This section describes major psychological problems facing traders. It is mostly the beginners who are faced with such problems because experienced traders find ways to adjust and tackle, one way or another, their psychological issues. For beginners, the reason of losses is largely psychological.
Let’s make a list of the main “enemies” of a successful trader (the ones hidden inside the trader him-/herself).
- Lack of discipline
- Seeking to make as much profit as possible (greed)
- Seeking to make profit as early as possible or to immediately make up for losses if incurred (overtrading)
- Overestimation of one’s abilities
- Lack of confidence in one’s abilities (or in one’s strategy)
- Trust in authoritative figures
- Hope for a favourable outcome of the market situation
- Fear of an earlier untoward situation being repeated (develops, to some extent, after the first incident)
The above list of “enemies” is hardly complete, but using the examples given we will try and elaborate on the most typical problems faced by traders.
Lack of discipline is a common problem inherent, to some extent, to any person. There is no such thing as 100% discipline. In some professions, it may be unimportant while in others, lack of discipline can prove disastrous. A trader must maintain discipline and work to cultivate discipline if he/she is not confident in his/her abilities.
Lack of discipline can show itself as negligence when entering and exiting the market, failure to keep trading records and reports, or unsystematic (generally speaking) trade – at any time of day, in any volume and with any first “liked” instrument. The number of transactions per time unit changes depending on the mood. Decisions to enter, exit or maintain position are taken based on random factors that can include anything from moon phases to medical condition of the trader.
Placing no protective orders (Stop Loss or Take Profit) is another sign of the lack of discipline. This can result in losses that are significantly larger than expected by the trader, or the profit available as a floating profit will not be fixed, while the price will change unfavourably.
To imagine the effects of such behaviour, think what a monkey could do if allowed inside a cockpit to pull levers, push buttons, and do whatever it likes. The chances that the plane would reach the destination are near to zero. Even if, at some point, the monkey lost interest in the levers and buttons and started eating a banana, the result would still be the same.
Seeking to make as much profit as possible (greed) is quite understandable, but rather detrimental to the trading. A beginner trader inspired by the fact that he/she may have an instrument helping to build an enormous wealth from the movements of currency exchange rates, naturally wants to acquire as much wealth as possible (and, preferably, as fast as possible). This desire makes the trader break the simplest rules of money management. However, entering the market with a volume that is too big is not, by far, the only consequence of the greed and, probably, not the most harmful one.
The worst act of greed is to close the position too early if it starts to bring profit. In a situation where a transaction has generated a so-called “floating” profit, the greed makes the trader fix the result, and to do so he/she needs to close the transaction. Such behaviour reminds of a gardener who plants a seed and then digs it out every hour to see if a sunflower has started to grow. Moreover, such behaviour contradicts one of the “golden rules” of trading: cut down the losses, but do not let the profit flow!
Too close orders, like Take Profit, are often placed in order to close the transaction as soon as the first profit is generated. Protective Stop Loss orders are usually not placed at all in this case. The trader hopes that he/she will be able to close the majority of transactions with profit; however, he/she has no idea what to do with negative transactions with a huge loss, and when there are too many transactions like this he/she becomes helpless.
However, if a trader is capable of controlling and restraining the greed within the reasonable limits, the greed can have a positive effect by helping overcome fear (see below). The thing is that a more or less experienced trader has certainly suffered heavy losses. Seeking to make profit helps overcome the fear of similar situations being repeated.
Seeking to make profit as soon as possible or to immediately make up for losses if incurred (overtrading).
The greed shows itself, among other things, by making the trader carry out a maximum number of transactions per a time unit. Assuming that every transaction has a potential to bring profit, a beginner trader goes by the logic that the more transactions are made, the more profit can be generated. As at the same time he/she tries to close even the smallest profit, the trade pattern of a trader like this consists of several dozens of profitable transactions followed by one or two large unprofitable transactions that remove all the profit and often lead to the loss of the deposit.
We are by no means trying to discourage the trader from using strategies such as pipsing, scalping etc. However, the trader should clearly understand what drives him at any given time point: strategy or greed. As part of the strategy (if the trader clearly understands the goal and risks of the transaction) short-term and very short-term transactions can take place. However, if a trader cannot explain why he/she has closed a transaction, he/she should analyze if the greed interferes with his/her work.
Another manifestation of greed is a constant uncontrollable averaging of an existing unprofitable position in an attempt to make it profitable or, at least, breakeven. This also results in an excess number of transactions and large volume of operations which breaks money management principles.
Seeking to enter the market immediately after incurring losses (a desire to recover losses) often makes the trader act emotionally and recklessly, which frequently results in a huge loss or a significant drawdown. As a rule, beginners try to recover the loss by doubling the volume of a transaction following the loss. Frequently, a re-opened position leads to an even bigger loss, and after several such iterations, nothing is left of the deposit.
At this point, we should make a note that there are strategies that require entering immediately after closure of the previous position. For example, a so-called reverse closure (a situation when a re-opened counter transaction closes the existing one and at the same time opens a position in a reverse direction). It does not mean that this strategy will fail. A difference should be made between entering the market in an emotionally unstable state in order to make up for the loss (which is not recommended) and working calmly under a clear strategy, which in terms of external features may be similar to such emotional behavior.
Beginner traders often overestimate their abilities in two cases
In the first instance, this happens when the trader starts out in the Forex market. As a rule, inspired by advertising slogans and reading one or two smart books (more commonly, short articles rather than books) the trader decides that he/she has found the “Holy Grail”, that this is going to be his/her “big break” and that from now on, all of his/her financial difficulties are resolved. The first success with demo-account makes the trader overestimate his/her abilities even more. You should be aware that working with a demo-account is practically free from psychological influences and in no way can be treated as similar to work with a real trading account.
At this stage (due to the lack of experience), the trader has not known the bitterness of defeat or suffered big losses, which boosts self-pride.
The second wave comes after the trader has lived through the results of first losses, gained considerable experience and had a chance to trade maintaining a constant, relatively stable growth of the deposit for a while. Sometimes, traders who, on the one hand, are no longer beginners but, on the other hand, have not yet reached the level of professionals, decide that they can “see” the market, have merged (emotionally) into it or acquired some other mystical abilities.
Overestimation of one’s abilities usually leads to the trading that is more aggressive than reasonable. Particularly, too large volumes are used to enter the market; no protective stop orders are placed (the trader is certain that he/she will not make mistakes and/or will always be able to close the transaction at the market price); the recommendation to diversify assets is ignored.
The effect of the lack of confidence in one’s abilities (or in one’s strategy) is as harmful to the trading results as that of the overestimation. The lack of confidence usually appears after each of the first 3-5 serious losses (loss of the deposit or fixation of a rather long series of unprofitable transactions). The lack of confidence can also appear if the trader has developed a strategy that should react to certain market conditions that won’t arise and there is no opportunity to trade or trading results in losses. Additional cause of the lack of confidence can be the opinion of other market players, especially when it is completely different from that of the trader. This is particularly true of beginners who lack experience and can be influenced by authoritative figures (see below).
The most common sign of the lack of confidence is a desire to avoid trading, i. e. not to enter the market for as long as possible. Even when favourable conditions arise (as judged by the outsider who is not interested in the trading of this particular trader and is not influenced by negative psychological and emotional factors), the trader who lacks confidence will find a reason not to enter the market. The result is stress related to low profit and money downtime.
Wanting to leave the position (to close transactions with loss “to avoid bigger losses” or with a small profit “to prevent it from turning into loss”) soon after entering the market is another sign of the lack of confidence. This should not be taken for greed, although the external features are similar, the motives behind trader’s behavior in such situation are dramatically different from those described above.
It often takes a long time to overcome the lack of confidence. Statistical study on trading strategy behavior using historical data as well as the statement analysis may help significantly. If the trader can make sure that his/her strategy was profitable in history, his/her confidence rises.
Trust in authoritative figures shows itself more evidently against the lack of self-confidence. However, even a confident beginner may be prone to this psychological problem. The biggest influence on traders is various glorified Forex “gurus”. Often they make money by selling their “signals”, “recommendations” or “forecasts”.
Common sense is what will save a beginner trader from the influence of authoritative figures. You should ask yourself why this specialist sells advice instead of making money by trading if he/she is really that good or whether he/she follows his/her own advice.
Trust in authoritative figures can result in working with an explosive mixture of a trader’s own judgments and opinions from several authoritative figures published in different sources (sometimes containing misrepresentations). With such potpourri, it is very difficult to differentiate between the things that matter and those that do not matter at all. Moreover, opinions of two different authoritative figures can differ substantially or contradict one another.
Education and autonomy in decision making are the only answers to this challenge. Trust in authoritative figures that can be regarded as a negative psychological and emotional aspect should not be confused with a normal, rational and reasonable wish to consult the calendar of events for the next week. Projected indices published in a quality calendar are compiled by experienced analysts and are worthy of consideration. Nevertheless, you should not take them as dogma, they are merely possible scenarios.
Hope for a favourable outcome of the market situation is closely related to the fear of loss. For a beginner trader, the fact that loss is a natural part of trader’s work is, at the very least, disputable. When the trader starts out he/she thinks he/she will make only profitable transactions (or, at least, will have a minimum number of small losses). Hope manifests itself in such a way that the trader does not fix non-profitable transactions hoping that the market will reverse in a favourable direction and he/she will be able to close transactions with profit. Surely, a “hoping” trader places no stop orders. He/she has no intention at all to close a transaction with loss.
For trading, hope is a bad advisor. The trader should monitor and analyze market situation and his/her responses should be flexible. If at the moment of entering the market the trader regarded the situation as favourable for, let’s say, a buying transaction, everything can change drastically within a few minutes. The trader should have no inner resistance to accept an unsuccessful entrance and fix losses when they do not exceed the normal risk level. In literature, this situation is sometimes called a “mistake”, though we are absolutely against the loss being called a mistake. The loss is one of the two possible and equal outcomes of any transaction.
Cases where the trader entered the market in violation of his/her own rules make an exception. Selected instrument, volume or direction of the transaction is wrong. The trader was reluctant to make the transaction, but for some reason carried it out. Now, that’s a mistake. The trader should accept it as early as possible and fix the loss.
Fear of an earlier untoward situation being repeated
Generally speaking, it is an ultimate manifestation of the lack of confidence (refer to the above). Fear develops when losses are too huge or were incurred under the circumstances that were not expected by the trader or which he was not ready for. Fear makes the trader stop rather than slow down his/her activity and can lead to long-term negative consequences by making lose confidence for a long time.
There are, essentially, no ways to prevent fear, as it is impossible to guarantee that the trader will not incur significant losses. However, the trader can get morally ready to the fact that loss is part of his/her work. You should never assume that full loss of the deposit is absolutely impossible, that this can happen to anybody, but you. You should remember that market trading is highly risky, that is why you should work with such volume of money that you can afford to lose without any damage to yourself or your family.
Let’s also look at the aspects of trader’s work using the means from investors or creditors. Psychologically, money obtained from third-parties is more “difficult” for a trader than his/her own. It is especially true for money that is loaned or borrowed at interest as well as for money that was invested. The bigger the sum is the more stress there is for the trader. The only thing that can help is to forget about the sum being managed and work with any account strictly in accordance with one’s strategy. The PAMM service provided by LiteForex is quite convenient for this.