DEFINITION of 'Trading Psychology'

The emotions and mental state that dictate success or failure in trading securities. Trading psychology refers to the aspects of an individual’s mental makeup that help determine whether he or she will be successful in buying and selling securities for a profit. Trading psychology is as important as other attributes such as knowledge, experience and skill in determining trading success. Discipline and risk-taking are two of the most critical aspects of trading psychology, since a trader’s implementation of these aspects is critical to the success of his or her trading plan. While fear and greed are the two most commonly known emotions associated with trading psychology, other emotions that drive trading behavior are hope and regret.

BREAKING DOWN 'Trading Psychology'

For an understanding of trading psychology, consider some examples of the emotions associated with it.

Greed is an excessive desire for wealth. Greed often causes traders to stay in a profitable trade longer than is advisable in a bid to squeeze out extra profits from it, or to take on large speculative positions. Greed is most apparent in the final phase of bull markets, when speculation runs rampant and investors throw caution to the winds.

Conversely, fear causes traders to close out positions prematurely or to refrain from taking on risk because of concern about large losses. Fear is palpable during bear markets, and it is a potent emotion that can cause traders and investors to act irrationally in their haste to exit the market. Fear often morphs into panic, which generally causes markets to decline at a much faster rate than they advance.

Regret may cause a trader to get into a trade after initially missing out on it because the stock moved too fast. This is a violation of trading discipline and often results in the trader getting in too late on the trade.

Successful traders have some common psychological traits that contribute to their success. These traits include –

  • Know your limits and do not over trade.
  • Risk management is the key to preserving trading capital and attaining trading success.
  • Maintain trading discipline at all times.
  • Know the difference between not fighting the trend and following the herd.
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