The Psychology of Forex Trading
It deals with the emotional condition of a trader when entering and exiting trades, looking for potential trade opportunities, or carrying out other trading-related tasks.
Usually, most traders experience losses because of negative emotions that poison their rational decision-making processes and cause them to make improperly planned trade decisions.
We, as humans, are innately emotional creatures, something which dictates our judgments. Eventually, even if you are an experienced trader, losses start accruing even in trades that could have been profitable.
Some traders think that divorcing themselves from emotions could solve their problems.
Without feeling afraid, it will be difficult to notice danger and escape from it.
However, in forex trading, fear is harmful when we allow the perceived loss-making threats to cause us to make irrational and unsound decisions.
Instead of motivating us to execute trades without worries, fear draws us back from making trades, convincing us that we are wrong. The fear of failure causes a psychological scare in our minds and send us dreadful warnings before making trade decisions.
For example, let’s say you have a long running position on the EUR/USD currency pair, and bad news comes regarding the state of the Eurozone economy, what would you do?
In such situations, most traders will feel scared, overreact, and quickly close the trade without a second thought. Even though they may be taking action to avoid losses, fear usually drives such decisions and could lead to missing out on the possible gains.
Fear in forex trading usually leads to ruins: as fear pushes traders to make unfounded decisions, their trading accounts get depleted slowly by slowly—until they receive margin calls.
2. If greed cripples your trading choices, then you’re drunk with it, and you’ll soon wipe out the trading account.
For example, traders intoxicated with greed usually fail to exit their winning positions because they think the market will forever obey them. Revenge trading usually takes place when traders try to make more aggressive trades, especially after experiencing losses.
Whereas the primary intention of revenge trades is to try to win back the losses, it often results in more losses than initially intended. You will speedily place trades without any planning or comprehensive analysis.
Secondly, because you become desperate to recoup the losses, revenge trading forces you to open trades with larger position sizes. You will ignore the risk management part of your trade plan just because you want to win back the losses quickly.
Lastly, it is an emotional trading habit that’s driven by the wrong motives. After a series of successful trades, a trader can become overconfident and start placing trades without careful analysis of the ever-changing market conditions.
Overconfidence can also cause you to risk too much capital, falsely believe in your analysis, or forget about your trading plan. Having a party after each successful trade is an emotional motive that can increase your trading flaws.
How to Overcome the Psychological Obstacles
Invest in forex education
Forex trading education is one of the critical ingredients for overcoming the above-mentioned psychological impediments. With proper training, you will gain essential skills for making rational decisions, instead of relying on your gut feelings.
If you want to blindly enter and exit trades without having sufficient reasons for making the decisions, you’ll become emotional, and hurt your trading capital.
You need to understand how the forex market operates and the factors that cause its movements. Typically, a trading plan consists of a set of guidelines and strategies for executing trade decisions.
A trading plan is usually created after doing an extensive analysis and studying the market behavior. Consequently, you’ll be taking trades based on feelings and without making any meaningful analysis of the market behavior.
With a plan, whenever there is a sign of trouble, you’ll not need to adjust your trade decisions fearfully or greedily. All your choices to enter and exit the market will be based on your predefined set of guidelines—giving no room for any emotion to cloud your mind.
For example, if your trade plan specifies that you will be entering retracement trades whenever the market bounces off one of the Fibonacci levels, you should stick to that rule as much as possible.
Here is a 4-hour chart of the AUD/USD illustrating how you could apply the rule.