Trading Psychology

Let me begin this blog on trading psychology with a story.

One fine morning Ramesh met Suresh and had chai pe charcha.
“I will be the next Warren Buffet”, said Ramesh, having opened a Demat and trading account.

Fast forward 9 months, date today is 9th March 2020 and the stock market is bleeding. There is chaos, bloodbath and uncertainty all around. Coronavirus has wreaked havoc and Gods have come down on Earth to punish the bulls and bulls are running for cover.

Ramesh called Suresh and spoke about his investments; if he did a mistake liquidating his fixed deposits and investing the proceeds in the stock market. Ramesh lost 50 per cent of his hard-earned money in this selloff, and he quit the stock market eventually.

We will come across many such Ramesh and as per industry estimates, over 95 per cent of traders lose money over a period of one year and some never return to market having burnt their fingers in the initial days. This data is no exaggeration. The only way you start seeing consistent profits is by making some loss initially, learn from them and avoid repeating them.

Two most important factor which can help reduce loss and improve win percentage would be Trading psychology and Money Management.

We will talk about trading psychology in this blog. For money management, refer to the link here.

Trading Psychology basically defines how we behave when certain things happen in a certain way.
Think about these situations and your reaction in such a situation.

1) What would you do if you entered a position and it goes against your direction?

Some might book little loss and exit the trade but many may hold the position hoping for a reversal which might not come very soon. The loss will keep mounting and finally, the trader will exit with a bigger loss.

Improvements – Traders must not get attached to their positions. The emotion such as hope, in this case, that the price will reverse, will force you to hold the position longer than you should have ideally held, and the loss could keep on increasing.

2) How would you react if your position is going in your direction, and you did not book profits, waiting for even more profits, and it reverses suddenly?

Traders must make sure that they do not become greedier after the position goes in their direction. This disturbs trading psychology.

Improvements – You must trail the stop-loss and if possible bring stop-loss above cost price. Buying penny stocks and making high-risk positions can also be classified as greed. They can destroy your capital and you will do revenge trading to recover the lost capital.

3) FOMO – Fear of Missing out.

Would you buy a stock that has sharply rallied 20-25 per cent in a week? Just because it has rallied, people enter into it thinking that they might be missing out on a great opportunity. This plays out in favour as well as against the trader. Usually when it goes against the trader, stock reverses very fast after a massive rally and it might become a reason for a big loss.

Improvements – Do not buy an overvalued or rallied stock in huge quantities. If you want to still trade it, size your position carefully.

Few others mistake which traders usually commit are

  • Trading against the trend It is very lucrative but the win percentage will be quite less unless backed by proper support, resistance and reversal theories. Beginners must befriend the trend and avoid trading reversal as much as they can. If need be, trade reversals in small quantity.
  • Taking the loss to heart Losses are part of the game and take the losses as a price you pay to the market for the learning it provides. Remember to not overpay, lessons can be learnt with small losses too.
  • Overtrading Frequent losses do cloud our judgement and we should avoid trading after a big loss. Big wins usually encourage us to take more risks which might also become a reason for a bigger loss.
  • Trading without setup Do not trade without setup and make positions just for the sake of trading – Beginners tend to overtrade without proper signals/setups.
  • Do not buy penny stocks – Avoid buying penny stocks. Even if you do, buy in a small proportion of your capital.

The stock market is not a get rich quick scheme, it takes years of learning and patience before you start making consistent profits.