The popularity of speculative trading in the financial markets, partly due to internet-based retail trading solutions, has created a new population of traders. Most of these traders are non-professionals attracted by the potential to generate revenue quickly.
Falsely Created Expectations
Many novice traders may believe that it is very easy to make money, especially when they are trying a broker service using a free practice account.
However, if these traders manage to generate a sudden substantial return, it can lead them to believe that trading is an easy occupation—one in which revenue can be quickly generated with little work by the trader. For the inexperienced, one good pick can make it seem like market speculation is the key to success and wealth.
Unfortunately, when these inexperienced speculators overtake this virtual investing environment and decide to start trading live accounts and risking real money on the market, the activity becomes much more complex. In many cases, the days of outstanding day-trading performance come to look suddenly and distressingly like old souvenirs—it is an abrupt initiation into the pitiless reality of the financial markets.
Real Life vs. Practice
When new traders take the leap from their virtual trading accounts to trading with real money, they enter into the most difficult step of their initiation to trading: trading psychology.
In other words, while it may be easy to trade when the risk of loss does not exist, when the trader's hard-earned dollars are thrown into the mix, his or her focus and price objective can go out the window. Often, traders using virtual accounts will feel relatively comfortable even when the market moves against the positions they enter. This allows them to keep their focus on their price objective and wait for the market to get moving in the right direction. Because there is little consequence tied to "virtual money," personal emotion does not interfere. Unfortunately, when a trader's actions come to affect the gain or loss of his or her own personal assets, that trader is less likely to behave in such a methodical way.
Emotions Can Rule the Trade
Emotions can be a trader's worst enemy. They often lead to misjudgment and losses. Feelings generate what psychologist Roland Barach calls "mindtraps" in his book, "Mindtraps: Unlocking the Key to Investment Success." Barach provides a collection of 88 lessons explaining the pitfalls, such as fear and greed, that hold many traders back.
Greed can lead a trader to hold on to a position too long in hopes of a higher price, even as it falls. This emotion has been the main reason behind many trades that have gone from large gains to large losses. To thwart this emotion, try to take an objective look at the reasoning behind your positions. When one of your positions experiences a large run-up, ask yourself whether the reasons behind your initial investment still remain; if not, it may be time to close or reduce the position.
Fear can prevent a trader from entering trades and lead to taking them out of positions far too early. If an investor is too concerned with potential loss and the risks that come with an investment, they can often be dissuaded from a good opportunity. Also, if a trader is more susceptible to fear, they may sell out of an investment far too early based on the fear of losing the gain they've made. In many cases, this can prevent a trader from cashing in on a much bigger gain.
Paralyze by Analyze
Paralyze by analyze is a phenomenon in which traders get so caught up in analyzing everything about a potential investment, they never actually pull the trigger on the trade. In this case, what often happens is the investor will constantly question all of the little details found in the analysis in an attempt to perfectly analyze a situation. This is a truly unachievable task, which can prevent a trader both from making monetary gains and from making experiential gains by getting into the trade.
A wide range of other emotions can rule a trader, but the important thing for any market participant is to recognize these emotions.
Acknowledge Your Emotions
All traders will experience at least one mindtrap, but the very best traders learn to recognize, understand and neutralize them. This process forms the foundation of any trader's training. Therefore, if you want to become a successful trader, you should first spend some time getting to know yourself and the particular mindtraps you tend to fall into. A skillful trader tends to have a strong desire to master their emotions and prevent them from affecting their performance.
Traders are only human. Perfection in trading does not exist. However, profitable trading can be achieved when a trader learns to manage their emotions. This will be easier for some than for others, yet only through experience can this skill be developed. Before you can learn how to win, you must first take some risks (or at least get into the market) and learn to master the emotions that come with making and losing money.