Trading psychology: Realistic expectations and a disciplined strategy are a must, says expert

Trading psychology: In his popular book, Trading in the Zone, Mark Douglas captures the essence of trading psychology with a simple but profound statement: “The key to consistent success in trading (or any other endeavour) is to learn to think in probabilities”. Puneet Maheshwari, Director of Upstox, says that this insight lays the foundation for understanding the complexities of trading. 

He says it implies that success in trading is less about predicting outcomes or being right and more about managing the probabilities. Trading psychology highlights various aspects of a person’s character and behaviour, he says, and adds that this, in turn, influences their decision-making and can lead to biased thinking.

Following this line of thought, Director of Upstox says that there are five key aspects of trading psychology that offer traders a way to develop a mindset that is attuned to the nuances and probabilities of the trading world — 

1) Greed and fear: Trader are faced with two of the most dominant emotions — fear and greed. During a downtrend, fear can cause one to sell holdings in a panic, potentially missing out on subsequent rallies.  Maheshwari avers, "Greed, on the other hand, may encourage one to take additional risks in search of more profit. Over time, successful traders learn to identify these emotions. They use this understanding and balance both fear and greed with knowledge to make more sensible, balanced decisions."

2) Herd mentality: Humans are social creatures by nature, and this trait extends to trading behaviour. The Director of Upstox feels that many traders follow the herd, which often leads to losses or market bubbles. "By following the crowd, a trader ends up ignoring his or her own analysis, resulting in poor trading decisions and loss of capital. When everyone is excited about a new sector or stock, it's tempting and easy to jump on the bandwagon. While it's good to be aware of the popular opinion, you should always do your own analysis before risking your money. How often can you be sure of good returns based on a popular opinion?", he opines. 

3) Hope: In trading, unchecked hope can be a double-edged sword. It often leads traders to make decisions based on gut feeling rather than strategy or curated systems. Maheshwari says that this approach blurs the line between calculated risk-taking and gambling. He adds, "This type of hope, mixed with greed, often leads traders to hang on to losing trades or miss opportunities to take profits while chasing unrealistic gains. Traders can always balance hope with realistic expectations and a disciplined strategy. This ensures that decisions are based on logic rather than wishful thinking."

4) Fear of missing out (FOMO): FOMO, or Fear of Missing Out, can be described as the fear of not being part of an interesting event - certainly a very powerful feeling in trading. This eagerness to trade can force you to jump into the middle of an ongoing trend or to make rash decisions that usually result in losses. Suggesting a remedy, Maheshwari says, "In such situations, traders should always remember that there will always be another opportunity to trade. It is better to avoid rushing into a trade that you have not planned and prepared for."

5) Loss aversion: Deeply rooted in human nature, loss aversion highlights our tendency to fear losses more than we value gains. In trading, this fear often leads to holding on to losing positions in the hope of a rebound, rather than accepting a loss. The Director of Upstox opines, "It's important to approach trading with a mindset that focuses on probability, not emotion. Acknowledging that not all trades will win and implementing strategies with pre-defined exits, including stop-losses, is essential. This approach helps manage risk and ensures that wins are more impactful than losses."

Summing it up, he says that all types of analysis are important, whether fundamental, technical or quantitative, but managing the psychological component can give traders an emotional edge. This enables traders to make more informed and logical decisions, manage emotions such as greed and fear, avoid the pitfalls of herd mentality and loss aversion, while effectively avoiding wishful thinking and learning from losses. "This comprehensive approach, a blend of market knowledge and psychological acumen, is often the difference between successful traders and the rest. It's important to recognise that sometimes the biggest challenge is not navigating market trends, but managing psychological biases," he signs off saying.