Forex trading just like any trading is a lot about psychology. Do you know the most common pitfalls among failing forex traders? Do you have what it takes to become a successful forex trader? This is our most comprehensive article in our trading psychology section where we’ll go through both psychological reasons for failing but also some other important reasons. Hope you’ll both enjoy and learn from it.
First the psychological reasonsAfter going to the trouble of developing and implementing a trading plan, why would a forex trader ever begin breaking their own trading rules?
Each individual trader will have a different answer to the above question. In many cases, inexperience is the first culprit. “Rules are meant to be broken” simply does not apply when trading in volatile market environments, as many a forex trader can attest. Unfortunately, many trading novices seem to choose especially volatile times to break their own rules, just when they should not.
A series of other reasons typically arises for more experienced traders, but whatever the cause, losing discipline with one’s own rules can often lead to a trading blow-out. This can put the trader firmly out of business regardless of their previous trading success and experience.
One of the pitfalls of not having a trading strategy or ignoring a well-developed one is following your emotions when making trades. Fear, along with greed and hope are the main trading emotions that make the forex market move. Because of the inherent fear of losing money that affects everyone involved in the forex market, fear could be considered the market’s number one emotion.
Fear
In general, the emotion of fear arises from a perceived threat and developed as a natural defense mechanism in most animals. The limbic brain, which makes up the most primitive and reptilian part of the brain, controls fear which originally took the form of the “fight or flight” self-preservation response characteristic in all higher animals.
While losing money is the apparent cause for fear, the root cause is a fear of poverty; no one wants to be poor. The fear of poverty is another deep-seated fear that society has programmed into its members and directly affects the trading community.
A Forex Trader’s Fear Responses
Several types of fear arise often in the course of trading whether consciously or unconsciously, these emotional responses include:
• The fear of failure
• The fear of missing out on potential profits
• The fear of losing everything or impending doom
The fear-based emotional responses cited above find their expression daily in the markets and often contribute to trading losses unless appropriately managed. Nevertheless, fear can be extremely useful in the event of calling the market wrong, as W.D. Gann, a well known trader from the last century noted “Fear will often save you if you act quickly when you see that you are wrong.”
Many professional traders will admit to allowing the gut feeling of fear to give them an indication as to the right time to get out of a trade. This applies to situations where the trader is either taking a profit or cutting losses short. Another Gann quote on fear sums it up nicely: “The fear of the market is the beginning of wisdom.”
How Fear Manifests in Forex Trading
Having a great trading system and all of the technical and analytical tools for success in trading will not suffice to be successful; a trader has to have the right mindset. This can only be accomplished by learning to control emotional responses when trading and in all trading situations.
An emotional response which can adversely affect a forex trader involves fear impeding the trader from taking action. This can be especially damaging if the trader has a losing position and finds themselves paralyzed while the market continues moving against them.
This type of response may also impede a trader from taking advantage of a trading opportunity going against their own trading plan and allowing fear to prevail over their own instructions.
Another instance of fear which arises during forex trading tends to happen after the trader has made a losing trade. Because of a lack of confidence caused by the previous losing trade, the forex trader might be too afraid to jump back in regardless of an opportunity to make back the money lost on the losing trade.
Fear will also cause a person to exit a profitable position earlier than would be necessary. This reduces potential gains and makes you unable to absorb inevitable losses longer. It is important to be able to absorb these losses long enough for your gains to outweigh them.
The fear of loss makes up a chief component of the forex market’s mass psychology, and it can lead to major market panics as people scramble to get out of positions at almost any price.
Dealing With Fear When Trading Forex
Basically, when dealing with fear, keep in mind that fear relates almost exclusively to future events. This could take the form of prolonging an unacceptable situation or of making a present situation worse.
A good way to deal constructively with fear is using fear to replace hope which can be extremely detrimental to a trader. For example, instead of thinking, “I hope the market will come back,” you can replace that thought with the much more helpful, “I’m afraid I’ll lose more money.” This thought replacement technique also aptly illustrates the dilemma that a forex trader faces when they have made a losing trade.
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