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Forex Market Psychology

A trading psychology, based upon how well you know yourself and are able to profit from your strong points, as well as control you weak ones, has a lot to do with how successful of a trader you will be. When you truly know yourself, then you are aware of how you are going to react under certain circumstances and you can protect yourself from self-damaging actions or decisions when it comes to managing a trade.

The overlap between trading and psychology is complex. Psychological factors, such as performance anxiety, can interfere with clear-headed decision-making about markets. Similarly, poor trading practices - such as taking on too much risk with excessive size - can magnify the normal stresses of the marketplace. Sometimes it is difficult to separate chicken and egg. Many traders put their money at risk without a demonstrable edge. It is difficult to imagine such trading *not* generating frustration over time. Other traders ground themselves in solid methods, but these may not fit their talents, skills, or personalities. A very short-term, aggressive method of scalping markets, for instance, may work fine on paper, but prove completely unworkable - and stressful - for a highly analytical, risk-averse trader.

Sometimes, however, trading psychology problems have nothing to do with trading. They are the results of pre-existing problems that will not be solved by different trading methods. Nor will they go away with simple coaching advice to control emotions and build discipline.

Your biggest enemy when trading is you. It is not the market, the market makers, or the world events. It is you! If you do not have a professional psychology then you will make the wrong decisions and lose money on a consistent basis. Here are the keywords, and concepts that you need for developing a professional trading psychology:

Trading psychology rules

  • Trade with a DISCIPLINED Plan: The problem with many traders is that they take shopping more seriously than trading. The average shopper would not spend $400 without serious research and examination of the product he is about to purchase, yet the average trader would make a trade that could easily cost him $400 based on little more than a "feeling" or "hunch." The plan must include stop and limit levels for the trade, as your analysis should encompass the expected downside as well as the expected upside.
  • Examine all of the facts carefully before you make a trade. Don't let excitement, fear, or someone else's influence cause you to enter or exit a position before the circumstances match YOUR guidelines.
  • What goes up must come down and what goes down should eventually come back up. A good trader understands that there are times when it is better to be in an all cash position and watching the market from the sidelines.
  • Don't let temporary circumstances erode your convictions. You know that you should take steps to protect your profits when a trend is weakening. So, do it. Likewise, you know what to do when the stock resumes trading up. So, do that, too.
  • Don't fall in love (or hate) with your stocks. The stocks do not care that you own them, and they are not your friends. Your only friend is your trading psychology. Pay attention to the technical aspects and do the right thing based upon your own system. Do not marry your trades: The reason trading with a plan is the #1 tip is because most objective analysis is done before the trade is executed. Once a trader is in a position he/she tends to analyze the market differently in the "hopes" that the market will move in a favorable direction rather than objectively looking at the changing factors that may have turned against your original analysis. Traders with a losing position tend to marry their position, which causes them to disregard the fact that all signs point towards continued losses.
  • Remain emotionally detached from the market and the excitement that its movement creates. Don't constantly check your share prices all day long (unless you're day trading). If you get caught up in "tick" watching then you are going to make wrong decisions based upon greed or panic. There is no valid psychology that includes greed or panic.
  • Unless you are a day or swing trader, the day-to-day prices of your stock are not that important. Stay focused on the large trends and do not try to react to every market move.
  • Unexpected things, both good and bad. Understand these events, be prepared for them, and take the appropriate actions. A good psychology takes into consideration that you cannot predict what is going to happen in the market.
  • Unless you're trading in short positions, only increase your position when prices go up, not down. Generally, when a price starts to move it usually continues in that direction for a while.
  • Establish and honor stop-losses to protect your money. When the stop loss is triggered, act immediately. Do not have second doubts. Avoid holding on to a losing position because you "hope" that things will turn around. Falling stocks will usually continue to fall until something positive happens to arrest the decline. You could be wiped out waiting for that magical moment. Get out of a bad trade and use the money to execute a different trade. Cut your losses early and Let your Profits Run. Most traders violate their predetermined plan and take their profits before reaching their profit target because they feel uncomfortable sitting on a profitable position. These same people will easily sit on losing positions, allowing the market to move against them for hundreds of points in hopes that the market will come back. In addition, traders who have had their stops hit a few times only to see the market go back in their favor once they are out, are quick to remove stops from their trading on the belief that this will always be the case. Stops are there to be hit, and to stop you from losing more then a predetermined amount! The mistaken belief is that every trade should be profitable. If you can get 3 out of 6 trades to be profitable then you are doing well. How then do you make money with only half of your trades being winners? You simply allow your profits on the winners to run and make sure that your losses are minimal.
  • Do not over trade. One of the most common mistakes that traders make is leveraging their account too high by trading much larger sizes than their account should prudently trade. Leverage is a double-edged sword. Just because one lot (100,000 units) of currency only requires $1000 as a minimum margin deposit, it does not mean that a trader with $5000 in his account should be able to trade five lots. One lot is $100,000 and should be treated as a $100,000 investment, instead of as the $1000 used as margin. Most traders analyze the charts correctly and place sensible trades, yet they tend to over leverage themselves. Because of this, they are often forced to exit a position at the wrong time. A good rule of thumb is to trade with 1-10 leverage or never use more than 10% of your account at any given time.
  • Trade only trend. It even does not important what time scale have you been using! The only difference is in stop-loss/target size: trading with longer-term trends requires large stops as well as larger potential targets. The most common trader's mistake here is in trying to follow larger scale trend with more comfort shorter stop-loss.
  • Do not tune yourself for quick profits because in most cases only correction movements are quick and sharp. The trend-following system will require you to hold a position for a more extended period of time. So, learn to be patient. When you try to open a position to get quick profits, in most cases it means that you are just trading against the trend.
  • Let profits run. There is natural psychological reaction to take profit too early because of fear that the market can reverse and eat trader's profit. Use protective trailing stops instead to exit profitable positions.
  • Use stop-loss orders to cut your losses. It is always difficult to accept series of losses, but there is no way to trade without losses. Learn do not feel guilty about losses. We know one trader who was trading successfully during 8 months and more then doubled his account. He finally sold EURUSD from 1.2400 and could not agree to close this position at 1.2500, 1.2600 and so on. His account was killed around 1.3400.
  • Do not pyramid loosing positions in a hope to exit on break-even point. Add only profitable positions.
  • Use money management to control the risk. Never over-leverage your position because 7-8 loosing trades in a raw could ruin your account. The simple calculation gives us 1:200 probability of such event. Never risk more then 2-3% of your capital in one trade.
  • Use trading system to avoid subjective or intuitive decision making. Act without hesitation when you are trading system generate trading signal with good profit potential. Always learn new ideas about technical analysis and trading systems: read books, articles, forums, attend seminars in order to build your own profitable trading system.
  • Use written trading plan. Develop self-discipline following your trading plan.
  • Learn how to control your emotions, fears and stress. Use different psychological techniques most suited to you. Remember that good trading system equals to only 50% of successful trading. You can have good trading system but stay around zero income for years only because of poor psychological training.
  • Learn on your mistakes. Write your mistakes on the diary and try do not repeat them.

Your psychology is a tool that enables you to predictably control your emotions and make decisions based upon cold, hard facts. Without this, you are going to be swept along with the stock market currents until you are eventually washed away in a tide of red ink.

When it comes to trading, one of the most neglected subjects deals with trading psychology. Most traders spend days, months, and even years trying to find the right system, but having a system is just part of the game. It is very important to have a system that perfectly suits the trader just as it is important in having a money management plan, or to understand all psychology barriers that may affect the trader decisions and other issues. In order to succeed in this business, there must be equilibrium between every important aspects of trading.

When you lose a trade, what is the first idea that pops up in your mind? It would probably be, "There must be something wrong with my system" or "I knew it, I shouldn't have taken this trade" (even when your system signaled it). Sometimes we need to dig a little deeper in order to see the nature of our mistake, and then work on it accordingly.

When it comes to trading the Forex market as well as other markets, only 5% of traders achieve the ultimate goal: to be consistent in profits. What is interesting though is that there is just a tiny difference between this 5% of traders and the rest of them. The top 5% grow from mistakes; mistakes are a learning experience, they learn an invaluable lesson on every single mistake made. Deep in their minds, a mistake is one more chance to try it harder and better the next time because they know they might not get a chance the next time. At the end, this tiny difference becomes the big difference.