Psychology: Master the emotions in trading

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In financial markets dominated by vast amounts of data, sophisticated analytical programs, and quantitative strategies, concern about the psychological aspect of trading may seem old-fashioned.

It is when we forget to question our motivations and emotional state that we become susceptible to making poor decisions.

While the digitization of commerce has changed many aspects of the profession, little has changed in the area of retail psychology. The old lessons, learned the hard way over decades of experience, are as applicable today as they were when they were first learned. Then we'll look at what traders can do to manage their emotions and ensure they make clear, informed decisions every time.

How the fear of missing out can ruin judgment

The fear of missing out usually occurs when the market makes a big move and you miss it. This can cause you to chase an entry that is never a good trading decision because you will end up with a bad entry price, and since you are caught up in the thought of missing out, you forget to manage your trade and your risk.

The fear of missing out is driven by the desire to be part of something good, even when all signs point to it not being a wise investment. Fear is so pernicious because we see other people succeed, even if they take unwarranted risks to do so, and we have a natural urge to join in.

The more wild successes other people have, which is usually directly related to the amount of risk they take, the stronger the urge to join in.

This fear is usually harder for new traders to grasp because they haven't been burned as often as someone who has been trading the markets for a while.

The best way to deal with the fear is to have rules, and if you break them, then you must receive some sort of punishment, such as no trading at for the rest of the day. You can't make trading decisions based on emotions, no matter how much money other traders make on a crazy run. There will always be other opportunities, so stick to your rules!

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Don't be afraid

Fear is a pervasive feeling of unwarranted panic that occurs when market participants as a whole take a generally pessimistic view of the financial, economic and political future.

In a climate of fear, traders focus on and amplify bad news, and they quickly close long positions or open new short positions. A climate of fear in the markets is self-reinforcing: The more people get scared and sell, the greater the general feeling of fear becomes.

In a climate of fear, it is very difficult for an individual investor to make rational investment decisions based on reasonable expectations about the behavior of the market as a whole.

Fear is common among traders because we don't know what will happen after we make a trade. We have an idea of what will happen, but we don't know with 100% certainty, and when there is a lot of money at stake and you don't know what will happen, it can cause fear and anxiety.

A good way to counteract fear is to act within your means and set an acceptable amount of loss. This way, you know before you start trading that you are only risking a certain amount.

This takes some of the uncertainty out of the trading process because now we know what's at stake. Every time I enter a trade, I tell myself that I might lose money, and that's fine, just don't lose more than my predetermined amount!

Another way fear gets in our way is when we trade with amounts that are too large, so we feel uncomfortable and afraid of losing too much money, or worse, blowing our account. That's why sizing is so important.