Forex trading psychology is associated with the mindset of a trader. It plays an important role especially in the career of a new Forex Trader. A new trader is generally influenced by multiple factors like greed and the fear of losing money.
As a new trader, you need to understand that Forex isn't a get rich quick scheme. It's nearly impossible to have all your trades be profitable. You will have good days and bad days.
Forex Trading Psychology Definition
- Forex trading psychology refers to your emotions and mental state in reference to trading. Good and bad emotions can be detrimental to trading. Yes, even good emotions can cause a negative reaction. That's why you have to learn how to control them in the good and bad days.
This is trading in a nutshell. What really matters is how you react to a loss. A trading loss can be devastating. It can easily hijack your emotions. Which can lead you to the typical problems like getting out of trades too quickly, holding on to them for too long, skipping trades on fear of losing or simply getting into more trades than you should in an attempt to get some winning trades.
None of these reactions are constructive. In fact, they can be critical if you don’t learn how to handle losing trades.
1. The Difference Between Good and Bad Traders
The major difference between the successful traders and failed ones is how they handle their trading losses. Successful traders take the losses as an opportunity to learn and improve their trading.
Coming back from a loss is always challenging. But success is never achieved by ignoring your trading losses. So if you want to become a successful trader you need to take your losses as an opportunity to become a skillful trader.
This is where forex trading psychology comes in handy. Learn how to control your emotions and you'll become a better Forex trader. Let’s discuss 7 rules that traders need to follow to stay focused and become more disciplined.
2. Never Let a Bad Day Cost You More Than You Make on an Average Winning Day
If your average profit on a winning day is $200, you should not lose more than that on a bad day. Knowing how to minimize risk is the most important part of Forex trading psychology.
Typically there are 4 possible outcomes to a trade; a big profit, a small profit, a big loss, or a small loss. You can be successful if you can simply eliminate the big loss from your trading days.
Risk Management is the primary difference between a successful and an unsuccessful trader. A proper risk management plan can steadily increase your profits.
While a poor risk management plan can wipe out your entire account. If you follow the 1% risk per trade rule, a precise stop loss level presets that 1% value.
Then you’d know beforehand the amount you risk losing should your trade turn negatively. And this goes hand in hand with the second rule.
3. Know the Stop Loss Level Before You Ever Get Into the Trade
A stop loss is a simple tool, but many traders and investors fail to use it. Any trading style can benefit from them to prevent excessive losses or to lock the profits.
A stop loss is just like an insurance policy that you hope you never have to use. But you always know you have protection when you need it.
So, always use a stop loss and know its level before you even get into the trade. You should also refrain from widening your stop losses when the market goes in negative territory.
You should stick to your planned stop loss knowing that there's another trade around the corner. If your trading strategy relies only on a single trade you must think of changing it.
Always remember that trading success is the accumulation of several winning and losing trades. If you remember that, you're forex trading psychology is starting out well.
What is Forex Trading Psychology?
- Forex trading psychology is all about learning how to control your emotions. Can you recover from a bad trading or trading day? What about when you've had a good trading day? The high that comes from that is addicting. As a result, it leads to greed. Which, in turn, leads to loss. Can you control your emotions from both good and bad trades?
1. Forex Trading Psychology Says Don’t Get Into Revenge Trading
A big loss can cause all sorts of emotional problems. For example, revenge trading, anger, frustration, and so forth. Especially, when a big loss it pushes you to immediately place your next trade.
But at that moment, you need to put that anger behind and stop yourself from revenge trading by thinking that there are nearly 250 trading days in a year.
You'll have many opportunities to recover your loss. If you do so, you'll give yourself the time to review your trading strategy, analyze your mistakes, and make a sensible decision for the next trade.
Always remember that revenge trading is extremely dangerous for two main reasons. First, it takes you away from trading discipline. Second, it shifts your focus from your trading strategy to recovering your losses only.
So, in any case, you must avoid revenge trading. That's how you'll reach a peak level of Forex trading psychology.
2. Forex Trading Psychology Says Accept Responsibility
If you’ve suffered a big loss you need to own it. You should never brush it aside, hide from it, or blame it on anything else. You can always find an excuse for a losing trade.
But as a trader, you must accept that you are responsible for whatever happens with your trades. If you don’t, the same thing will happen again.
So the right way to move forward is by accepting the responsibility and see what you could have done differently. This approach will help you to reduce the chances of having a loss again.
It may also help you to change the asset you are trading or change your trading style. That's what Forex trading psychology is all about.
3. Stop Trading for Awhile
Just when you think you've tried everything, sometimes, it’s better to take a break to find out your mistakes. This will get you back to a better mindset that'll help you to refocus.
It'll give you time to review the events carefully and you would be able to analyze where you fell short. For instance, you may find out that you were taking too much risk or holding the losing trades for too long.
You may also find out that your trades were not well planned. And perhaps you were not mentally sharp during that period. Forex trading psychology for the win!
Taking a break from trading is one of the most difficult things to do for a trader. But a break can help to preserve your investment, save your sanity, and focus on other things.
Perhaps, the market was too volatile when you were continuously losing and a break from trading may provide improving market conditions. If you're too emotionally involved in trading and deciding to take a break is getting harder, think positively to convince yourself that this break is going to give you better trading ideas.
4. Trade Small Lots
After a losing streak, your confidence can shatter. As a result, not having a clear mind can also cause you to be overly aggressive. This isn't a good sign from a trader’s perspective as trading huge lots can accumulate to your losses.
At this stage, you should take a step back and start trading in a demo account. After all, it's fake money and there's no trading pressure. So it's easier to focus on trading and not worry about the losses.
A few winning trades in a demo account will once again raise your confidence and bring you back in a better mental state. Your Forex trading psychology improves.
Then you can get back to your real account and start trading with small lots. Don't jump right back to the same lot size you were trading earlier.
In the first few days, keeping trading small lot sizes and every winning trade will build your confidence. Then you can go back to a slightly higher lot size and gradually start trading with a lot size that your trading plan permits.
A winning day with a small position size will help build confidence, and you can slightly increase your position size as the account balance goes up.
Embrace the Process
Trading is a continuous process of learning. And that's why Forex trading psychology is important. Just like in real life you also need to learn in trading from your mistakes.
Losing money should become a motive to analyze your actions, reading more, and educating yourself should be a part of your trading.
The more you learn the more informed you will be on the market condition and that is what you need to have the odds in your favor.