What Is Trading Psychology?
Trading psychology refers to the mental and emotional aspects that influence a trader’s decisions and behaviour in the markets. It includes how emotions like fear, greed, and overconfidence can lead to impulsive actions, often stopping traders from following their strategies.
You have to understand and manage these psychological factors for making rational, disciplined decisions that align with your trading plan.
How Psychology Can Impact Trading
On paper, trading can seem simple. However, the reality of trading is much more challenging because of one significant obstacle: our psychology.
You might know what you should do in theory, but emotions and psychological biases often prevent us from following through. Fear of missing out (FOMO), overconfidence, loss aversion, and even biological reactions like the release of dopamine and cortisol can disrupt our decision-making.
For example:
- FOMO drives us to trade in high-uncertainty markets, even when we know it’s risky.
- A streak of profitable trades can inflate our confidence, leading us to take lower-quality opportunities.
- We close potentially large-winning trades early, just to lock in a smaller, immediate win due to our aversion to loss and desire for instant gratification.
Overconfidence from previous wins can lead to reckless behaviour. Meanwhile, during losing streaks, our brains release cortisol, a stress hormone that sends us into a negative spiral. We make poor decisions, such as taking trades without a positive expectancy, or increasing risk in an attempt to recover losses.
This is the battle between logic and emotion, and it’s where many traders sabotage themselves.
Can We Remove Emotions from Trading?
A common piece of trading advice is to remove your emotions entirely. The idea of trading like a robot, purely rational and emotionless, seems appealing. But is it possible or even desirable?
Renowned neuroscientist Antonio Damasio once studied a patient whose brain damage prevented him from feeling emotions. On the surface, it seemed like this patient could make purely rational decisions, ideal for something like trading. However, when asked to choose between two appointment dates, he spent over 30 minutes analysing every possible factor, he was paralysed by indecision.
This shows that emotions are critical to decision-making. If we had no emotions, we wouldn’t be able to make effective decisions because we would get lost in endless cost-benefit analyses.
So, the goal isn’t to eliminate emotions from trading. Instead, we need to understand how emotions influence our decisions and how to manage them.
The Root Cause of Self-Sabotage
Most traders don’t realise that their self-sabotaging behaviours are symptoms of deeper psychological root causes. To truly address these issues, we must first understand what’s happening in our brains.
This area is huge and it would take a long time to cover. But just to summarise, there are four key fields: psychology, behavioural economics, neuroscience, and neuroeconomics. Together, they give us insights into how our minds work in trading environments. By understanding concepts from these fields, you’ll be able to recognise potential issues before they derail your performance, and diagnose problems when they appear.
Moving Forward
The important thing is to understand that trading psychology is about far more than staying calm or avoiding emotional decisions. It’s about truly understanding the way your brain operates and how emotions, hormones, and biases impact your decision-making.
In our program, we show traders how to build an integrated model of the “trading brain,” allowing them to take control of their mindset and, in turn, their trading outcomes. With this knowledge, they can manage the psychological traps that undermine their performance.