Trading Psychology
All the great gurus of stock markets always emphasize the principles of Value investing, stressing how anyone can yield the benefits of compounding from a good stock by being invested for a longer duration. Yet we often see the retail investors deviating from these principles, either because of their greed of making quick money from the stock markets, or for the adrenaline rush of daily transaction of stocks — Trading.
As statics shows, only 1 out of 100 traders make an overall profit from the Market, & most of these traders bust their trading capital completely in the first 90 days. If you’re reading this article & have managed to survive these first 90 days without busting your account, then you’re already in the race to reach that top 1%.
4 skills are required to become a profitable trader — Fundamental Analysis, Technical Analysis, Risk management & Trading Psychology. Among these the most difficult skill to master is, no doubt, learning how to build a Trading Psychology.
The first step towards mastering your psychology while trading, is knowing the common mistakes that most traders do in Markets. So, let’s start by understanding the top 3 Psychological mistakes:
1. F.O.M.O Trading
“It’s already 1 pm, But Markets seems very Bullish. It's no harm if I take one trade & do some quick scalping”
“Recently it is announced in a news channel that this stock will hit the upper circuit today, thus I must trade on this stock”
These are common examples of FOMO (Fear of Missing Out) Trading. The majority of the traders in the Market are not full-time traders. Hence, they tend to rely on secondary sources, such as — online stock scanners, news from Tv channels, Tips from various social media handles &, etc.; for stock selection or trade recommendation. Often these trades, without following one’s own back-tested strategy, result in losses.
Solution: Cut down the noise/Become a loner-trader for a while!
Most successful traders often take at most 2–3 trades in a week or even in a month. Trading is never about the frequency of trades, rather of accuracy. Try cutting yourself off from ‘outside noise’ and wait for the opportunity to come into your setup & then only take your trades. This will also improve the risk-reward ratio of your trades.
2. Revenge Trading
“Yesterday, I have lost a significant sum on this share. Today will be surely different”
“If I will lower my stop-loss for the 3rd time today, this trade will surely start moving in my direction”
Does it remind of any past trade? These are common examples of Revenge Trading. These mistakes happen when you start mixing your emotions into trading. Instead of accepting that you cannot have 100% accuracy when it comes to trading, you start pushing losses with the hopes of your trade will soon take a U-turn. This mistake is a prime cause of huge losses that retail traders make.
Solution: Cut down on our trade size!
The market is always supreme. Never try to dictate what you want from the market, instead start to accept whatever move the market makes. Accepting these rules is often difficult, hence start with reducing your trade size. Also, never hampering your risk management by doing averaging a trade that is heading south. The quicker you will cut off the loss-makers, the sooner your profits will increase.
3. Gambler’s Fallacy
“Share price can go either up or down, hence my probability of a profitable trade is 50%”
“If I have made a loss on my first trade, then if I reverse the direction of the same trade, I may make a profit”
To understand this mistake, let's take an example of the fair coin toss. In a 10 round coin toss, if the first 5 toss results in ‘Heads’, then what is the possibility of ‘Tails’ appearing in the 6th toss?
Similarly, Changing the direction of trades and wishing for the reversal of the losses; or, after making 4 continuous losses & betting heavily on the 5th trade wishing it will be profitable to recover all the losses is futile.
Solution: Realize trading is a Test match, not a T20!
Instead of fixating on the result of a trade, start seeing your trades as a series of events. It may happen that even after having a correct trading system & proper risk management for trades, there could be a streak of losses due to the volatile market. Hence, to evaluate the success percentage of your system have at least 20 trades to validate your hypothesis.
Conclusion: Though technological advancements have transformed the working of Stock Markets by providing various functionalities to retail investors, it has also raised various red flags on the extent to which Stock Markets could be manipulated. Hence in my next article, I will shed some light on the market manipulations.
Reference Sources:
Book:
Trading in the Zone: Master the Market with Confidence, Discipline, and a Winning Attitude — By Mark Douglas
Links:
1. https://www.chegg.com/learn/statistics/introduction-to-statistics/gamblers-fallacy
2. https://www.orbex.com/blog/en/2019/08/the-destructive-power-of-revenge-trading
