The importance of psychology on forex trading

Trading is quite unique in its ability to evoke the type of emotions that drive decision making in all sorts of directions. This is particularly evident in forex-handel when price movements rise and fall aggressively within milliseconds. Which is what makes one’s psychology so important to thrive in the foreign exchange markets.

What is it about the way you feel that is so important in forex trading?

There’s this general perception that all that matters in forex trading is your ability to conduct technische analyse and to manage risk. What’s often given little attention however is the idea that feelings can make or break a successful trade. Emotions are powerful, not least of all in the trading space. And controlling them poses a significant challenge for a lot of people.

But what emotions are we talking about exactly?

Well, some of the more popular are feelings of fear, anxiety, panic, overconfidence, and greed. These become particularly prevalent when someone is new to trading.

Fear en anxiety for instance have the ability to push someone towards making impulsive decisions, opening or closing trades prematurely, resulting in losses. Greed on the other hand can lead to overtrading, i.e., opening more trades than necessary in the hopes of making more profit.

However, too many trades or too large a position can lead to adverse trading outcomes too, especially if based on feelings rather than hard data.

When feelings become entangled with cognitive biases

Often times, the triggers for certain emotions may lie in the cognitive biases that we maintain, be they subconsciously or consciously. In the field of trading psychology, cognitive biases play a significant role because they too can lead to poor decision making. The most common biases that exist are:

1. Confirmation bias: when a trader seeks out data that confirms pre-existing beliefs, ignoring information to the contrary.
2. Herd behaviour: when traders or other financial practitioners mimic the behaviours of a larger majority.
3. Overconfidence bias: common among more experienced traders, this refers to ones tendency to overestimate their knowledge or expertise. This is also called self-attribution, and often leads to the trader regarding their expertise as superior to others, even if not true.
4. Mental accounting:  developed by Richard Thaler, this bias refers to the value that different individuals give to the same sum of money. The idea is that the criteria that people use to establish value is subjective rather than objective, and that this emotive component may result in negative trading outcomes.
5. Verankeringseffect: occurs when a trader is over-reliant on irrelevant factors or the first piece of information they find, as a benchmark for guiding trading decisions.
6. Loss aversion: this bias refers to the inclination to prioritise avoiding losses over seeking gains. This sometimes results in traders holding onto positions for far longer than what is necessary, in the hopes the market will change course.
7. Recency bias: this form of bias happens when a trader relies too heavily on or assigns greater weight to the most current information they find, appointing less value to older information.

Being mindful of the types of biases that you may be holding on to will assist you in shifting your focus to more objective data, so that you can make more strategic decisions based on facts and logic, rather than emotions or preconceived notions. 

Knowing how to deal with loss in forex trading

Experiencing losses is an inevitable part of forex trading. However, how one deals with this loss sets the tone for currency trading in the future. Particularly in the context of trading psychology. This is because the feeling of losing money, especially exponential amounts of money, can trigger overwhelming emotional reactions.

Sometimes, a trader may even resort to what is called revenge trading, which is driven by the impulse to execute sometimes unnecessary trades to recuperate losses. The problem with revenge trading is that it commonly leads to reckless trading, led by knee-jerk emotional reactions rather than proper research or analysis. 

So, what does a trader do to maintain discipline and control? How do they get a proper handle on their emotions, even after a financial setback?

Build a trading plan for forex trading

A well-thought-out plan becomes the rule-book by which you’ll trade. It will list your goals, your risk tolerance, your budget, position sizing, entry/exit criteria, and so forth. A forex trading strategy keeps one focused on their objectives. It mitigates impulsive behaviours, and provides a structure that reduces feelings of uncertainty.

Adopt risk management tools

Ensure you have proper risk management measures in place to reduce the risk of loss. No matter how experienced you are, consider setting stop-loss or take-profit orders to safeguard your funds. Be cautious with your position sizing, the last thing you want is to invest all of your capital into a single position without having done a proper analysis into the likely success of that trade. Because if that trade goes south, your potential for losing all your money increases considerably.

Engage in ongoing learning

A very important part of maintaining a strong psychology in forex trading is ensuring you’re equipped with sufficient information and skills to trade. If you are going into trading blindly, your emotions are likely to get the better of you. If however, you are prepared, with an optimal trading education to boot, there’s more of chance that your trading decisions will be based on data rather than emotions.

Remember to take a break

The forex market operates 24/5. It is highly volatile and prices fluctuate aggressively. Avoiding emotional burnout depends on various factors. This includes taking a break, stepping away from your computer for several minutes or a few hours to clear your mind, and refocus on your strategy. It also involves sticking to your plan and avoiding trading for the sake of trading.   It might mean taking up mindfulness practices, exercising regularly, eating healthily, etc.

Ensure your goals are realistic

The last thing you want to be doing as a trader is setting up unrealistic expectations for yourself. Forex trading is not some get-rich-quick scheme. It requires proper planning and working towards earning consistent profits. But this comes with discipline and patience. It also comes with having the right experience, trading related education, and knowledge.

Signing up for a demo trading account with a reputable broker

Another way to strengthen your trading psychology in forex trading is to gain practical trading experience. One of the most convenient ways to do this is by signing up for a demo trading account which, through IronFX, will give you access to MetaTrader 4, a leading forex trading platform globally.

You’ll be able to practice opening and closing trades and learn more about technical and fundamental analysis. Using virtual funds, you can execute a variety of different trading strategies, and assess outcomes. Seeing as your own money isn’t at risk, you’ll have the time needed to gain confidence and skills before moving to a live trading environment. This will cultivate a much stronger trading psychology than if you were to kick start your trading journey knowing nothing at all.

Trading with IronFX

Becoming an IronFX trader means gaining access to a high-quality, flexible trading experience, multiple asset classes, an extensive range of account types, and fast trade execution. Through this international broker with clients across the globe, you’ll also be able to enjoy seamless withdrawals and deposits, and market access via the MetaTrader 4 (MT4) trading platform, arguably one of the world’s most popular trading systems amongst global traders. The IronFX Academy also offers an abundant source of educational resources to boost one’s skills and acquire fundamental trading insights.

Disclaimer: This information is not considered as investment advice or an investment recommendation, but instead a marketing communication. IronFX is not responsible for any data or information provided by third parties referenced, or hyperlinked, in this communication.