Trading psychology is one of the most important factors to consider when trading the foreign exchange market. As in the real estate market everything is about location, location, and location, in the investing industry, all is about psychology, psychology, and psychology.
So, what is the reason many people don’t take trading psychology seriously? Because they have the erroneous notion that they are in control of their emotions and mental state.
Long story short, managing your emotions, and exercising discipline are crucial aspects to making money in the Forex market. Today, we are going to talk about the importance of trading psychology in Forex.
What is trading psychology in Forex
Trading psychology is all about the emotions and mental conditions that a trader is facing when he or she is buying or selling assets as well as when he is managing risks associated with their investments.
The trader’ decision-making process is well affected by an emotional component. It can push investors to take wrong decisions influenced by fear or greed.
Former Federal Reserve Chairman Alan Greenspan once said that one of the many lessons that he and other economist learned from the great financial collapse of 2007 was the power of fear and greed when fear is more dangerous than greed.
Greenspan explained that when people are greedy, they don’t take risks seriously and take decisions they won’t take in ordinary moments.
Fear is even worse as it pushes investors to make horrendous investing decisions on behalf of the wrong psychological perception that they are protecting their money.
However, it is not only in times of recessions or corrections. It often happens in day trading and with every single trade that investors do.
As a summary, greed influences the decision-making process to accept too much risk in single trades, and it finally makes losses soar. On the opposite, fear drives decisions that motivate people to avoid risks and generate smaller than average profits.
So, how we can avoid that? The best option is to have a forex trading plan and stay loyal to it. But first, let’s understand trading psychology.
How to manage psychology in Forex
Understanding trading psychology in Forex is a crucial aspect to success as a trader and investor. However, how we can manage our psychology when it comes to the situations a trader should face with every trade?
The answer comes through the understanding of yourself and to identify what are your skills and your weakness. Therefore, you will be able to define your trading style, set your strategies, and the always essential plan for the position.
Once you know what your strategy is and how much risk you can accept or how many hours do you want to trade, it will be easier for you to manage your psychology.
The sense of fear is the nemesis of the volatility. People usually feel more fears when they can not control things. That happens in moments of high volatility or when the market is going in the opposite direction of his trade.
When traders get bad news, or the market is going against them, it is not uncommon to get scared. Remember what Greenspan said about fear: It is dangerous because make people make decisions that take money from markets.
Traders usually overreact with fear and feel motivated to liquidate their positions, so they are killing their profits on the false statement of protecting their money.
But traders need to understand what fears represent to their positions and then avoid to take decisions based on concerns.
The best way to avoid fear is to maintain the trading plan that motivated the trader to open the position. Keep profit target, stop loses, etc.
Understanding greed is complicated because people have success motivated by their ambition, and it is often confused with greed. In Forex, greed is also a fuel for many traders as they want to do better trades, improve their timing, and make more money. So, they can get caught on an excess of risk that can wipe out their entire portfolio.
As Wall Street’s old school says, “pigs get slaughtered,” the same happens with greedy investors. People who are greedy and do not have respect for their trading skills and possibilities usually finish their trader career soon.
The best option to overcome greed is to have a trading plan designed on a rational investment decision that you should follow and respect in any case. Follow your numbers, the risk associated, and don’t go where you shouldn’t go.
The art of a right trading plan
So, what is the right trading plan for you? It is simple, a plan to trade what you can, what you know, and how you know it.
Before setting a trading plan, you need to understand what are your possibilities, your trading style, and the risk you can tolerate. Then, identify what strategy do you want to take and define the parameters of that strategy.
Then, price to go into the market, or open the position, profit-taking, stop loss and maturity time of the position.
Then, when your position is on the market, follow the news and technical event to reevaluate it, but follow the rules you have set on your trading plan. Be confident in what you are and what you believed in making that trade.
Remember that you are deciding to go to the market because you have your reasons, so, trust your guts!