Blog: Market Psychology

Timing is an essential element in trading and investing.

For any product or market, if you buy and sell at the right time, you can make a lot of money, but if you get the timing wrong, you can also lose a lot of money.

And to get this timing right, you need to have the discipline and patience to WAIT for the right timing.

Wait for the Best Opportunities

In trading, there is a time for action, and a time for inaction.

Unfortunately, for most people, they cannot stand inaction. Or perhaps they think that trading should be full of action.

Hence they keep trying to find opportunities to take action, even if they opportunities are not the best opportunities.

Let’s be honest, good opportunities are rare. And best opportunities are even more rare.

Trading is 99% waiting (and researching), and 1% action (executing the trade).

If you are doing the opposite, then you will end up with a lot of activity, but very little profitability.

As a trader, we should approach trading like a sniper. (As opposed to wielding a machine gun.)

Do all the planning and stake out the target.
Wait for the perfect timing to make the kill.
Only pull the trigger when we have an excellent opportunity.
Make every shot count.

Do Not Chase a Missed Trade

Back when I was doing full-time proprietary day-trading, we had to watch the markets closely for hours to wait for the best trading opportunities.

Sometimes, we could be eyeing a big juicy trade, and we all knew it would likely be the trade of the day.

It could be an unscheduled news announcement, price taking out a key level (breaking support/resistance), or a pullback opportunity to enter a trend.

Whatever it was, the event usually happened quickly, hence the window of opportunity is usually very small. So we would all wait patiently for this trade, while monitoring the prices.

Now here’s the tragic part.

After waiting for hours, you suddenly have to go to the restroom.

So you rush for a 5-minute toilet break and dash back to your trading desk, only to find that the event you had been waiting for happened while you were in the toilet.

Maybe the breakout happened and the price has gone up a lot from your original planned entry price.

The big question is, will you still want to take the trade even though it is no longer optimal?

Would you want to chase this trade?

Many people would, but it is a bad idea.

Because it causes you to deviate from your trading plan.

And when you end up taking sub-optimal trades, you end up with sub-optimal results.

It is painful, but it would be wiser to pass on this trade, and wait for the next better opportunity.

After all, it is better to miss the boat, than to leave on one full of holes.

A Good Entry Allows Easy Risk Management

Now you might be wondering, what’s the link between entry timing and risk management?

If you execute a trade according to your trading plan, you should already have a planned stoploss for every trade.

So if you make an entry using the entry price on the trading plan, then risk management is easy because you can just use the planned stoploss.

However, if you deviate from the trading plan (eg. chasing a missed trade), then the plan becomes useless.

For example, if you planned to go long, with a reward-to-risk ratio of 2:1, but you entered late, and price has already gone way above your intended entry price, where are you going to place your stoploss?

If you use the old stoploss price, then you will have to adjust down your lot size, otherwise your risk will be higher than your intended risk.

And even if you do that, your reward-to-risk ratio is now less than 2:1, so is this still considered a good trade?

Emotional Traps

We all hate losing money, and hence we sometimes get trigged emotionally by losing trades, and end up in a downward spiral of bad decisions.

Here are 2 common self-destructive behaviours:

Impulsive trading
Revenge trading

a) Impulsive Trading

This usually happens due to greed and hope, where people are afraid of missing out (FOMO), so they start to see every trade as a great opportunity, and want to take as many trades as possible.

When this happens, they usually do not bother to follow their trading plan (assuming they have one in the first place) or do any research, and usually just go with “gut feel” to justify their trading decisions.

To be honest, this is more like gambling than trading.

If you are new to trading, and you start finding trading opportunities on every chart you see, then you might want to watch out for impulsive trading.

Make sure you stick strictly to your trading setups, and avoid using random chart analysis to justify your impulsive trades.

b) Revenge Trading

This usually happens after a particularly unlucky trade (price almost hitting your target then reversing to hit your stoploss), or a string of losses.

People start to feel cheated or angry, or their ego might hit take a hit after this string of “failures”.

As a result, they take more trades because they want to win, in order to “take revenge on the market”, or “teach the market a lesson”.

At this point in time, they obviously no longer follow the trading plan or any risk management, and trading in this bad psychological state will often result in even more losses.

This is why it is often a good idea to take a break from trading after a string of losses, so that you can mentally recalibrate yourself.

In the next chapter, will learn how to deal with losses in a constructive and beneficial way.

complete guide to investing and trading psychology cover

If you would like to learn more about trading psychology, also check out: “The Complete Guide to Investing & Trading Psychology”

Spencer is an avid globetrotter who achieved financial freedom in his 20s, while trading & teaching across 70+ countries. As a former professional trader in private equity and proprietary funds, he has over 15 years of market experience, and has been featured on more than 20 occasions in the media.

Best Habits to Improve Trading Psychology

Knowing all the different cognitive biases and dangers of emotional decision-making can make us more aware of whether we are thinking logically and making the right decisions.

But it can hard to be on 100% alert all the time, especially on stressful days.

So, what are some of the simple habits we can cultivate to eliminate or reduce the risks of cognitive biases?

Stay mentally neutral, even if you have open positions.
Ask yourself, “if you did not have any positions at the moment, would you still choose to take the same position which you are currently holding?”
If you are unsure, you can always close the position and enter it again later.
Have confidence in yourself and in your trading system.
Every system will definitely have losing days, so if the losses are within the expected range, do not panic and discard or trading system too quickly.
If your system works, it should recoup those losses and more on the winning days.
Always use a stoploss.
This helps to eliminate many of the negative impacts of cognitive biases, such as loss aversion bias, endowment bias, regret aversion bias, anchoring bias, optimism bias, cognitive dissonance bias, etc.
Once you are stopped out of a position, you immediately become neutral, and can choose to take a position in either direction.
Make sure you have sufficient data for your evaluation and testing.
If you are doing backtesting for your strategy, make sure you test it over a sufficiently long period of time and under different market conditions.
If you are evaluating your results and performance, make sure you have at least 100-200 trades before drawing any conclusions.
This will help you eliminate the representativeness bias.
Keep good trading results and also a trading journal.
This will allow you to compare your decision-making process with the outcome of your decisions, and help you eliminate the confirmation bias, optimism bias, hindsight bias, overconfidence bias, optimism bias, and self-attribution bias.

If you would like to learn more about trading psychology, also check out: “The Complete Guide to Investing & Trading Psychology”

What are Cognitive Biases & Behavioral Biases?

To help traders and investors overcome the problem of emotions in decision-making, the first step is to be aware of the situations in which we might exercise flawed thinking, in the form of cognitive biases.

Cognitive biases are systematic errors in thinking that affect the decisions and judgments that people make, so they might think they are making logical and rational decisions, but in reality they are not, because the thinking/deduction process is flawed.

Once you are aware of these biases in your decision-making, it would be easier to find ways to avoid or overcome them.

If you would like to learn more about trading psychology, also check out: “The Complete Guide to Investing & Trading Psychology”

What is Behavioral Finance?

In classical finance, traders and investors should always make rational decisions to maximise their self-interests, but in practice, quite often they end up making decisions that are not always rational, due to the influence of emotions and cognitive biases.

There is a whole (relatively new field) of finance called behavioral finance, which seeks to understand why this happens.

Behavioral finance is the branch of finance that combines classical finance (rational decision-making) with the psychological/behavioral aspect of market participants.

In layman terms, classical finance tells us what people should do, whereas behavioral finance tells us what people actually do.

The main reason for this difference is that classical finance assumes that humans are rational decision-making robots, but in reality humans are subject to emotions, flawed thinking, cognitive biases, etc.

If you have tried trading in the markets, or even played a game of chance like poker, you will know how hard it is to make rational decisions once money is at stake, and greed and fear starts to cloud your judgement.

If you would like to learn more about trading psychology, also check out: “The Complete Guide to Investing & Trading Psychology”

Achieving Long-Term Consistency in Trading

In the game of trading and investing, the goal is not to make once-off huge bets and have large swings in your portfolio based on your luck.

The ultimate goal is to achieve consistent returns over the long-run.

And to achieve this consistency, traders will not only need to have a good trading plan, but will also need to master the psychological and mental aspect to be able to execute the plan flawlessly over and over again.

Your mind is your greatest asset, and also your greatest enemy.

Hence, you can think of consistency as a state of mind, where despite the outcome of any trade (win or lose), and despite your current mental state, you can continue to perform and execute your plan in a consistent manner.

Consistency = Repeatability
Repeatability = Scalability
Scalability = $$$

If you want to make it big, and trade a large trading account, you first need to master trading a small account.

If you can consistently trade a small account, it means you can repeat the results and performance onto a larger account.

So this will allow you to scale up, and trade a larger account.

If you try to scale up without consistency, then you will see large swings in the capital of your trading account, and it is only a matter of time before you blow the account.

So how can one master trading psychology and achieve the ideal mental state?

If you would like to learn more about trading psychology, also check out: “The Complete Guide to Investing & Trading Psychology”