Hello all traders! In this video, we discuss the third secret of professional traders’ success, which is resolving the human and market trading psychology conflicts.
As mentioned earlier, a successful trader needs to develop a profitable trading system with an edge, and master its execution under a deliberate practice coaching system using smart drills. Although the development of a system seems to be straightforward from a financial perspective, there are lots of human psychology elements which need to be considered in advance.
To understand the importance of trading psychology, first, we need to grasp what drives the market and its price action movements. The markets are an open auction environment evolved to facilitate trading. Market participants are constantly betting against each other to determine the fair value price of a financial instrument. This creates buying or selling pressure which subsequently moves the price of traded financial instrument.
The cumulative decisions of these collective humans determine the market price’s direction. Since market participants have various degrees of investments, risk tolerance, and short- to long-term reward expectations and sentiments, this makes the price direction unpredictable! As a result, price movements in the stock market, along with other financial instruments, exhibits a wave shape pattern. Each wave cycle is repeated throughout different time frames, similar to fractal patterns seen in nature.
Traders put their money at risk by betting the price goes in a specific direction, hoping that the price would move in their benefit and they make make a profit. The profit of some traders caused by a price movement in one direction is paid by the loss of others, and this is phenomenon is known as a zero-sum game. Therefore, amongst market participants, there is a constant desire to profit and constant fear of losing money.
This crowd psychology makes the market a live, emotional entity and its mood represents the collective emotional feelings of all its participants. As a result, the market goes through cycles of greed when the price is rising, and a cycle of fear when the price is falling. This concept of market psychology is essential for traders to understand so they can execute their trading plans with confidence and accuracy.
With money at stake and a desire not to lose, emotional pressures build up and many traders let this get the best of their logical decisions. Emotional trading can happen to even professionals, and it’s important to understand when emotions get the best of a person. If a trader feels they are getting emotional, they should stop and take some deep breaths, and if need be, start trading again the next day. This is because emotional trading can even cause a profitable trading system to begin losing money.
Many investors and traders show signs of lack of discipline and are influenced by various emotional mismatches and cognitive biases, which have been identified by the science of Behavioural Finance in recent years by groups like Vanguard. Behavioural finance is the term which describes the psychology of making financial decisions, and is correlated with emotional trading and market psychology, which effects price movements in the stock market.
Successful traders have mastered reading the price psychology action behaviours of the overall market participants, and incorporate trading psychology to the design of their profitable trading system. They follow their trading plans accurately and know which moments they should be buying and selling, regardless of the overall market sentiment.
We’ll go into details about different aspects of behavioural finance in our next blog posts which discusses price action psychology and trading psychology in further detail. To understand more about the Price Action Psychology conflicts that are affecting the majority of traders and need to be considered during the design of a trading system, please click on the next “Blog Page”.
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