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Psychology in trading

In this section of the site, I am going to discuss lightly but at the same time completely and exhaustively (yet without making it too boring), a topic that, in my opinion, is underestimated by most investors and kept in low regard by many people, especially those approaching the financial markets for the first time. I am talking about behavioural finance and money management.

If in a moment of absurdity, I decided to publicise a book by advertising that I claimed to reveal the most successful technique in the world and the best set of indicators, it is likely that a lot of traders, or those merely curious, would buy the book expecting to find a magic formula to becoming rich. These individuals are people who want to be “spoon-fed” work that has been done for them, without wanting to start from the origins in order to understand the underlying dynamics of financial markets.

In the next articles I am going to talk about things I have tried personally, some consistently, others more superficially. This is why I have deepened my study of behavioural finance because I believe it helps us understand our mistakes.

The objective of this section of the site is to highlight some situations that most of you will be able to identify, by employing some practical examples. I assure you that, by starting from these aspects, you will be able to track an improvement and develop more quickly an understanding of your own mistakes. This will grant you an opportunity to grow and improve faster.

It is no coincidence that, in spite of the many, and in some cases excellent trading techniques available, only a few traders get positive and, above all, constant results over time. I think the problems behind failure in the trading world are twofold: on the one hand, an incorrect behavioural approach to the financial markets; on the other hand, a lack of any operating rules or money management.

Most people are wrong about the approach to the financial markets because they do not consider trading a real business. These aspirant traders lack a trading plan and sound risk management. Many traders know certain strategies very well that, in theory, should be profitable, but their lack of a trading plan leads them to improvise exits from the market by anticipating the target. They could have managed the position better, and thus achieved a more profitable return.

Or, in other instances, they might be disoriented and incapable of any reaction when the market goes against their position, causing them to fail to cut their losses, which they would have done had they had an anticipated exit plan. They start to “argue with the market,” which only makes their losses heavier until they shut down the computer, hoping that the market will forgive them for their naivety, sooner or later.

Since there is no end to the worst, there are also traders who operate without any risk control. This means that often, the consequences of their mistakes have a disastrous effect on their trading accounts, which leads them to realise (but only after) that trading is not their thing, that trading is a business for professionals, not for improvisers.

I think the main problem lies in the fact that trading is considered by most people to be a type of gambling. Catherine Crook de Camp, American science fiction and fantasy author and editor, once said: “if instead of playing the horses, an individual chooses to play the market, that is his own affair. Only he must understand that speculating in stocks is gambling, not investing.” This is a perfect example of how wrong the misconceptions people have about trading really are.

For sure, some “deceptive” have really helped develop this idea in the collective imagination of our society. Let me be clear from the beginning: trading is an entrepreneurial business. When you start a company, it is of fundamental importance to draw up a business plan to avoid any nasty surprises. Your business plan is called a trading plan.

It is therefore essential to define, before opening a trade, all the aspects that relate to it. The share of equity you want to risk in each operation, the maximum percentage of loss you are willing to put up with, stop-loss, target and risk/reward ratio.

All this will put you in the right conditions to undergo less of the psychological effects I will go on to discuss in the next articles, which negatively affect your choices. This is because, if you already know what your maximum loss for your trade can be, and if it is not a problem for your trading account, then you will make that trade serenely, without the stress that accompanies most traders.

So, you will see in this path that a good trading plan with simple, clear and precise rules will put you in the best mental conditions to trade and get success.

Many traders know certain strategies very well that, in theory, should be profitable, but their lack of a trading plan leads them to improvise exits from the market by anticipating the target. They could have

David is a trader with over 25 years of experience (two years as a fund manager) in currencies and commodities. He collaborates with a major European commodity investment company, and he is the author of several successful books about trading and financial markets.

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