There’s an old maxim from the fourth century BC that applies as much to modern stock trading as it did to life back then: “Know thyself.”
That general principle was first carved into an ancient Greek temple. So what the heck does knowing yourself have to do with trading?
If you want to be a better trader, you need to master your own mind, because nothing can wreck your trades faster than emotions. Fear, greed, hope, regret — they can all wreak havoc on your trading success.
If you’ve spent any time trading, you probably already know that. But do you know what do about it? Keep reading and you will.
In this article, you’ll learn tips to help you control your emotions while trading. We’ll also cover common mistakes to avoid and seven steps to psychologically prime yourself for the stock market.
Table of Contents
- 1 What Is Trading Psychology?
- 2 How to Master Your Trading Psychology Skills in 7 Steps
- 2.1 #1 Practice With a Paper Trading Account
- 2.2 #2 Assume Your First Losses as a Fee of Learning
- 2.3 #3 Observe the Habits of Successful Traders
- 2.4 #4 Set Stop Losses to Protect Your Account
- 2.5 #5 Choose Your Favorite Patterns and Stick to Them
- 2.6 #6 Learn How to Properly Read News Catalysts
- 2.7 #7 Use a Stock Screener to Locate the Best Stocks
- 2.8 The Right Mindset for Trading
- 3 Conclusion
What Is Trading Psychology?
Trading psychology deals with the mental state and emotions of traders. It’s the influence of your behavior and characteristics on how you trade. It also touches on your discipline and risk-taking.
Your mind plays a big role in your success at trading securities in the long term. Understanding how you think about trading can be just as important as your stock market knowledge and skills.
Let’s look at two big emotions in trading:
- Greed. Greed can make a trader stay a position too long just to try to wring every last cent out of it. It can also be a factor in taking on risky and speculative positions. It’s most common toward the end of bull markets when speculation runs wild among traders.
- Fear. Fear is the opposite of greed when it comes to trading. It’s the reason people sell early to cut losses and avoid taking on extra risk.
Fear sentiments are common during bear markets. It can make some traders exit the market irrationally. Never underestimate the force of stock market psychology. Fear can turn into panic and lead to huge selloffs.
These emotions and many more play an essential role in your overall trading strategy. Mastering them is fundamental to becoming a great trader.
Why Is Stock Market Psychology Important?
As a trader, you have to understand your emotion and mindset. It helps you identify when you’re acting irrationally.
Psychology and the stock market are closely intertwined. Let’s put it in the most basic term: It’s your money!
Imaging losing $1 … meh. Losing $50 … not ideal, but you’ll live.
Now imagine losing thousands of dollars or more. That’s probably enough to spin you into a bit of a panic. And panic can make you behave in ways you never expected.
That’s why you have to understand your stock market psychology when you trade. If you don’t, you can be swept up in the heat of the moment, by news hype or panic.
A successful trader learns to manage their emotions — even when everyone else is losing it. How? Create a set of trading rules and stick to them. Consistently. Lay out your decisions in advance to remove emotions from of the equation (as much as possible).
The key: You must follow the rules that you set for yourself. Don’t allow greed or fear to creep in make you deviate from your predetermined goals. That’s just sabotage!
Here’s what your rules should cover, at the minimum:
- Limits on how much you’re willing to gain or lose in a day on a security.
- At what prices you’ll enter or exit a trade. If you hit a specific profit target or loss, you either take the money or cut your losses.
Most importantly, educate yourself. The more you study the market and devote your time to training, the more you can trade using your brain and logic.
That also includes committing to research and studying charts. Better decisions depend on the tools and strategy you use. They also depend on you quashing fear and uncertainty.
Important note here: You also need to stay flexible. Experiment with new ideas here and there, such as testing different places to set your stop losses. Experiment is invaluable to the learning process.
How to Master Your Trading Psychology Skills in 7 Steps
Looking to get a grip on your trading psychology? You’re in the right place.
These seven tips can help you master your own mind …
#1 Practice With a Paper Trading Account
Being consistent with day trading is as much about experience and practice as it is about skill and knowledge.
Maybe you don’t feel ready to throw your hard-earned cheddar in the pot just yet? Set up a paper or ‘play money’ trading account. You can practice real-time trades while minimizing the stress and emotion you’d feel if you’d invested real money.
Paper trading can help you build confidence in your decisions without the constant worry mistakes and consequences.
You can always reset your balance and try again. Remember to keep track of what’s working and what’s not.
Most traders want to be cool, emotionless, money-making machines. To make that happen you first need to learn how to rule your trades with logic on a day trading simulator. Then learn to use that very mindset when trading for real.
If you’re new to trading, a paper trading account can help you adjust to the trading software and the process of reviewing and executing trades. Use it to practice using limit orders and stop losses and generally learn how to manage your risk.
You can opt for a simple setup, like a spreadsheet, to paper trade. Or you can embrace technology — lots of websites offer free accounts. Look for one with real-time or slightly delayed market data to watch market conditions as they unfold.
Before you jump into day trading, practice with paper trading for a few weeks or even months. Be sure to keep a detailed record of your trading performance over time. You’ll need to account for other factors, too. Are you in a bull market or bear market? When and if the market changes, your strategies may no longer work.
Bottom line: Don’t hesitate to trade with a paper trading account for a while. It can help you find confidence in your strategy long term.
By the way, paper trading isn’t just for beginners; it’s a handy tool to return to as your skills change and grow. Use it to try an increased trading risk or strategies you’re just not ready to bet real money on.
#2 Assume Your First Losses as a Fee of Learning
There’s nothing quite like jumping into a live account — not even after months of practice.
It’s just … different. Now there’s real money involved. A stock simulator can only do so much, after all.
Using real money can set your trading emotions on fire!
You’ll probably panic and exit positions too early when you one of your holdings starts to drop. Then you’ll kick and curse yourself when it bounces back to your initial goal price a few hours later.
Or you might hold on to a position too long out of greed — hoping to squeeze out just a little more. And you’ll ignore every red flag, like a major slowdown in momentum. That’s just the school of hard knocks. Most traders go through it. You’re not alone and, no, there’s nothing wrong with you.
Some traders can learn from reading and avoid making the mistakes of their mentors. But for most people, emotions will get the better of them. Sometimes, you’ve gotta learn the hard way. Just see your initial losses as paying your dues to the stock market. It’s all part of your trading education.
#3 Observe the Habits of Successful Traders
Success leaves clues.
There’s no need to reinvent the wheel. Instead, learn from the thousands of successful traders who’ve gone before you.
Not too long ago, it was difficult to observe the habits of successful traders. You’d need to intern at their brokerage firm, learn by working for them. But now, all hail the internet! It’s easier than ever to learn from millionaire and billionaire traders. Many offer online courses, membership sites, and even YouTube channels filled tons of free knowledge. The sad part: most people simply never take advantage of any of it.
Stick to what’s been proven to work!
Highly successful traders spent time learning the basics. They constantly seek more knowledge and do more research. They scan stocks daily and continue to observe others.
Most importantly, they set goals. These traders scrutinize their process and progress. Of course they make mistakes, but they learn from them and improve.
Successful traders are proactive, not reactive. And they focus on the process of finding great market opportunities, instead of on the outcome (like how much money they might make).
#4 Set Stop Losses to Protect Your Account
“It can’t possibly go any lower, right?”
Remember those words as you watch your favorite stock continue to drop point by point. Through multiple support levels and against all indicators, you’ll hold on to hope.
If you’re too emotionally invested in a stock, you’ll find it hard to pull the trigger when it’s time to sell.
This part is critical: You must set up stop losses in advance. No excuses.
Set your computer to automatically sell at a predetermined point before emotions enter the equation. It might seem impossible when a stock breaks through your key levels, but the reality is that your analysis only exists in your mind.
The market won’t bend to your will. It can — and often will — do things that you totally don’t expect. It may seem to defy every ounce of your logic and everything you’ve learned. But simply by understanding the random nature of the market, you can help your advance your trading goals.
Cut Your Losses Quickly
Some waves of the market are simply too strong to paddle against. When they come, learn to go with the flow and cut your losses.
You want to keep your stop losses wide enough that a small dip won’t needlessly exit you out of a position. It also needs to be tight enough to immediately sell when things don’t go as you expected.
Take time to find that balance. For newbies or anyone trying a new strategy, it’s better to err on the side of caution. Look to cut your losses quickly.
#5 Choose Your Favorite Patterns and Stick to Them
Everybody has their preferred chart patterns that seem to work best for them — head and shoulders, cup and handle, etc.
Looking for patterns is essential to trading psychology. Patterns tend to repeat, so identifying them can be a reliable way to trade.
Paper trading is a great opportunity to experiment with different patterns: See what you can easily and reliably identify.
You have to find what works for you. Pick a few of your favorites (say, two to five). Practice consistently recognizing when they occur. Then stick to them once you start trading with real money.
#6 Learn How to Properly Read News Catalysts
You can have the best technical analysis when it comes to stocks — and still go broke if you don’t also take news catalysts into account.
Finding the right catalyst can greatly help your bottom line … if you spot it early.
We might even argue that news catalysts are potentially more important than having the ability to read and understand charts and financial statements.
Most people will read a news story and then assume that the news will be a catalyst. By the time you read that news, so has every other trader. And they’ve already acted on it. A smarter approach is to do the opposite. Use a stock screener to check out stocks first. Then look for a news event to explain its performance.
Several stocks within the same industry might be rallying because of the same catalyst … but maybe there’s one lagging that you can still jump on.
#7 Use a Stock Screener to Locate the Best Stocks
Picking the best stocks is no simple task. There are just so many out there.
It’s hard to keep track of what different stocks are doing day to day — we’re talking heaps of data to analyze.
So … how do you find any useful information in stacks of seemingly useless data?
A stock watchlist can help you focus on the specific stocks that meet your needs. You can set your own requirements based on your strategy for the kinds of stocks you want to monitor.
- Do you want to buy small-cap or large-cap stocks?
- What kind of P/E (price to earnings) ratio is acceptable to you?
- Do you only want to buy stocks in a specific sector?
Stock screeners can filter through thousands of stocks to help you find companies you want to trade. That way you can focus on only a handful of stocks that already meet the majority of your criteria.
Here comes the difficult part — knowing what to screen for.
Screeners are super flexible. They can filter stocks based on hundreds of different variables. You need to know what you’re looking for, and why, for them to work effectively.
The downside of stock screeners is that they can only look at quantitative factors. You’ll need to further investigate each stock for qualitative issues — labor problems, pending lawsuits, government regulations, and so on.
Stock screeners are an awesome place to start. But it’s just that, a starting point. It’s up to you to continue researching once you’ve got a manageable list of stocks to work with.
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The Right Mindset for Trading
Your trader mindset can make a huge difference to your trading success.
Let’s say you make 10 winning trades in a row. You feel on the top of the world when that happens, right? But there can be bad streaks, too. And they can make you doubt your knowledge and methods — even when you know they’ve worked before.
It’s easy to get overconfident when things are going your way and just as easy to get scared when the market turns against you. Remember your trader mindset to keep yourself level: Try to approach the market with positive-yet-neutral attitude.
Let logic, not emotion, dominate your trades.
Don’t Second Guess Yourself
If you’ve been trading for years, you probably have a good idea of what works and what doesn’t. Even if you’re new to trading, you likely have basic skills and knowledge from paper trading.
Don’t second-guess yourself. Stick to the rules you’ve set for yourself and the trades that are proven to work for you.
Never Have Regrets About a Wrong Trade
There’s no such thing as a perfect trading record. Fact: Mistakes happen. Sometimes things just don’t go your way. The key is to recognize when you’re wrong and use it as a learning opportunity.
Remember that the market can be fickle and random. You’ll never be able to predict it completely.
Don’t look at every loss that you incur as a failure — see it as an opportunity to learn.
As long as you did your research and followed your trading rules, there’s no shame in admitting you were wrong.
The perfect trade doesn’t exist
No one wins 100% of the time. You need to know that you’ll usually leave some money on the table when you exit a trade.
It’s better to exit a position with some success than to risk a loss trying to get a bit more. Accept that you’ll never get it exactly perfect and you can save a lot of time and money in the long run.
Commit yourself to ongoing learning
There’s a common quality among successful people: a commitment to lifelong learning.
The stock market is constantly evolving and changing. That means you have to change and evolve, too. Embrace what technology has to offer — new tools, screeners, indicators, and more. Use everything available to hone your skills and edge.
Competition won’t just fade away. It’s up to you to stay ahead of the game.
Want to learn from top traders? Good idea. There’s no shortage of successful traders spouting their triumphs. There are thousands of books available for you to pull insights from.
Psychology is a massive part of trading stocks. The better you understand your mental and emotional patterns while trading, the better you’ll likely do.
And it’s not just your psychology — it’s understanding that every trader may be on an emotional roller coaster. Will you ride it with them, or will you use logic to make smarter moves?
Don’t let unchecked panic, fear, and greed sabotage the trading skills and knowledge you’ve worked so hard to build. Set your rules ahead of the trade. Plan your entry. Plan your exit. Stick to the plan. Remove mindset and emotion from the trading equation — as often as possible.
And remember to practice. Paper trading can give you a lot of insight as to how you’ll react in an actual trade, without the risk.
Watch what other successful traders do. Learn how to read news catalysts. And (always!) use stop losses wisely to protect your bottom line.
Have your emotions ever wrecked a well-planned trade? Do you use stock market psychology to your advantage? Leave and comment and tell us what works for you!
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