Importance of Psychological Factors in Day Trading

Novice traders mistakenly believe that having technical or fundamental analysis skills would guarantee them success. However, the reality is that the most important aspect, especially when making the first steps in day trading, is the control over emotions. The psychological factors might have the greatest impact on a trader’s results no matter how good he is at analyzing the markets.

Remember that trading is not limited to a single transaction – one has to carry out multiple trading deals and stick to a strategy in order to generate consistent profits. Following a plan even during drawdowns requires a certain level of discipline, a quality that should be practiced by all traders. Sadly, people do not always behave in a reasonable manner – often, emotions affect us, and we act differently than usual. Traders must learn the basics of emotional control.

Even when traders record consecutive winning trades, they might be eventually affected by emotions. In fact, the person who wins should be cautious because there are psychological effects that might cause traders to turn a blind eye to obvious risks.

Here are some of these seemingly inoffensive but dangerous emotions:

  1. Euphoria – this is only a variety of greed that becomes visible when a trader has managed to secure a series of winning trades or a single but significant win. This state of over satisfaction and positive sentiment might lure traders to open even more positions, even when this is against the strategy rules or money management principles.Usually, traders are tempted to bet in the same direction as the earlier winners. However, this might turn out badly. In fact, this is why some traders record their biggest loses immediately after several good deals.
  2. Self-attribution/overconfidence – self-attribution is the bias that makes traders attribute winning trades to their own decision-making skills and actions while considering the bad outcomes to be caused by external factors. The step from self-attribution to overconfidence is very tiny, and there is often an overlap between the two.

    For example, when a trader with self-attribution bias opens a long position on a stock that eventually gains generous percentage points, he thinks that the cause of the price increase relates to his talent of analyzing the markets and predicting the trends rather than factors like good economic circumstances. This might lead to overconfidence, which will make the trader take rapid decisions without relying on research.

Since being a winner can lead to biases, you might expect that those who lose tend to become more careful when trading. Well, this is far from the truth. There are several emotions that overtake traders who lose.

Here are two of them:

  1. Revenge – this emotion often comes immediately after a loss, with the trader becoming agitated and ready to ignore money management rules in an attempt to recover the lost amounts. Often, the loss is greater than one could handle, and this is when the feeling of revenge becomes keener.Given that they are anxious, traders, especially novice ones, would get back in the market immediately and try to cover the previous losses. Nonetheless, because their decisions are surely derived from emotions, chances are that they will fail again.
  2. Loss aversion – also called regret aversion, this bias related to the trader’s discomfort experienced after realizing that his decision turned out to be wrong. This emotion is guilty of taking less risk and not acting properly when the trade goes against us. For example, think about a trader who goes long when the stock is priced at $15. At some point, the share price declines to $10, and there are strong fundamental signals indicating that the bears are stronger. However, our trader doesn’t like to be a loser, so he refuses to exit his positions and waits for the stock price to come back again.

Traders who lose might also feel a mix of emotions like fear, desperation, and panic, with the latter one being the most dangerous.

To take control of emotions, one should stick to a strategy and have a strong discipline. You should act like a robot that doesn’t feel anything beyond his program. You should begin practicing discipline for the first days of your trading. This is easily achieved when attending specialized schools and day trading academies founded by trading experts.

Bottom Line

A good strategy mixed with basic money management rules will keep you away from psychological extremes. This is especially important in day trading, which is a demanding activity that might involve a lot of stress.



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