Lesson 1: Human Emotions

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.

• Our thoughts affect our feelings. For example, if you think you are a loser in the markets, it’s hard not to feel sad and depressed.
• Our feelings also affect our thoughts. For example, A trader who equates winning to doing the right thing in trading could fall into the trap of bad trading habits if he gets a winner out of a bad trading habit like over-position sizing.

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.

Trading Emotions

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

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 of Missing out – This can be explained as the tendency to want to participate in the markets because the markets are in motion. A Trader who starts trading without mentally rehearsing and preparing for needs is likely to suffer this fear.
• Fear of Leaving money on the table – This can be defined as the tendency to want more than is enough. This fear is primarily caused by greed. A trader who suffers from this fear struggles to take profits even after markets have attained their targets. The Trader fears that by exiting the position, he or she will miss out on some more profit if the markets continue moving to his advantage.
• Fear of Losing Money – A trader who struggles to execute a position despite good preparation and research is likely to be suffering from this disease. Many traders develop this fear after realizing how easy it is to lose money in the markets.
• Fear of being wrong – Our attitudes on being wrong can lead us to the wrong path in trading. For example, since we are taught being wrong is bad, traders struggle to cut losses in trading. If we can’t cut losses early in trading, we tend to fall into losers in the markets.

Bio-chemical reaction

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.

How to manage fear:

1. Breathing Techniques – We can move our brain’s focus from amygdala hijackings to the prefrontal cortex by controlling our breathing. It, therefore, means we make ourselves more rational since the prefrontal cortex is more responsible for rationality and reason.
2. Self-awareness If we can cultivate mindfulness over our mental states, we can master our fears.
3. Visualization techniques can also help us manage our fears. It includes visualizing going through what we fear and coming up with practical ways to deal with what we fear. It helps minimize the concern.

PERFORMANCE ANXIETY

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:

• Racing pulse and rapid breathing
• Sweaty and cold hands
• The uneasy feeling in the stomach

How to overcome performance anxiety

1. Practise mindfulness – Self-awareness will always help in overcoming our emotions. We can practice habits like journaling which help in cultivating self-awareness.
2. Visualization techniques like mental imagery can also help. In this case, we can imagine ourselves doing the tasks well.

Euphoria and Excitement

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.

Anger and Frustration

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.

Impulsive decision making

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:

1. Trading without following a plan.
2. We forget our risk management rules and strategies.
3. Self-sabotage behaviors like taking trades that are not systematic.

How to Manage our Emotions in Trading

1. CULTIVATE SELF-AWARENESS

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.

2. A FOCUS ON THE PROCESS RATHER THAN THE OUTCOME

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.

3. HABITS LIKE MEDITATION AND JOURNALING

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.

4. CHANGING OUR PHYSIOLOGY OR BODY POSTURES

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.