Welcome to my Masterclass.
In this lesson you will learn what the foreign exchange market is all about and how we are able to take advantage of the worlds biggest exchange.
The other skill you need to master
Trading psychology might sound like a made-up phenomenon, but it’s a very real thing. The markets may not have emotions, but as a person, you do. Thats why trading psychology is so important. This is also part of what makes trading such a rollercoaster: you feel those intense highs and terrible lows.
You’ll never be able to totally remove human emotions from trading. However, gaining an understanding of the psychology of trading can help you remain calculated and level-headed when the heat is on during a trade.
To attain and maintain a sustainable long-term career as a trader, it’s incredibly important to cultivate a mindset where you can stay calm during trades and avoid succumbing to emotional reactions.
But as a human, how do you keep visceral reactions in check so that you can approach trades from a place of emotional strength? It takes effort. You’ve got to work on understanding trading psychology and guiding your mind to set yourself up for success.
Ready to get mental? In this chapter, we’ll share our take on some of the most common emotions in trading, how they affect traders, and how to avoid giving in to them.
Below you see the psychology curve of Wall Street investors. Although investing (long term buy and hold) is not the same as speculating (what we do - taking action on short term market opportunities), the emotions that arise during a trade are exactly the same.
What is Trading Psychology?
To dissect the meaning of trading psychology, let’s look at both parts of the term separately: trading and psychology.
You already know what trading is, but what does psychology actually mean?
According to Merriam-Webster, psychology is defined as “the study of mind and behaviour in relation to a particular field of knowledge or activity”.
In the case of trading psychology, this would be your emotions in regard to trading. After all, successful trading depends just as much on controlling your emotions as it does on your ability to signal trade entries and exits.
So many losses and bad trading decisions are made because traders get emotional in trades and lose their better judgment. This is when they make stupid decisions, seemingly forget every trading basic, and neglect to follow their carefully thought out trading plan.
Unfortunately, when you abandon your trading plan and try to buck against trading basics like capping you risk at 1%, things usually don’t end up very well. To attain and maintain success as a trader, you really have to work hard to cultivate a mindset where you don’t let your emotions get the best of you. This is what trading psychology is all about.
Reducing Errors in Judgment and Impulsive Actions
Now you know what trading psychology means. But why does it matter? Why is it worth spending time to develop and refine it in your trading career? Improving your trading psychology can have incredible effects on your trading career by helping you reduce errors in judgment and impulsive actions.
How so? First off, it’s an opportunity to consider how trading psychology affects you personally. Considering your own reactions during trades can clue you in on triggers that prompt you to make bad decisions.
For instance, you may notice that whenever you begin to lose money in a trade, instead of trusting your plan and keep your stop-loss at 1%, what you do is begin to panic when price comes near your exit price. You rationalize holding on to the position longer in hopes that things will turn around and decide the remove your stop-loss.
As many traders who have done this know, it rarely works out that way. Usually, you end up losing a lot more with that “hold and hope” mentality. As a rule of thumb: whenever you feel yourself "hoping" for anything with regards to trading, be very careful not to self sabotage!
When you become mindful of your personal tendencies and emotional reactions in trades, you’re able to identify shortcomings that are holding you back. Once you begin to identify such behaviors and what causes them, you can begin to take steps to change them.
By working on eradicating these emotionally reactive responses, you can develop a stronger sense of steadiness while trading.
Unhealthy risk-reward ratio’s, and holding on to losses is a psychological phenomenon. Most traders have a tendency to avoid losses at all costs. This is also known as “loss-aversion” theory, or “Prospect Theory”. It means that losses tend to have a bigger impact on traders (and people in general), than an equal amount of gain does.
When an average trader wins $1.000, this leads to less emotional impact, than when it would have been a $1.000 loss. That’s the reason many traders hold on to their losing trades, and turning them into big losses, as they can’t accept the loss. This obviously creates an unhealthy risk-reward ratio.
How Prospect Theory works is illustrated in the next matrix:
The 4 Emotions of Trading
When it comes to emotions in trading, the big four that tend to get traders into trouble are greed, fear, hope, and regret. Let’s take a look at each of them:
This isn’t the movie “Wall Street,” and you’re not Gordon Gekko. Greed is not a good thing for traders. Here’s what it can make you do:
Set unrealistic price targets. Greed can make you set unrealistic price targets based not on reality but on what you wish you could make from a trade. This is a real problem, because while you’re dwelling on how much more you could make if you stay in a trade, you could be missing out your chance to either cut losses or maximize profits - as your trading plan dictates. With this mentality, you’re not looking at the trade clearly, and are more likely to make bad decisions that cost you money.
Ignore the rules. Greed can make you do dumb things like ignore intelligent risk-management practices. When you’re in a greedy mindset, you can get so blinded by the idea of what you could make, that you take risks and gamble. Unfortunately, this attitude can get you in a lot of trouble - I’ve seen more than one trader lose all their money by ignoring the rules.
While caution is good in trading, fear can mess with your mind. A fear-motivated trader is more likely to do the following:
Give in to panic. When your trading decisions are rooted in fear, you’re more likely to do things like sell in a panic, regardless of the price. The inability to weather normal market events like pullbacks. Fear won't allow you to step back and determine whether or not entry and exit points are intelligent, thus disabling you from executing successful trades.
Avoid risk entirely. As a trader, you want to do all that you can to mitigate risk. But it’s a simple fact: The markets are volatile, and it’s impossible to trade without assuming some level of risk. If you’re completely risk averse, you could find yourself suffering from the “paralysis of analysis” - where you’re so caught up in reviewing the technicals that you become too scared to actually execute trades in a timely fashion. You may also find yourself avoiding quality setups because you’ve been burned before.
Fall into the FOMO trap. On the flip side of being risk avoidant, fear can also inspire rash behaviour like chasing setups that have already taken off, simply because you’re scared of missing out on the action. Unfortunately, chasing setups is rarely a good strategy. It makes you ignore rules and risk management practices. But more importantly, if you’re chasing, you’re already behind the curve and sound risk to reward is already out of the door.
Generally, hope is viewed as a good thing. However, as a trader, it can lure you into a deluded sense of security that things will work out in a trade - even if price action tells a different story.
This so-called “hold and hope” mentality can make you do things like this:
Wait for price to turn around. It’s humbling to admit that a setup isn’t performing as you’d hoped. A false sense of hope can lead you to believe that things will improve if you just hold on to the trade a little longer - even if there’s zero evidence or data pointing towards that happening. Instead of doing the responsible thing and cutting your losses, you hold on in vain.
In situations like this, often enough the price will continue to plummet or rise, compounding your losses. And just as you can no longer take it, and close the trade for a massive loss, price immediate reverses and sky rockets to your target. I've seen this happing so many times, I can't even count. There even is a special saying amongst traders to illustrate this nerve racking fact. When a rookie trader asks an experienced trader on how long a market can go up without pulling back, they say that it can go up indefinitely until you decide to buy it.
Wait for a catalyst that may never come. Traders with a false sense of hope might also trick themselves into believing that there’s a huge catalyst (confluence factor) just around the corner that will save the day. This could be the outcome of a future news event, or price approaching some inflection point. In this situation, you might hold out hoping that the upcoming catalyst be in favour of your trade position.
Of course the exact opposite could (and probably is) true, leaving you with an even greater loss once price impulses out the other way. News flash: This is trading, not a movie with a guaranteed happy ending. To expect that things will turn around with no hard data is magical thinking, not logical thinking. Hope is not a strategy!
Regret can paralyze your thinking, life, and overall well being! It’s a beast of an emotion in trading. Here are some common reasons why traders feel regret:
Missing a trade. Every trader will feel regret about the trade that got away at some point. However, it’s important to remember this: There will always be another trade. There will always be another chance. By wasting your time obsessing about the one that got away, you may, in fact, be missing out on current and future opportunities.
Not taking profits. Did you wait too long, disregarded your trading plan and miss out on maximum profits? Or, did your trade slide from green to red? Hey, you’re not alone. This happens to every trader from time to time. Instead of kicking yourself about it, take the time to evaluate where you went wrong - at what point should you have taken profits when looking at your trading plan. Learn from this experience, and resolve to do differently next time.
Losing money. To the best of my knowledge, no trader has ever jumped for joy at a big loss. However, it’s part of the game. If you’re so traumatized by loss that you can’t move forward, it’s going to be a problem. Losses are part of trading as you know by now. Just as every business has a cost to operate, a trader has losing trades as their cost to do business. Instead of dwelling, take the time to consider if you could have done anything differently. If you learn from the experience, then there’s value in the loss.
How to Improve Your Trading Psychology
Ideally, you’d trade as if you were a computer: based on facts and data and without any shred of emotion. If you were able to do so, you’d probably have a higher win rate and wouldn’t have the same emotional gut reaction to things like having to accept losses.
However, as much as you can aspire to that, the fact is that you’re human. You’ll never totally be able to shut off emotions in trading. But you can take steps to improve your reactions so that your suffering can be minimal.
Here are some tips for how to improve and refine your trading psychology:
1. Get Yourself in the Right Mindset
As a trader, you can benefit from daily pep talks and self-motivation exercises. No, that doesn’t mean that you need to go all Tony Robbins on yourself. Simply reminding yourself of things like the fact that market prices are not personal can be powerful reminders. Of course, another effective way to get in a positive state of mind for trading is to give yourself the gift of time.
If you’re constantly waking up at 8:02 a.m. and scrambling to study and prepare before the trading day begins, you’re more likely to approach trading from a flustered and rushed state of mind. It’s much harder to maintain a level head like this.
Try waking up a little earlier so that you have time to acclimate to the day. It may help to set up a morning routine of working out or meditating before you start your research, so that you can approach trades from a calm and relaxed mentality.
For example see the trading setup below. A perfect swing reversal setup with a nice high test candle at resistance. You decide to take the trade, and initially all goes as planned. As with almost every position price pulls back at some point to almost your entry point. What would you do if you were not completely level headed and confident in your strategy? What if your previous 2 trades were losses? Would you have closed the trade for a little over break-even to avoid the potential loss and stress that goes with it? Or would you have sticked to your plan and ride it out??
Taking a few moments to get centered and make sure your head is in the right place before you start trading can have positive ripple effects all day long. You might not totally be able to remove emotions from the equation, but it can help reduce potential damage when you find yourself making quick decisions.
2. Have a Great Base of Knowledge
One of the best ways to improve your trading psychology is to increase your knowledge. Having a strong base of knowledge about how trading works will set you up to make better decisions, both long-term and on the fly.
By gaining technical prowess about how trading works, you are better able to navigate the many curveballs that will be thrown your way throughout the course of a trade, and react in a calm manner.
Think about it this way: You’d never take on a huge home repair without educating yourself about what’s involved with it and the potential things that could go wrong. You’d want to be prepared for all outcomes, which requires knowledge and research.
With trading, educating yourself can prove similarly helpful in allowing you to minimize risk and make smarter decisions. One of our goals with this training masterclass is to help new traders create a strong knowledge base that is applicable and actionable in trading.
We make sure to educate you not only on the basics, but also teach you how to actually use that knowledge and the trading techniques to be able to make profitable trades. A strong foundation of knowledge is always a good thing, and it will help you make more informed decisions as a trader.
3. Imagine Winning
Olympic athletes will do visualizations of seeing themselves winning a race or game. It might not actually get them to win the gold, but it certainly doesn’t hurt their performance. Numerous studies have shown that visualizing practicing a certain activity is just as effective as actually getting off the couch and doing that activity.
Why not do the same with your trading? Visualizing how it might feel to make a killing on a trade can be very motivating, and it can help prompt you to try to figure out real steps that you can take toward making it a reality.
Physical inspiration can prove helpful as well, in the form of a physical list of your goals, or a visualization board featuring photos of things that you’d like to buy or achieve with your potential earnings. Not long ago, Forbes reported on a study about the power of vision boards.
According to their findings, “One in five small business owners used a vision board or other visual representation when starting their business; 76% of those business owners said that today their business is where they envisioned it would be when they started it.” By imagining the best case scenario, you can inspire yourself to achieve more.
4. Imagine Losing
Expect the best, but prepare for the worst. Visualizing a big win is important, but you should also take a few moments to consider how it might feel, or what it might look like to lose big too. Look at it from a perspective where it’s a preventative exercise that can keep you from making truly foolish mistakes. By considering the worst that could happen, you can take proactive steps to avoid such outcomes, and potentially save yourself from blowing up your account.
Often, the element of surprise can work against you in trades, prompting knee-jerk reactions on your part. You may find that making a list of what could go wrong will help you maintain a level head if you are faced with needing to cut your losses or other blocks in the road.
The fact that various scenarios have crossed your mind will make them easier to handle if they actually happen. By considering what could go wrong in a trade, you can make a more detailed trading plan to save you from negative outcomes. The more realistic and detailed your trading plan is, the more likely you are to stick with it.
5. Remind Yourself That it’s Real Money
Did you know that some traders actually keep a stack of cash on or near their work area? True story. But why do they do it? For two key reasons. First, seeing physical cash can be a powerful motivator of what you’re working toward as a trader. It reminds you that as a trader, this is what you could stand to gain: real, cold, hard cash.
However, the second reason might even be more important. Physical cash is a reminder that when you’re trading, it’s real money at stake. When you’re trading online, it can be easy to forget that the numbers on your screen are actually representative of dollar signs. They represent dollars that actually belong to you. You are purposefully and willingly risking this money in hopes of gaining returns.
Remembering this fact can help you make smarter decisions with your money. You don’t want to lose that money. So be sure to be responsible: Always do your due dilligence, make a trading plan, and approach trades in a meticulous way.
6. Observe the Habits of Successful Traders
Imitation is the sincerest form of flattery, or so they say. When it comes to trading, you never want to copy another trader’s work exactly. Not only is it bad manners, but it just doesn’t work. There are simply too many variables in trading, to copy someone else’s methods exactly and hope for success. You’ll always be a step behind, and that means you’ll never have an edge as a trader.
However, that having been said, observing the positive characteristics of successful traders and cultivating aspects of them or methods into your own trading can be extremely effective for your own improvement.
Piecing together the successful methods that work for others can make you a stronger trader. It can also help you observe the positive effects of good trading psychology. So do look at what others are doing well, and try to see how you can incorporate their methods, habits, or traits into your own unique style of trading.
7. Practice, Practice, Practice
You’re rarely good at something the first time you do it. Trading is no different. In this trading masterclass, we teach our students the skills and strategies they need to know to move forward as traders. Diligent study and hard work will absolutely make you a stronger trader.
However, time can (and likely will) be your biggest teacher. Practice is also the best and most reliable way to gain the mental strength it takes to trade and to improve your trading psychology. To put the strategies you've learned to the test we encourage all our students to back-test the hell out of them. One of the amazing features of Tradingview is, that we can go back in time. Trade like it is January 1st 2018. This way we are able to get massive amounts of chart time and experience in the market, without risking one real dollar of our hard earned money.
Every tip listed in this post will be most effective over time and with practice. None of them are intended to be a one-time exercise, otherwise, their effectiveness will be limited.
8. Observe Your Progress Over Time
One of the best ways to improve your trading psychology is to monitor, observe, and document your progress over time. An effective way to do this is to take daily notes in a trading journal. This might be in an excel document on your computer, or you might use the recommended Edgewonk trade journalling software. It might be handwritten notes. But keep a record of what you’re doing as a trader.
Document your successes, and try to see if there are trends or things that you are doing that are reliably making you money. On the flip side, take the time to keep track of things you’re doing that are reliably wasting your time and making you lose money.
Over time, this log will act as an invaluable resource to streamline and improve your trading and to make your mental clarity stronger on each and every trade. As humans it is easy to lose track of your overall performance when you just won or lost a few trades. The law of large numbers and random distribution of winners and losers will throw you off. Only when you re-examine your past trades and overall trade performance will you get a clear view on how you are performing and progressing.
Controlling Your Trading Psychology After Losses
Trading psychology can be a fickle thing. When you’re riding high after a profitable trade or two, you feel confident, in control and on track. But when things start going south or you lose money, you can quickly become a wreck and make bad decisions. These tips can not only help you get back on track after a loss, but they may help you avoid losses in the first place.
Stick With Your Trading Plan
If there’s one exercise that you do to strengthen your trading mentality, it’s this: Make a trading plan, and stick to it. A trading plan is like a roadmap for the trade ahead. You determine your entry and exit, the size of your position, and your risk and reward ratio, among other things.
Just by making the plan you’re more likely to stick with it, simply because it’s there. But it also helps you mentally prepare. If and when things do shift quickly in your position, you can refer to your plan. If the price reaches your predetermined points, you know what to do. A trading plan can help provide a feeling of security that can help get and keep you on track.
Follow Market Trends
One of the best ways to improve your trading psychology is to go with the flow. This may seem at odds with my earlier reference to trading like a machine, but hear me out. Many traders make the mistake of trying to bend the market to fit their needs or desires. However, it doesn’t work that way.
There are cycles to the market, and just because you like a certain asset or a certain style of trading doesn’t mean it will work in every market climate. The trading strategies that we lay out in this masterclass are very clear on that. When their criteria cannot be met, there is no trade.
One of the most important things to remember: sometimes the best trade is no trade. Many successful traders find this to be the most important aspect of trading. Knowing when not to trade is just as important as knowing when to participate in the markets. Don't try to mold the market. It’s bigger and stronger than you, and it always wins.
Importance of Stop-Loss Orders
Having a stop-loss in place can be a great way to ease your mind during trades. A stop order is an actual order type you can place with your broker. With a stop order, you specify that you will buy or sell a stock if and when it reaches a certain price. That amount is called the stop price. Once the stop price has been reached, the order is executed.
Stop orders can help stack the odds in your favour as a trader. Of course, you never have total control of what will happen. However, by putting the stop order in place, you’re making an effort that can have a positive outcome for your trade.
A mental stop is less tangible: basically, it’s making a mental decision or promise to yourself about when you’ll exit a trade for a loss. With a mental stop, you still have to do the work of executing the trade. So in a way, mental stops will require more willpower to actually make a plan and stick to it. When it’s automated, like with a stop order, you’re less likely to change your mind at the last second. Stop loss orders can help you cut your losses, so use them!
Be Disciplined and Never Stop Learning
To continue refining your trading psychology over time, consider these your two guiding principles: Be disciplined, and never stop learning.
They go hand in hand. Be disciplined about making and maintaining positive trading routines, and be diligent about following the market and continuing to read, study, and learn.
Be obsessive about learning about how trades work. Study the past behaviour of the market, and try to learn how they act and react the way that they do. Do all sorts of background work and become an expert on all areas of trading.
If you keep doing these things over time, you’ll be able to make more educated and tactical decisions about trades.
By taking the time to work on your personal trading psychology, you can improve your overall career as a trader. So much of trading is mental, so it’s important that you remain diligent and attentive, yet detached enough that your emotions don’t get the best of you.
Following the tips detailed in this chapter can help you take a big step toward becoming a stronger and more stable trader.