Does success as a trader depend on understanding psychology?

Practically any trading aspect could be considered as a result of psychological processes. Traders that patiently wait for an ideal opportunity to execute a trade keep the psychological aspect of trading under control. The same cannot be said for beginners who still need to find a psychological balance in the process of waiting for profitable trading signals.

At first sight, such a simple task as a buy or sell of a security requires the brain to take into account information received with the help of advanced instruments of the market volume analysis of the ATAS platform, price action (price action is the analysis of the behaviour of the price and patterns, which it formed) and also to conduct quick calculations of the size of risk or capital, allocated for a trade, and to post a stop loss or take profit. When you start thinking through what volume of information your brain should take into account during trading, you will notice sooner or later that a clear mind and good mental health are key factors of your long-term success. Besides, it is applicable not only to traders or investors but also to any professional activity.

Let’s consider the sporting activity which is often considered as a very close to the intraday trading sphere of activity. When athletes train they master not only their physical skills. They also pay significant attention to the training of their mental health or psychology.. Perhaps it will sound banal, but the fight is won in the head first. The same is true about traders. For example, if you have a bad day but still decide to trade, there is a high probability of making a loss since your brain is somewhere else.

The trading psychology concept is not new and there is a huge amount of studies on how to get ready for successful trading. The trading psychology is a very important aspect of trading in the financial markets, since the market reflects the collective psychological behaviour of all its participants. Let’s consider an example of the growing bullish market. Investors buy on rally because they are in the bullish mood. Such behaviour could be caused by objective reasons or their greed.

On the other hand, there are many cases when good market news resulted in sells. Such moments send a signal about pessimistic forecasts of investors and, despite whatever good news, the market growth looks of little promise to them. Consequently, a trader, who trades in the market which reflects the collective psychology of all its participants, needs not only to understand the market behaviour, but also to train his mind in order to improve control.

Thus, the trading psychology has two important functions. First, the market by itself is a reflection of the psychology and mood of investors. Second, the psychology of one trader plays a very important role in identification of further prospects of the market.

When we speak about the trading psychology, two words often come to our mind: fear and greed.

Fear arises in the stock market when investors are reluctant to take risks and look for a shelter in the low-income assets in order to preserve their capital. There is a simple explanation for it. Investors are too scared at such moments to invest into the stock market since they forecast that losses, most probably, would exceed the expected profit from investments.

Greed in the stock market, in its turn, is a desire of investors to get a high profit taking a high risk. It is explained by the optimistic mood of investors with respect to the prospects of the economy or stock market and that is why they are inclined to take a higher risk.

The same emotions exert a strong influence also on retail traders. You should admit that it is difficult to bring yourself to increase your market position when you feel fear. However, it is much easier to increase your market position after you have executed a number of profitable trades.

It is neither more nor less than the influence of fear and greed at the personal level, while the stock market cycles at a larger scale, shown below, are a reflection of the behaviour of the whole investment community. The falls of the stock market are nothing else as psychological cycles in action caused by the investors’ behaviour in the result of some negative market news.

In the majority of cases, when the stock market falls, you will see interventions of central banks or governments in order to support it. Usually, central banks threaten to decrease interest rates or to flow more money into the economy. Such statement interventions can largely calm down investors, which facilitates gradual restoration of the stock market despite the fact that the announced measures may not be realized in practice in the future.

In order to demonstrate the market sentiment (sentiment is a dominating mood of the market participants), we recommend you to look at the DJIA (Dow Jones Industrial Average) chart. We are interested in November 2016 when Donald Trump was elected the 45th President of the US. The DJIA sharply fell on the day when the election results were announced, since investors didn’t clearly understand what impact the Trump’s protectionist policy, declared during the pre-election campaign, would have on the economy. However, the same day, Trump calmed down investors and soon shifted his attention to the plans of the fiscal stimulus and taxation reform.

The President’s statement was sufficient to fundamentally influence the investors’ sentiment and add fuel to the market rally which brought the market to new historical highs.