How to avoid emotional trading risks

Active portfolio monitoring is critical for navigating the ever-changing conditions of the financial markets. Traders must, however, manage the emotional ups and downs that can arise from market fluctuations. Indeed, traders frequently trading when prices are rising and sell when prices are low, driven by the media’s excitement or fear.

How can traders get around volatile markets while remaining calm and diversify their portfolios to achieve the best possible overall returns across all market conditions?

The key is to understand the motivations for emotional trading to prevent both euphoric and depressive  traps, which can lead to poor decision-making.

In this article, we will look at the importance of trading psychology for both new and experienced traders, as well as provide tips on how to trade without emotions.

Common emotions in trading

Anxiety

Excessive trading is a common source of fear. Trading with an incorrect size increases volatility unnecessarily and leads you to make mistakes that you would not make if you weren’t under the stress of risking larger losses than usual. Another cause of anxiety is that you are in the ‘wrong’ trade, which means it does not fit you.

Excitement

Excitement is a key emotion to have. Trust is the final component of any successful trade, and if you lack excitement or faith, you may not be in the ‘right’ trade. ‘Right’, refers to the correct trade based on your strategy.

Greed

If you only want to take trades that you believe will be profitable, you may become greedy. Your greed may have resulted from success, but if you’re not careful, you might take wrong decisions. Always ensure that you are following your trading plan.

7 steps to emotion-free trading

Understand your personality

One of the most important aspects of developing successful trading psychology is recognising your personality traits early on. You must be honest with yourself and accept if you have impulsive tendencies or are vulnerable to making decisions out of anger or frustration.

If this is the case, it is critical to keep these characteristics in check while actively trading, as they can lead to reckless and unnecessary decisions with little analytical support. However, it is also critical to leverage your personal strengths. For example, if you are calm and determined, you can use these personality traits to your advantage.

Recognising your biases is equally crucial to determining and being aware of your unique character traits and emotions. Biases are an inherent part of human nature, yet you should be aware of your own before opening or closing any trades.

Create & stick to a trading strategy

A trading plan is essential for achieving your goals. It serves as a guide for your trading and should include your time commitments, available trading funds, risk-reward ratio, and a trading strategy that you are comfortable with.

For example, a trading plan could state that you will devote one hour each morning and evening and never allocate more than 2% of the overall value of your portfolio to any single trade. This can help to reduce losses and limit the impact of emotions on your plan because the rules for opening and closing a position are already set for you.

Individual factors such as emotions, biases, and personality traits should be considered when developing strategies. If you acknowledge your biases you may be less likely to act on them.

Be patient

Patience is crucial for maintaining control, and it is critical that you remain patient in your trading positions. Acting on emotions like fear can cause you to miss the opportunity for a profit by closing a position too soon. Trust your analysis while remaining patient and disciplined. Similarly, when looking to enter a trade, it’s important to be patient and wait for the right moment rather than jumping into a trade immediately.

If you want to speculate on GBP currency pairs like EUR/GBP or GBP/USD, wait until just before a Reserve Bank announcement when volatility tends to increase at this time.

Be flexible

While having a trading strategy is important, keep in mind that no two days are alike, and continuously profitable periods do not exist. With this in mind, you should feel comfortable assessing how markets change on a daily basis and adapting accordingly.

If there is more volatility on one day than the previous day, and the markets are moving particularly unexpectedly, you may decide to suspend your trading until you are certain you understand what is going on. Being flexible can help to limit your emotions allowing you to evaluate each situation on its own strengths and ensuring you remain realistic during your time in the markets.

Take time to recover from a loss

After a loss, the best thing you can do is take a short break from your trading account to gather your thoughts rather than rushing into another trade in an effort to make up for some of your losses.

Successful traders accept their losses and see them as opportunities for growth. They typically have a few moments to themselves prior to returning to their platform, using this time to assess what went wrong with that specific trade to avoid making the same mistake again.

By doing so, they keep emotions like pride or fear under control by allowing themselves to cool down before addressing another trade with a clear head and sound judgment.

Withdraw profits

Quitting while ahead and collecting your profits is equally important. A series of successful trades can make you feel unstoppable, and you may rush into another position to try it all over again.

You might even open a series of new positions, confident that none of them will fail because today is ‘your day’ in the markets. This could lead to you taking unnecessary risks or diversifying your portfolio too quickly without thoroughly researching each market.

Happiness can be as harmful as anger in the markets, so it’s important to recognise when it’s interfering with your decision-making or negatively impacting your trading psychology.

Keep track of your trades

A trading journal allows you to record all of your losses and wins, as well as the emotions you felt. Your log can help you determine whether what you did at any given time was a good decision.

For example, keeping track of your trades can be used to remember when you decided to cut your losses as well as the asset’s eventual price. This allows you to determine whether you made the correct decision. It can also be used to keep track of when you accepted your profits and whether your emotions influenced your decision to close that position too soon or too late.

Final thoughts

Trading the financial markets is an emotionally charged endeavour, and traders frequently experience a range of emotions, from euphoria to fear and despondency. Trading with emotions may result in cognitive biases, impulsive decision-making, and loss aversion, all of which can harm performance. To navigate the mental rollercoaster, traders must be open to their emotions and use strategies to keep them under control.

Knowing how to manage your emotions while trading can make the difference between success and failure. Your mental state has a significant impact on your decisions, especially if you are new to trading, so maintaining a positive attitude is essential.

Disclaimer:
This information is not considered 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.