The psychological effects of forex trading

 

A popular saying suggests that 90% of trading forex is in the mind, with the remaining 10% being the trading system or strategy employed. It is essential that all traders understand the psychological effects of trading in order to develop ways to mitigate the negative effects of letting emotions affect our trading decisions. The combination of fear and greed are both the enemy of a successful trader and being able to keep these balanced whilst opening and closing trades is one of the single most important aspects of becoming profitable. There are a number of ways in which traders try to keep a check on the psychological aspects to trading and very much depends on the type of trading personality of each individual trader.

Using a mechanical trading systems

One of the reasons why automated and mechanical forex trading systems have become so popular is due to the fact that they remove the emotional decisions of a trader. Traders often prefer to use a rigid set of rules for both entry and exits, planned in advance of the trade, in order to ensure that they don’t get emotionally caught-up in the live markets. Trading systems, whether automated or mechanical, remove the impulsive reactions of traders which can lead to bad investment decisions such as closing positions too early or hanging on to a position too long.

Although many automated trading systems, known as Expert Advisors (EA’s) are highly unreliable, this shouldn’t prevent traders from developing a mechanical way to trade their own personal strategy. Mechanical trading is a fixed set of conditions or rule which, once achieved, provides a buy or sell signal with limited emotional decision-making from the trader.

Applying stop losses to every trade

Entering a forex trade is often described as far easier than exiting due to the fact that closing a position will often result in either a profit or a loss. Two fundamental mistakes that traders often make, however, is either keeping a position open too long, risking profits or extending losses, or not allowing a trade enough time to develop for fear of making a loss.

Stop losses are an excellent and essential way to insure that each trade is executed as planned and removes the emotional decision from the trader. Without a fixed or floating stop-loss, planed in advance of entering the trade, the temptation can be to let losses accumulate when the trader’s perspective of a failed trade becomes blurred with self-confidence that the trade will eventually work out. Stop losses act as a mechanical way to close out losing positions and also allows traders to project accurate win:loss ratios and develop a solid trading system.

Removing emotions from trading decisions is one of the most important aspects of becoming profitable and something which many new traders fail to take in to account. The psychological effects of live markets with real money will effect each trader differently and for this reason developing strategies to remove decision-making during a trade becomes absolutely essential.


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