How Can Trading Psychology Be Improved?

Beginner traders want to think that what they need to improve their trading result is a better analysis and more information about the market, so they try to learn everything they can about the market, chasing all kinds of data and analysis tools. What they don’t really realize is that 90% of their problem lies in trading psychology, and by improving their trading psychology, they improve their trading results.

Unfortunately, many of them believe there is a perfect strategy out there that can make them all the money they want. They get stuck in a vicious cycle searching for the Holy Grail: No strategy lasts more than three months before being thrown out in search of a better one. Yet, the account balance keeps going down and will continue to do so until the trader realizes that what s/he has been looking for outside lies within.

As with athletics and other competitive skill-based activities, there is no success without being mentally prepared. To achieve success in trading, you must develop your trading mind. You have to have the mindset of a trader —understand the nature of the game, train your mind to be disciplined, and be mentally present in the “moment.”

The role of trading psychology in achieving success cannot be overemphasized, which is why, in this post, we will be discussing what trading psychology is about, why it is important, and the ways you can improve yours.

What is trading psychology?

Trading psychology is that aspect of trading skills that involves the trader’s mindset and emotional control when interacting with the market. It is concerned with how mentally prepared a trader is to handle the various challenges associated with trading the forex market, and achieving that mental readiness is a skill of its own.

In fact, some veteran traders would say that 90% of the skills you need to trade the forex market is trading psychology — the remaining 10% is your analysis and money management skills. If this is the case, it makes sense to spend more time developing your mental skills than technical and fundamental skills.

But that is not the case with new traders. They rather spend all their time trying to perfect their analysis skills that they either end up with analysis paralysis — unable to place a trade because they’re unsure of their analysis — or they make a mess of their trading strategy and lose their money. No wonder record has it that 90% of new retail traders lose their trading capital within two years.

With price data being printed continuously 24/7 and many economic data and political news that can have an impact on the market trickling in, the forex market is a high-pressure environment. So, trading the market requires one to be mentally present in the ‘moment’ — what the legendary Mark Douglas called operating in the ‘Now Moment.’

Talking about Mark Douglas, the late famous trading psychologist, he stated five truths that should shape every trader’s mindset:

1. Anything can happen: This means that the market can move in any direction at any time.
2. You don’t need to know what is going to happen next to make money: While this may sound contradictory to the essence of technical or fundamental analysis, which is to predict what the market will do next, it only explains the status of your analysis. No matter how you analyze the market, it can never tell you, with 100% certainty, what will happen next in the market. Interestingly, you don’t need to be certain of what will happen next each time you place a trade before you can be profitable.
3. Your edge is nothing more than an indication of a higher probability of one thing happening over another: This further explains the second point — your trading strategy only tells you what is more likely to happen and never what will certainly happen.
4. There is a random distribution between wins and losses for any given set of variables that define your edge: Whatever the win rate you strategy offers, those wins are randomly distributed. In other words, there can be streaks of losses and wins. You are never sure of the outcome of each trade.
5. Every moment in the market is unique: No two moments are the same in the market — no matter how similar they seem — because it’s not the same traders who created the first moment that are present in the second moment. A signal may look like a previous one, but the outcome may be different.

When you really grasp the implication of these truths and make them a part of your belief system, you would realize why you need to keep your trading emotions in check, forget about the outcome of each trade, and fully focus on implementing your trading plan.

Why trading psychology is the most important for traders

Trading psychology is the most important trading skill to acquire as a trader, and there are many reasons why it is so. Here are some of them:

1. It perfects other trading skills: Having the right mindset helps you to perfect the other skills you need to succeed in the market, such as money management and analysis skills. It gives you a mindful edge over the market, enabling you to see things as they truly are — “being in the zone.”
2. It reduces your likelihood of making trading mistakes: When you have the mental skills to efficiently implement your strategy, you will be less prone to making trading errors because you trade according to your trading plan rather than your feelings.
3. It helps to protect your trading capital: With proper money management and fewer trading errors, your trading account will not likely suffer a devastating loss. Preserving your trading capital is the primary survival ticket, and when you hang on long enough, you will learn how things work and start making money.
4. It enhances profitability: Trading psychology helps you to become a successful trader. Without those psychological skills, it is virtually impossible to become consistently profitable in the market. No trader has ever achieved success without having the right trading mindset.

Ways to improve your trading psychology

Now that you know what trading psychology is and why it is important to acquire the skills, let’s consider how you can improve your mental skills. There are several things you can do to improve your trading psychology, and these are some of them:

1. Have a main source of income

One of the primary things you can do to improve your trading psychology is to have a stable source of income. It doesn’t matter what the source is, provided it yields stable income and still affords you enough time for your trading. You can get a job if you want, but make sure that it gives you ample time to analyze, place orders, and manage your trades.

A better option may be to set up a flexible business you can control the time you spend on it. It could be anything, but since you’re already trading online, you may consider online businesses. They are often flexible and don’t require a lot of capital to set up. One good one is dropshipping. You may also sell your skills, such as graphics designing, video editing, writing, web and app development, and others, on any of the freelancing platforms, and you can do these jobs remotely from your home.

Having a good source of income helps your trading in so many ways, but the most important one is that it removes the need to make money from trading at all costs. When you have a stable source of income, you won’t depend on your trading profits to foot your bills. So, it removes the psychological burden of having to make enough money every month — a situation that can make you start forcing profits in every trade, leading to poor decisions like trading without a stop loss, averaging losses, or even using excessive leverage.

Another benefit of not having to depend on your trading profit is that it helps you to grow your trading account by retaining all your profit. If you want, you can even grow your account at a faster rate by adding more money to your account from your income.

2. Have a clear-cut trading strategy

To reduce the chances of trading based on gut feelings, you must have a clear-cut trading strategy that can be implemented even by a robot. Your entry criteria must be clearly spelled out. The same thing goes for your profit-taking criteria and the position of your stop loss.

When your strategy is objective, it becomes easy to identify your trade setup and place a trade, and you know how many pips to risk in the trade and where to take profit. This way, you won’t have to be guessing what you are to do at any stage or doing that based on what you feel.

In other words, with a clear-cut strategy, you minimize the chances of your emotions dictating what you do in the market. You will be giving yourself a psychological edge over the market. But you must have the discipline to fully implement the strategy as you put them down.

3. Test your strategy with demo trading

You have to practice how to execute your trading strategy by trading with a demo account first. This gives you the opportunity to master the strategy and know all the peculiarities with its implementation, and at the same time, you will get to master all the necessary functions of your trading platform, which makes trading a lot easier and faster.

But the most important thing about trading your strategy with a demo account first is that you get to front-test the strategy in a risk-free environment to be sure it can make money before you put your hard-earned money on the line with it. It doesn’t matter if you back-tested the strategy; back-testing, especially when done manually, is not enough to tell you how well a strategy can perform in real-time. With demo-trading, you objectively implement the strategy in real-time.

When you have traded enough sample size, say 100 to 200 trades, you can analyze the result to know if the strategy actually has an edge in the market. Here, you use the win and loss rates, the win size, and the loss size to calculate the expectancy. If the strategy has a sizeable positive expectancy, you can afford to trade it on a live account. With this, you can trust the strategy when your money is on the line.

Never trade a strategy with real money without front-testing it on a demo account to confirm that it can make money. The confirmation gives you the psychological boost to implement the strategy without fear.

4. Have a clear trading plan

A trading plan is different from a trading strategy, but your strategies are a part of the plan. In addition to the strategy, a trading plan also contains the money management and account growth plans, which are all important in forging your overall trading success. The plan should also state how regularly you review your trading strategy, including the number of trades that constitute a sample size.

Make sure your trading plan is clearly written and that all the necessary sections are covered. You should know how much of your account you want to risk in every trade, the appropriate lot size to trade, at what account balance you increase your lot size, how much of your trading profit you must retain for your account growth, and how often you review your trading strategies.

With a clear trading plan, you make things easier for you. If you are disciplined enough, you can effectively execute your plan, as it leaves no room for making emotional decisions at the heat of the moment. But if your plan is not clearly written, you will start trying to figure things out in the middle of a trade, putting you at the mercy of your prevailing trading emotion at that moment.

5. Understand that trading is a game of probability

One thing at the center of mastering your trading psychology is a deep realization and conviction that trading is only a game of probabilities. You have to think and breathe this truth and make it an operational reality in your trading world. It is what harmonizes every step you take in the market.

Once you have a strategy that has been verified to have a positive expectancy, consider yourself as a casino. Each time you play there will be an outcome, which can be a win or a loss, but that individual outcome does not mean anything. When you play enough hands, your edge will surely manifest — either you will have more wins than losses, or your wins will make more money that even if you have more losers than winners, you will still be in profit.

6. Focus on executing your trades

With the realization that each trade has a certain probability of being a winner and a probability of being a loser, you won’t need to bother about the outcome each trade you make, because it makes no meaning. A trade ending up a winner shouldn’t make you excited, and a loser shouldn’t make you anxious either. They are just individual outcomes, and there is no way to influence them.

So, your best bet is making sure you take all the trades that meet your trading criteria and trade them well. In other words, focus on your execution process and ignore the individual outcomes. This way, you engage your rational mind on the important things while denying your emotional mind the opportunity to start analyzing the outcomes, which can affect your decision-making process.

7. Have a good money management strategy

The primary rule in trading is to preserve your capital. Traders do that by risking a small percentage of their account capital in each trade. While risking a little of your trading account at a time helps to preserve your trading capital, it also helps you to control your emotions so that you can implement your strategy better, and here’s how.

When you trade with a little amount you can afford to lose, you won’t be excessively attached to the money and the outcome of that trade. This keeps your emotions in check because losing the money won’t make much difference on your trading account.

The story is different when you are risking a bigger percentage of your capital in a trade. Because of the size, you will be emotionally attached to the trade and how it is developing. You may be afraid to use a stop loss, and even when you use it, if the price wants to hit your stop loss, you may be tempted to widen your stop loss, thereby creating the room to lose more money.

Using a good money management strategy that allows you to risk a little at a time helps you to control your emotional mind so that your rational mind can focus on what really matters.

8. Learn to accept loses

No matter how good your trading strategy is, you will still have some losing trades, and sometimes, a streak of losses. You should know beforehand that such things happen and be ready to accept them. The drawdown can be discouraging at times, but if you had traded the strategy long enough on a demo account, you would have been aware of that level of drawdown. So, it wouldn’t come as a surprise.

You can then take solace in the fact that your strategy has a positive expectancy, so after a losing streak comes a winning streak. Another thing that can make the losses easier to accept is risking a little amount in each trade.

9. Block profit/loss panel on your trading platform

Emotions can be very difficult to control sometimes, and one of the things that feed our emotional mind when we are trading is seeing the effects of our winning or losing positions on our equity or account balance. As the profit/loss fluctuates on the panel, your emotions also jump widely.

When a profitable position that’s about to reach your profit target suddenly turn red, your emotions can instantaneously move from heaven to hell — from a state of ecstasy to morbid fear or despair — and in that state, you can make poor trading decisions like removing your stop loss or averaging down.

To reduce all the emotional torture, it may be wise to block the profit/loss panel and even the equity/balance. If you can’t block them from your trading platform, you can use an opaque adhesive tape to cover the numbers.

10. Take a break after three wins or losses

In your trading plan, you should have an emotional circuit breaker. What this means is something you do when your trading emotions are likely to start running high. For example, after a streak of three straight wins, you may feel very excited and start overtrading. Similarly, when you have a streak of losses, you may become afraid to take the next trade, or you may become angry and try to revenge on the market.

So, you can decide to go for a walk or do something else after three straight wins or losses if you are a day trader. This helps you to break away from the emotional surge that may follow such situations. Even if you are a swing trader whose signal appears after a couple of days, you may have to take a little break from the market to refresh your system.

11. Come up with some trading thoughts that you repeat while trading

Create some inspiring thoughts you will be repeating in your mind throughout the trading day. It could be something like “stick to plan.” As you repeat it in your mind, you will tend to act it out, and that would mean trading according to your plan. This can help suppress your overriding trading emotions at any moment. If you’re about to close a trade early out of fear, the thought can help you to hold on until the price reaches your profit target.

12. Keep reminders in front of your trading desk

If repeating an inspiring thought in your mind seems difficult, you may write them down on a piece of paper and paste them in front of your trading desk, above or beside your screen, such that anytime you move your head away from the screen you will see the words and repeat them. The words I find most rewarding for this purpose are those Mark Douglas’ five fundamental truths about trading. Those words address the innermost truths about trading that we often tend to forget.

13. Practice meditation daily

A 10-15 minutes meditation or any other mindfulness exercises, such as yoga, or mindful walking, can help you a lot in improving your trading psychology. First, they help to relax your mind. Second, you get to develop a mindful presence of your body and the things going on in your body. For instance, during meditation, you may decide to focus your attention on your breathing, and you get to know what your normal breathing is like when you are relaxed. Emotional arousals often start with a change in breathing and muscle tension, so if you can spot it at that stage, you can stop the emotion from taking over your mind by taking conscious deep breathing.

14. Be humble

Finally, be humble and keep learning. You can never learn enough when it comes to trading the financial markets. There is always something new to learn with each trade you place or any piece of information you get in the market. No matter what you think you have achieved or how long you have been consistently profitable, don’t ever think that you’ve known it all — stay humble and be open to new knowledge. In this game, it’s either you stay humble or the market disgraces you.