Why psychology in trading is more important than you think

A few years ago, psychology in trading was a field I didn’t pay much attention to

I believed that either you have strictly defined rules or you don’t. You either stick to these rules or you don’t respect them. And if you don’t respect them, it’s as if those rules didn’t exist, and psychology in trading is just a catchy slogan. However, life brutally verified my theory to the point that I became a psychology student. This decision was well thought out.

One day, wondering why I was making the same mistake again, I found it difficult to find an answer. The more I searched for it, the more emptiness consumed my thoughts. I decided that to properly understand the patterns behind every action we take, I would start with academic preparation.

In the psychology student community, there’s a joke that sometimes circulates, saying that every one of us—psychology students—should go to a psychologist, not to study psychology. On one hand, it’s a joke, but on the other, there’s quite a bit of truth to it.

When it comes to trading, instead of looking for answers in five years of study, it would be easier to attend a few sessions with a good psychologist. However, it’s difficult to find a psychologist who understands the problems of a trader. The ideal psychologist for traders is one who has been or is a trader themselves. Ideally, a psychologist-trader who could present some kind of result as proof that they know what they’re doing and saying, both as a psychologist and as a trader. I don’t know anyone like that, which is why I chose the harder path.

Studies are not only about academic knowledge; they also provide opportunities. During studies, we meet other psychologists, psychotherapists, hypnotherapists; we encounter various fields and enrich ourselves in many areas.

Fifteen years ago, when I graduated high school, I was convinced that I didn’t need studies—just as, until recently, I thought psychology didn’t matter. Fifteen years later, I’m a student, and of psychology no less—a twist of fate. But what do we really know about life and about what we’d like to do, what competencies we’d like to have, when we’re teenagers?

Psychology in trading as a fundamental element of success

Most traders spend their time searching for various methods, combining them to achieve the best results, constantly optimizing, chasing the so-called golden grail, completely ignoring psychological aspects. When something doesn’t work out, when they face failure, instead of looking for the root cause in their own mind, they once again tweak and improve their strategy. And so, the vicious cycle continues.

If you were to think about it, what was the cause of your last failure or recent unpleasant experience in the market?
Was the strategy to blame?

I have no doubt that achieving good results in the market requires the following elements:

• A simple strategy
• Capital management
• Proper psychological preparation

A simple strategy

It can be based on moving averages, Bollinger Bands, time ranges, Ichimoku, Fibonacci retracements, VWAP + deviations, footprint charts, etc.
The list is long, but is there any point in listing them all? There are many paths.

When choosing the elements to base your strategy on, you should be careful not to overcomplicate it. The more complex the strategy, the harder it will be to control the decision-making process. While this may result in more effective setups, on the other hand, it will be harder to make decisions that are objective from the strategy’s point of view.

A more complex strategy will often place us in situations where there’s a conflict of signals from different components, which opens the door to subjective decision-making. We’ll be prone to selectively following elements that favor our chosen direction.

Capital management

The most important aspect of planning a capital management model is setting realistic expectations. It’s important that they’re realistic, achievable, and reasonable.

If the expected rate of return is sensibly balanced, it will be much easier to keep the entire decision-making process under control.

If expectations are realistic, it’s natural that losses—inevitably a part of trading—will be much smaller, and as a result, they won’t impact us as destructively as larger losses would.

To illustrate:
If your goal is to achieve a 5% return on your account in a month, a 0.5% loss won’t do much harm. If your goal is 50% in a month, a 5% loss in one trade will be much harder to accept.

Proper psychological preparation

This is something we must continuously support on many levels. Starting with basics like physical activity and a healthy diet, and moving on to other very important elements:

• Emotional control: Fear and greed are key emotions that globally influence not only individuals but the entire market. I’d even go so far as to say that what we see on the charts is just the result of these two dominant emotions among traders.
• Stress: High levels of stress negatively impact the rationality of our decisions. It’s very important to recognize when you’re experiencing high levels of stress. If you feel stressed in a given situation, it’s worth stepping away.
  If this situation is caused by taking too aggressive a trade that doesn’t align with your planned capital management, it’s all the more reason to step back.
  I mention this because overly large positions are often the main cause of high stress levels. This stress can manifest in many ways. Initially, you might feel excited, but in my opinion, this is a false face of stress that will only reveal itself when the market turns against you.
• Discipline: The key aspects of discipline are, above all, consistently following your plan. Discipline goes hand in hand with habits—if you build discipline into your habits, it will be much easier to maintain in the long run.
  Discipline will also help prevent overtrading. Discipline can curb the temptation for excessive trading, which usually leads to losses.
• Coping with losses: Smaller or larger losses will happen—they’re inevitable. You must accept this and learn how to deal with them. Proper psychological preparation is based on the belief that losses are a natural part of trading, allowing us to learn from them and become better traders.
  Losses must not affect our motivation or determination to reach our goals. This is why I frequently emphasize realistic expectations. Realistic expectations = smaller losses = easier to accept and deal with.
• Patience: Our results should come from consistent planning and execution of our strategies. Success takes time and a balanced approach. We must avoid impulsive decisions at all costs. Impulsive decisions usually occur after suffering losses. Do you see now why it’s so important for those losses to be as small as possible?
• Reflection: Regularly analyzing your trades helps identify emotional patterns that guide your decisions. Reflecting on your mistakes and successes is a crucial element of growth for any trader.