journal; use them and don’t trade without them.
You need to think of Forex trading like a business instead of a hobby. Be calm and calculating.
Operate with a disciplined routine during your entire day trading session and you will soon be able to keep your emotions at bay and not let the market “get in your head”.
Conclusion
The best and most direct piece of advice that one can give when dealing with the psychology of Forex trading, is to develop a trading plan and stick to it. It is crucial that you come to terms with that fact.
Emotions such as fear, euphoria, and greed are normal, however, your success in Forex trading will rest on your ability to push these emotions aside and function logically and systematically according to your Forex trading plan.
Understanding the psychology of Forex trading will help you deal with emotions that can divert you from your trading plan. Acknowledge the presence of these emotions and train yourself to be able to function highly despite them, according to research in South Africa.
