by Ian Harvey
Trading psychology looks at the mental and emotional aspects of being involved in the world of the stock market. While trading on the stock market can be exciting and potentially lucrative, it can also be very stressful if an individual is not able to manage his or her ‘mental game’ in the trading arena. Volatility in particular, whilst an innate part of the stock market, is one aspect that many traders can find hard to deal with.
Learning to cope with the emotional effects that may be produced by the innate ups and downs of volatility in the stock market is a very important part of creating a winning mindset in trading. A very good start to managing the emotional roller-coaster that may be produced by the volatility of the stock market is to recognize the value of this volatility. Literally, if volatility did not exist, there would be no arena in which to trade. Especially in options trading, the volatility of the underlying stock determines whether or not there is likely to be enough price movement to make entering a trade viable.
Another point is deciding when it is necessary and helpful to study the volatility of a security, and when watching it is the least helpful thing you can do. Basically, the time to observe the volatility is prior to entering a trade. Use the appropriate tools and techniques to decide whether there are sufficient positive indications to justify entering the trade. Next plan the trade, including entry and exit points and setting and stop loss and/or a stop limit. Automating a trade is especially useful for a trader who is prone to becoming emotionally involved, which includes a large percentage of traders! It takes discipline, but the best thing you can do is to “set it, and forget it”. Once you have made decisions to the best of your ability, the best thing you can do is to turn your attention to finding the next trade, or absorbing yourself in other activities. Of course this is easier said than done, but it is a major key to a successful trading career, as well as a balanced life.
Keeping a realistic attitude towards trading is also very helpful. A successful trader knows that not all trades will be successful, and that losses are part of the trading experience. They also ensure that they do not have a disproportionate amount of capital invested in any one trade, so they are able to take these inevitable losses in stride. Rather than being discouraged by losses, they accept them and move on, while finding any points of understanding that they can from the experience. This trader also understands that the concept of ‘get-rich-quick’ is not the best approach to successful trading psychology, and they are happy to continue making reasonable and steady gains.
Keeping the big picture in mind, and keeping all trading activities in balance is vital in developing a calm and viable approach to trading. Take the practical steps of diversifying investments, and steering clear of investing money that you cannot afford to lose. Don’t become too focused on one particular trade, as this can make it feel like the outcome of that trade is all-important, which magnifies the feeling of risk and blows the accompanying stress way out of proportion.
Look at the worst case scenario, which is that you lose a percentage of what you invested in this trade (having set a stop loss to make sure you at least get back a percentage of your investment – we use a 60% loss as the standard). If you have only used a percentage of your trading capital, which in turn is only a percentage of your total assets, on this trade, doing this quick reality check should help to put the outcome of any one trade back into a reasonable perspective.
A successful trading psychology comes from understanding the challenges of the stock market environment and your own profile as an individual and as a trader, as well as having a sound grasp of the practical aspects of trading and the discipline to adhere to well designed plans and strategies.