Emotions can be defined as responses to internal and external events and processes. Humans experience emotions as feelings.
In forex trading, due to the money factor involved, people tend to make decisions emotionally. Emotional decision-making is likely to lead to losses.
For us to understand why emotional decision-making is wrong, think of a trader who reacts to losses. The Trader is likely to execute another position that is not in his plan after losses due to the pain and frustration of losing money.
Successful trading requires sound decision-making and rationality. Rationality does not mean an absence of emotions. Instead, we must learn self-awareness over our mental states and how to program ourselves for trading success.
We will now look at some of the most common emotions that every trader experiences in his trading. The difference between the winning and losing traders is that the winning traders are very good at managing and processing their emotions.
For example, Successful traders have learned to avoid executing trades that are not systematic and in the trading plan.
Fear is a natural, powerful, and primitive human emotion. It involves a universal biochemical response as well as a high individual emotional response.
Fear alerts us to the presence of danger or the threat of harm, whether that danger is physical or psychological. Some fears are from real threats, while others are false and are caused by our imagination. Most people experience anxiety from a flaw in perception.
In trading, fear manifests in four typical ways:
Fear is a natural emotion and a survival mechanism. When we confront a perceived threat, our bodies respond in defined ways. This physical response is also known as the “fight or flight response,” with which your body prepares itself to either enter combat or run away.
This biochemical reaction is likely an evolutionary development. It’s an automatic response that is crucial to our survival.
Physical reactions to fear include sweating, increased heart rate, and high adrenaline levels that make us extremely alert.
Performance anxiety can be explained as the fear about one’s ability to perform a specific task.
In trading, many Traders have a challenge with performance anxiety since they are focused on the outcomes of the trade setups rather than the process of trading itself.
Performance anxiety results in a trader managing anxiety rather than trades.
Familiar challenge traders have with performance anxiety is trade management. A trader may have done everything according to his plan but still struggles to hold trades to his targets upon pullbacks common in trading.
One method that we can use to manage our anxiety is “meaning reframe.” This means that instead of viewing pullbacks as threats to our profits, we can view pullbacks as opportunities to add to our winners in the markets.
Performance anxiety symptoms may include:
Our brains react with excitement and euphoria when reality exceeds our expectations.
In Trading, Traders often experience streaks of winning and losing in the markets.
After a winning streak, Traders tend to be euphoric and forget that the probabilities still hold in the markets. After a losing streak, Traders lose confidence in their judgments and trading systems.
For example, a system with a hit rate of 50% could get at least three winning or losing trades in a row depending on the market conditions. If the Trader turns euphoric or grandiose, he is likely to make emotional decisions like over-position sizing or not following trading rules in the markets.
This emotion occurs when our expectations of reality don’t match up with reality itself. One way to manage our anger is to minimize our expectations in life.
In trading, anger makes traders result in lousy trading habits like holding losses since they want to prove the markets wrong.
A common cause of frustration is when the Trader has researched markets but fails to adhere to his expectations. The Trader may channel his frustration into beneficial behaviors like fine-tuning his system or style of trading. Still, he could also turn to unproductive behaviors like over-trading or executing trades without research.
Out of all emotions discussed, this could be the most dangerous for a trader. The act of acting in the world without thinking of the consequences of our choices can be detrimental. In trading, impulsive decision-making can manifest in different ways. They include:
We can’t deal with a problem that is out of our scope of awareness. Successful trading requires an understanding of our different mental states.
For example, if we realize that we make good decisions when happy, we can aim to be satisfied before trading and avoid trading when we are sad.
Emotional trading mainly occurs due to our focus on the outcome of trades rather than the process of trading. For example, a trader may develop fear after getting two losing trades in a row. However, a trader who has learned to be objective and focus on the long term is likely to continue trading objectively despite two or three losing trades in a row.
Research has shown that people who meditate have higher levels of mindfulness. Meditation helps in cultivating self-awareness and reprogramming our brains.
For example, self-reflection in the markets can be harnessed or improved by a habit of meditation. This habit includes reflecting on your trading patterns and finding effective ways to stop negative patterns and enhance positive trading patterns.
In looking at the nature of emotions, we realized that they do affect our physiology. We can therefore alter our mental states by changing our body postures.
For example, If we realize fear results in a fast heart rate, we can reduce the fear by lowering the pulse of our hearts. In the markets, we can think of a trader who panics once he starts losing. He can learn to slow down his breathing during panic hence reducing the fear.