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Trading Psychology (Part 1)

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Your success or failure in trading depends on your emotions. Having a good trading system is not enough. You may have an exellent system, but if you feel upset, anger, arrogant, your account is sure to suffer. According to conventional financial theory, participants are, for the most part, rational wealth maximizers. However, there are many examples where emotion and psychology influence our financial decisions, causing us to behave in irrational ways. Behavioral fianance is a new field that combines behavioral and cognitive psychological theory with conventional economics to provide explanations for why people make irrational financial decisions. This topic will give you an edge to understand the underlying reasons and bias that cause people behave against their best interests. Hence, you may have some useful tips applying to your trading style.

Loss Aversion


That means investors are more sensitive to loss than to potential return. In other words, losses have more emotional impact than an equivalent amount of gains. For example, the joy of winning usd 50 is less than the pain of losing usd 50. This helps to explain why investors hold losing postions too long and sell winning positions too soon. Applying this to your trading, you should set stoploss and target before opening position. Never remove stoploss order with hope that market will be back your position.

Anchoring


It is a tendency we attach or anchor our thoughts to a reference point even though it may have no logical relevance and no sense to your situation. For example, an investor anchor on the previous high USD 40 of ABC stock and the current price of usd 20, he erroneously believes that ABC is undervalued. In trading, you attach to your opening position or recent high/low. When the market moves against you, instead of accepting you are wrong and exit your position, you still believe it is too high or too low. Then you start hoping the market wil move back to your position. But the price never come back, you are sure to suffer a big loss even loss everything. The lesson is Do not buy a stock/ FX with a thought too high or too low and always use stoploss order. (To be continued)