The psychology of trading

31 Okt 2023

The psychology of trading presents one of the most significant challenges, especially for day traders.

Initially, when individuals enter the world of trading, they primarily focus on profit. Their thoughts are consumed by calculating how much they can earn. This focus on profit is entirely valid, as trading is, ultimately, a means to make money. However, the real trick lies in developing the mindset of a speculator. Over time, traders must shift their focus from profit to potential risk. The "Risk/Reward" calculator should be constantly running in their minds. If the potential for profit in a particular trade is low, then it's usually best to avoid it.

However, for beginners, it often doesn't work this way. Their unaccustomed brains are constantly bombarded by new emotions, with the primary culprits being greed and fear. These emotions lead to continuous, uncontrollable reactions.

To become a professional trader, one must learn to set aside these emotions. This is easier said than done. Everyone emphasises removing emotions from trading, but the reality is that emotions are deeply rooted in the subconscious, often overriding conscious efforts. To address this problem, a deeper understanding is needed, looking at the fundamental aspects.

Fear: Fear arises when confronted with the unknown. Take the example of children's fear of the dark. Darkness was a historic human adversary because it harbored predators that could potentially harm people. For a long time, human civilization lacked the technological means to repel these predators. In our instincts, fear equates to death. This explains the intense reaction generated by fear.

In modern times, cities are illuminated day and night, and predators are scarce. However, fear persists as if it's programmed into us. Why aren't adults afraid of the dark? They know there is nothing there. They are familiar with the situation, and this knowledge breeds confidence, mitigating fear.

Greed: Understanding the roots of greed is a more intricate task. In essence, greed can be traced back to a form of fear. Imagine that our ancestors spent hundreds of thousands of years in conditions of resource scarcity. Food, clothing, warmth, and more were essential for survival. Life depended on securing these resources. If you couldn't feed yourself, you'd perish; if you were cold, you'd die. Death, in this context, is equated with fear. To save your life, you needed more resources. To ensure an abundance of resources, you had to strive tirelessly.

Over millennia, for the sake of practicality and daily life, humanity introduced money as a means to acquire these resources. That's when greed became linked to money. In modern times, there is no resource shortage, but this deeply rooted emotion persists as part of our nature.

Excessive greed typically leads to impulsive actions. While impulsiveness can be advantageous in some areas, it is detrimental in trading, where it often results in errors and losses.

So, what can traders do to address these challenges? As previously discussed, it all boils down to fear, which can be conquered through familiarity. Familiarity, in this context, refers to understanding the relationships between different trading actions and their corresponding outcomes. Our field is entwined with probabilities. Mathematics underpins virtually every aspect of trading. To be profitable, traders must strive for more positive outcomes. Therefore, the key is to identify the chain of actions and consequences that leads to favorable results.