Trading psychology coaches, most notably the late Mark Douglas, have continually preached about the substantiality of psychology and why it might be the missing component for the average losing trader.
The well-documented high failure rate is probably less to do with a lack of understanding of the technicalities of forex but could perhaps be about a few classic psychological mistakes.
Psychology is certainly not an element worth ignoring because even the most skilled trader is prone to making emotional errors if they remain unchecked.
This article will outline 4 of the most common psychological challenges the average trader will face in their career and provide solutions to overcome them.
1. Fear of missing out (FOMO)
Fear of missing out or FOMO is a feeling trader will experience at some point in their journey.
It can come in different forms. For instance, one may fear missing out on a trading opportunity shown by another trader on social media or the internet, even when it is entirely distinct from their own strategy.
Another example is someone missing a trade and then entering at a much less favorable entry point, meaning they either have to use a much wider stop loss or make it too tight to compensate.
Both circumstances only scratch the surface of the FOMO trap. Regardless, such events stem from believing we should capitalize on every single trading opportunity, whether it comes from us or others.
The solution
- Traders must base their strategies only on the quality rather than the quantity of their positions. The balance to strike is not missing too many trades but also not taking sub-par setups either.
- One must stick to their trading plan and form a conviction of their opinions about the markets without external influence.
- Opportunities are abundant in the markets. For every missed opportunity, there will always be another around the corner. Unfortunately, it is rarely ever immediate, reinforcing the importance of patience.
2. Fear of being wrong
Trading forex is not about being right or wrong; it’s about probabilities. The natural human instinct of being right or wrong stems mostly from society involvement, where we equate the latter with failure.
Anyone who feels this way will very likely take it personally, feel vulnerable, and have little control. However, markets are always neutral at all times, and we should never have personal feelings towards them.
The solution
- The foundation of forex trading is an environment with a high level of uncertainty; this is the fact and harsh reality traders have to accept, unfortunately.
- Most traders who fear being wrong never think long-term. Therefore, they are likely to personalize a loss from one random individual trade, which misses the point of trading probabilities and strategies entirely.
It may seem difficult to imagine anyone can make money in a market with random outcomes.
Though like a casino, consistently profitable traders develop a form of ‘house edge’ where they know that they should increase their bottom line over an extended series of trades.
- The winning percentage does not correlate with being profitable. Therefore, technically, one can make money winning 40% or even less of their trades through the robust implementation of risk-to-reward.
- Traders must have the right expectations in line with the reality of the markets, and this starts with using the correct language. Instead of saying “Price will definitely go down,” a better statement is “based on historical analysis, this trade is likely to move lower.”
3. Fear of Losing Money
The fear of losing money and being wrong are interlinked. We know being wrong not only suggests a lack of intelligence but more often than not, there is a real financial implication.
Having a fear of losing money is actually not a bad thing, but it can equally also have negative consequences.
The solution
- Traders should never forget one of the golden rules of investing, ‘Never invest money you cannot afford to lose.’ In other words, one should always use disposable income or risk capital they will not need for living expenses.
- Once we’ve accepted the risk of losing money, traders have the luxury of deciding how much they are willing to lose through appropriate position sizing.
Risking small is a straightforward fix to overcome the fear because the impact of loss is little compared to risking a substantial portion. Despite the amount of evidence a trading opportunity may suggest being a ‘sure thing,’ there is never any need to blow an account since there are no guarantees for its success.
- Even when a trader is risking small, it is of no use if they have no confidence in what they are doing, risking real money. Therefore, they need to spend a considerable amount of time developing all aspects of their trading strategy and performance in the demo stage.
4. Exiting trades too early
Exiting trades too early is another psychological hurdle and can involve different actions. It also shares sentiments to the fear of losing money.
The common instances of exiting trades too early include manually closing positions before they’ve hit the stop to take a smaller loss or exiting a trade with a small profit well before a predetermined profit target level.
When one closes a trade before it reaches their stop, the belief is they are limiting losses. Conversely, a small profit reassures them they are not leaving any money on the table when markets are supposedly showing signs of going against them.
The solution
In nearly all cases, the simple fix to this problem is for traders instead to let the market take them out of their trades automatically instead of manually closing them. The implications of this shift are huge.
For instance, if a trader closes a position already in a loss though the market hasn’t yet reached the protective stop, they voluntarily take a loss. Price may move against them for a certain period, though it technically has not nullified their trading idea.
Technically, the price can still move towards the trader’s desired direction at any moment. Manually closing a trade could, in some instances, limit losses, but it will undoubtedly mean a trader misses many profitable positions as a consequence.
Final word
For many, forex might seem to be playing tricks on them. This belief does have merit because while markets are always neutral, a different mindset is required to navigate it.
While someone’s trading strategy forms a large part of their chances of long-term success, there are several psychological traps they should identify and fix right away to solve the puzzle of trading success.
