Understanding Trading Psychology

Stock and bond markets are fundamentally groups of people all trying to make decisions with incomplete information. Understanding psychology can be key to learning the way decisions are made.

Frequently Asked Questions
  • How do you be emotionless while trading?

    While it’s impossible to completely eliminate emotion from human thinking, there are ways to limit irrational thinking while trading. The key is to understand the cognitive biases that humans have and adjust your behavior accordingly. In addition, don’t deviate from investing plans you’ve made in advance just because of a downswing in the market, as you’re likely to react too strongly out of fear.

  • What is trading psychology?

    Trading psychology is the application of the field of psychology to financial trading. Doing so allows you to understand the ways in which humans react to financial markets in ways that follow human biases. This can help understand how the market works the way it does as well as minimize these in your own trading. The relationship between finance and psychology is explored in the field of behavioral finance.

  • What cognitive biases undermine traders?

    While virtually any cognitive bias or other psychological pitfall can hurt trading, two of the most common are confirmation bias and the sunk cost fallacy. Confirmation bias is when you give more weight to data that confirms what you already believe while giving less to info that proves you wrong. It’s critical to try and work extra hard to evaluate and take onboard data that disproved your ideas, as your first instinct will usually be to discount it. The sunk cost fallacy is the idea that previous losses or costs should contribute to your decision, making when nothing you can do will get them back, and so you should only make trading decisions based on their effect on the future. For example, if you’ve invested a lot in a business that turns out to have a bad business model, you should act as if you were looking at it as a fresh investment without regard for money you’ve lost previously.

Key Terms

Explore Trading Psychology

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Cognitive Dissonance
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Market Jitters
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Sunk Cost Dilemma
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Peace Dividend
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Value Trap
Positive Mental Qualities of Successful Traders
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Media Effect
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Behavioral Finance: Biases, Emotions and Financial Behavior
Solvency Cone Definition
Top 4 mistakes that cause futures traders to fail
Office Building
Confirmation Bias: Overview and Types and Impact
Chasing money
Sunk Cost Trap
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Regret Theory
Scale In: Overview of the Trading Strategy
Positive Feedback
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Regret Avoidance
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Cutoff Point
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Net Order Imbalance Indicator (NOII)
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Fulcrum Point
Hot Hand: What it is, How it Works, Evidence
Home Country Bias
Fighting the Tape
Bid Whacker
Sunshine Trade
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In The Pink: Meaning, Overview of the Slang Investing Term