Trading Psychology – Introduction

In this section of the site I am going to discuss, in a light but at the same time complete and exhaustive way (without making it boring), a topic that, in my opinion, is underestimated by most investors and held 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 madness, I decided to promote a book by claiming that it revealed the most successful technique in the world and the best set of indicators, many traders, or the merely curious, would probably buy it expecting to find a magic formula for getting rich. These are people who want to be “spoon-fed”, who want the work done for them, without starting from the basics to understand the underlying dynamics of the financial markets.

In the next articles I will talk about things I have experienced personally, some consistently, others more superficially. That is why I have studied behavioural finance in greater depth: I believe it helps us understand our mistakes.

The objective of this section is to highlight some situations that most of you will be able to recognise, using practical examples. I assure you that, by starting from these aspects, you will see your own improvement and understand your mistakes more quickly. This will allow you to grow and improve faster.

It is no coincidence that, despite the many trading techniques available, some of them excellent, only a few traders achieve positive and, above all, consistent 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, a lack of trading rules and money management.

Most people approach the financial markets the wrong way because they do not consider trading a real business. These aspiring traders lack a trading plan and sound risk management. Many traders know very well certain strategies that should, in theory, be profitable, but without a trading plan they improvise their exits, closing the trade before the target is reached. They could have managed the position better and obtained a more profitable result.

Or they may be disoriented and unable to react when the market goes against their position, so they fail to cut their losses, as they would have done with an exit plan prepared in advance. They start to “argue with the market,” which only makes their losses heavier, until they shut down the computer, hoping that sooner or later the market will forgive their naivety.

And things can always get worse: there are also traders who operate without any risk control. This means that the consequences of their mistakes are often disastrous for their trading accounts, which leads them to realise (but only afterwards) that trading is not for them, that trading is a business for professionals, not for improvisers.

I think the main problem is that most people consider trading a form of gambling. Catherine Crook de Camp, the 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 the mistaken ideas people have about trading.

Some scammers have certainly helped to spread this idea in the collective imagination of our society. Let me be clear from the start: 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 your trading plan.

It is therefore essential to define, before opening a trade, all the aspects that relate to it:

• the portion of your capital you want to risk on each trade
• the maximum loss you are willing to accept
• the stop loss
• the target
• the risk/reward ratio

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

So, you will see on this journey that a good trading plan, with simple, clear and precise rules, will put you in the best mental state to trade and achieve success.