Amid a barrage of factors that determine success in the markets — fundamental analysis, technical indicators, economic data among them — perhaps none is more powerful (or more often overlooked) than the one between your ears. Fact is, your trading psychology becomes the ‘hidden’ partner in every trade you take. It can be your best friend, while it methodically compounds your wealth or the worst enemy, as it methodically grinds down your account.
You know the ones, its a million indicators or a simple system but well formulated systems and nothing works permanently because shit will go south when you throw in your fears, greed and no discipline. Which brings me to the harsh reality that the most challenging barriers for maintaining consistent profitability are not on your charts, but coded into your brain.
Let’s get into the five most destructive trading psychology mistakes and, better yet, offer a clear-cut plan on how to overcome them.
Mistake #1: Running Losses and Cutting Profits Short
‘It’s a very basic but careless idea to let your losers run, while taking your profits at the first opportunity.’
It’s the classic, profit-destroying mistake that has its roots in two core emotions: hope and fear.
Letting Losses Run: A trade goes against you. You don’t get out at your stop loss, but rather pause. You think, “Maybe it will come back.” You’re waiting for the market to give you validation that your decision was right at the beginning, and you don’t care or want to believe it is best to not take pride or P&L along with you when entering a trade. The loss, as it deepens, is increasingly difficult to repair — and denial perpetuated becomes a cycle. This is known as “marrying a trade.”
Taking Profits Too Soon: The reverse is also true, when a trade starts moving in the direction of your position, you get nervous. You fear the profit will disappear. You notice a small profit and click the “close” button, only to see the trade keep going and going some more – another 50, 100 or 200 pips without you. It’s the fear of losing a winner that keeps you from ever making those big, profitable trades that make up for all the tiny losses.
The Fix: A healthy dose of a positive risk-reward ratio and brutal discipline.
The trick, he says, is to systematize your behavior. Do you have to be free, do you have to be without hope and fear?
Set Your Risk-Reward Before Entering A Trade: Do not trade without knowing exactly where you will get out at when you are wrong and right also known as stop loss and take profit. A good rule of thumb is to target a risk reward ratio of 1:2 or 1:3. That is, you are risking $100 to win $200 or $300. With this ratio, you can be inaccurate more than 50% of the time and still make money.
Examples include: Trust Your System – If your system give you a tested 1:3 R:R trade, then you must trust that it will work over a series of trades. One winning trade makes up for three losing trades. This simple math gives you the freedom to follow your plan without ego.
Implement a Trailing Stop: To prevent from cutting your winners short, use a trailing stop. And profit is automatically taken as the trade goes in your direction You can let your winners run (in your favor), without forcing yourself to remain on board in what’s a psychologically challenging decision.
Mistake #2: Revenge Trading
The market just served you his loss. Your heart is racing; your ego is bruised, and you’re filled with frustration. The visceral, knee-jerk response is to jump right back in and try to “win back” what you lost. This is called revenge trading, and it’s like throwing gasoline on a flame.
Trading out of revenge is driven by emotions, not analysis. Now you are not trading your plan, you are trading your anger and desperation. This results in low-probability, high-risk trades that you would never take under normal conditions. You’re chasing the market, you start overtrading and you size up in a big way, transforming a single bad trade into there will be one hold your breath moment today! that might blow up your entire account.
The Fix: Deploy A “Cool-Down” Procedure
A significant loss makes your brain an idiot; it will not be making measured judgments. You need a circuit breaker.
Walk Away: The second you feel that hot wave of anger after a loss, get up and walk away from your screens. Close the trading platform. Take a walk, make a coffee, do some push-ups — anything to interrupt your emotional feedback loop.
“Three-Trade” Rule: Create a mandatory rule for yourself one, which says that if you have a losing trade of a certain magnitude (let’s say anything greater than 1% of account) then you’re not allowed to take another trade for that next three set-ups or the rest of your session. This imposes a cooling-off period.
Analyze, Don’t Criticize: After you have composed yourself, go back and analyze the loss. Ask yourself: “Was I following my plan?” If you took that gamble, well, now it’s just a new cost of doing business — eat it and move on. If you did not, why, and write down the lesson.
Mistake #3: Confirmation Bias
It’s human nature to notice, seek out and remember data that reinforce our pre-existing beliefs, and then dismiss or forget anything that contradicts them. Deadly trap, in trading.
You believe that the EUR/USD is going to rise. And then suddenly all you see are the bullish signals. You concentrate on friendly Eurozone numbers but overlook blatantly strong US data. You draw your trendlines to your stories. You take a long position and then drill down through the news for any headline that confirms your righteousness.
You’re blind to risk thanks to confirmation bias. It does not allow you to enter a trade with an even keeled approach and will keep you in losing positions long after the market has told you that your thesis is incorrect.
The Fix: Be Your Own Devil’s Advocate
The great traders aren’t right all the time, they are just good at recognizing when they are wrong.
Write a ‘ Pre-Mortem ’: Before entering a trade, make yourself write down at least three reasons the trade might not work. What would make the chart, or the news, to tell you are wrong? This actively enlists the logical, critical portion of your brain.
Seek Disconfirming Evidence: Develop the habit of actually seeking out those data points and levels which go against your bias. If you are constructive, where is the key support that would turn you bearish if broken? If the answer is “there isn’t one,” you are writing with bias.
Define Where You’re Wrong Previously, I had written that trading plans need to be fairly universal in how they are applied as different stocks or scenarios may dictate different variables and data points. In that vein: Your trading plan should also contain this form of map before you place the investment. This includes not only a stop loss, but a defined point at which to sell the security that you’ve identified would indicate that something were wrong with your investment thesis. This takes the abstract concept of “being wrong” and turns it into a real, usable signal to get out.
Mistake #4: Overtrading
There are two ways in which this overtrading shows up: trading too frequently and trading too large.
Trading too Much (Boredom/Chasing): This trap is the “action junkie” monster. The market is slow and there are no real specific setups from your plan … but you need to “be in the game.” So you take a sub-par trade. Or, you notice a move already under way, FOMO (fear of missing out) kicks in and you chase the price at an awful entry. These trades often have a terrible initial risk-reward to begin with.
Trading Too Big (Overleveraging): This is the fastest way to wipe out. When you trade a size that’s too large for your account, you add tremendous psychological stress. A wiggle in the market that’s both typical and smalltime will feel like a close brush with death. This stress is keeping you from thinking clearly and it’s almost impossible to stick with your plan.
The Fix: Focus On Quality vs. Quantity & Stick To Position Sizing
This comes from taking high-quality setups and managing your risk not the number of trades you take.
Have an “A+ Setup”: You should know exactly what your best trade looks like. Be brutally specific about the conditions that are necessary. If they’re not, you take no action. Embrace the power of patience. Sometimes the best trade you make all week is the one you don’t even take.
The 1% Rule: Never ever put at risk more than 1 or 2 % of your trading capital on a single trade. For an account of $10,000, that means a maximum loss per trade of $100. This rule is non-negotiable. It helps make sure that a streak of losses — and of course there will be one, at some point — is a survivable drawdown (though deeply unpleasant) rather than an account-destroying catastrophe.
Journal your Trades: You should journal every one of your trades, and those you don’t take. Wondering what the setting was, why they entered or left, and how it turned out. Reviewing this journal would make it very obvious if you are overtrading and help keep you accountable to your “A+ setup” rule.
Mistake #5: Not Having a Plan of Action
To trade without a written, specific plan is to sail rough seas with no map or compass. You are at the whim of the waves, reacting to every splash with emotion and conjecture. A vague notion of “I think gold might go up” is not a plan.
An undisclosed plan Agenda makes for erratic, emotional decision-making. What is your entry criteria? Your exit? Your position size? If you can’t write your answers to these questions down in black and white, then you are not trading — you are gambling.
The Solution: Your Trading Business Plan
Trading Plan = Business Plan. Everything you do in the market is governed by this rulebook.
Your written plan must include:
Your Strategy: The exact entry rules — for example, where to buy and when (i.e. “Buy when 50 EMA crosses above the 200 EMA and RSI bounces from 30”).
Risk Management: Your position sizing model (1% rule) and traditional risk-reward ratio.
Trade Management: Your stop loss and take profit placement and any adjustments procedures (i.e. trail your stops).
Market Conditions: Which markets you are going to trade and the time frames you will operate on.
Journal and Review: Commit to journaling your trades and reviewing your plan weekly/monthly.
With this plan, you change the question from the stressful, emotional “What should I do now? to the straightforwardly procedural “What do my plans tell me to do?” One word – Professional Trading This is professional, disciplined trading at its best!
Conclusion: The Journey to Mastery
There is no end line in enhancing trading psychology, only a long journey that make us have insight to ourselves and discipline. These five errors are ubiquitous because they are human nature. Market, in its cold and brutal logic, takes advantage of these flaws without mercy.
The solution, is not to remove emotion but rather to erect a strong system — rules, risk parameters and self-imposed checks and balances — that prevent the emotions from hijacking your decision-making process. How To Beat 9 Of The Most Common Trading Problems By facing head-on these psychological pitfalls, you stop fighting against yourself and start to become a disciplined, systematic trader that consistently makes money. The war to become and remain successful in trading is actually not on the chart – it’s in your mind.