How to Master Trading Psychology

Trading is a mental game in which what happens in your head can be just as important as what happens in the market. To have a successful career in trading, you must be able to make decisions that are detached from emotions and biases. Personally, it took me a long time to understand my own mental pitfalls and master the mental side of trading. If you’re struggling with things like discipline, patience, or impulsive decisions that lead to losses, I know exactly how it feels. So in this article, I will show you how to understand your own trading psychology to avoid mental pitfalls and make better trading decisions.

Let’s go!

Why You Need to Master Trading Psychology

Trading psychology refers to your state of mind and emotions when you trade.

I’m pretty sure you can recall a time where you lost money after executing a trade based purely on emotions, mainly fear and greediness.

Every trader out there has made this mistake before, but what separates successful professional traders from the rest is their mastery of their psychological state.

What this means is being able to understand your emotions, habits, instincts, and biases before you trade so that you avoid irrational decisions.

Many professional traders struggle with the mental side of trading. For example, a common pitfall is to execute a trade that doesn’t match your strategy out of FOMO only to lose money afterwards. There is also overtrading out of frustration. Another hurdle is analysis paralysis which keeps some traders from seizing opportunities.

It’s understandable to fear making a mistake, but trading and risk taking always go hand in hand. Your goal is to make calculated risks backed by data instead of letting emotions and habits drive your decisions.

So having full control over your emotions is critical to your success in trading. To do that, you need to develop a strong and disciplined mindset.

In the following section, I am going to explain the major aspects of trading psychology that you need to develop along with common pitfalls that traders often fall into.

The Major Aspects of Trading Psychology

1. Discipline

Discipline is the cornerstone of any profitable trading strategy. It means sticking to your plan especially when you are tempted to break it. If you go against your plan and start trading on a whim, you’ll develop bad habits – like revenge trading or premature exits – and make costly mistakes.

While your trading strategies won’t always work, you can always adjust them to improve your results. The losses you’ll suffer due to a lack of discipline are far greater than those resulting from an improvable trading strategy.

To develop discipline, you need to create your own trading rules and follow them diligently. Here are some of the rules I follow:

• Set a clear stop loss

• Trade with the trend of the market – it’s no use trying to catch a falling knife

• Don’t leverage in a highly volatile market

• Always do your research

There are only just a few of my rules. You need to find the rules that work for your trading style and risk-level tolerance, and then follow them to the letter.

2. Patience

Trading is all about timing – making the right decision at the right moment. Knowing what you want to buy or sell and doing nothing until the right time comes is what makes an effective strategy. This requires self-control and being able to keep emotions like FOMO in check.

In more practical terms, after finding stocks that match your strategy, you wait for a trade setup to fully form and then enter the trade when you see the trade trigger.

While there is a thing such as holding on to a winning or losing position for far too long, impatience will drive traders (especially day traders) to get in or out too early.

I know it can be hard to be patient in a world of instant gratification. I used to enter trades that didn’t check every box in my checklist and exit other trades too early. As you can imagine, I lost a lot of money because of impatience. But once I learned the importance of waiting for the right moment, my profits started increasing in response.

So now you might ask: how does one go about developing patience? Well, let me give you a few pointers:

• Wait for a promising setup to take form

• Make sure a trade matches all your criteria before entering it

• Don’t settle for a tiny profit due to fear of subsequent loss

That said, even with patience there are times where you lose money. So let’s see how you can train your psychology to deal with that.

3. Dealing with losses and extended drawdown periods

Losses can have a devastating effect on traders. I’ve seen many traders lose their confidence and others fall into depression. Others cope by trading hastily in the hope of making up for their loss. This inability to handle loss properly only leads to even worse outcomes.

Granted, making an emotional and financial recovery from a severe loss is not easy. I’ve been there and I know what it’s like.

But here’s the thing: losing money is unavoidable in trading. Even the best traders will lose money on numerous occasions. What you can do about a loss is treat it as an opportunity to learn so that you make better trading decisions.

When you lose money, accept it and take a short break from trading to review the situation and determine the reasons for that loss. Do that and you’ll find yourself better equipped to trade effectively in the future.

The same goes for long drawdown periods: They are part of trading and won’t come knocking on your door. You need to know when to cut your losses, determine their causes, and revise your strategies to improve your trading and net more gains than losses.

Two mistakes I made in the past were cutting winning trades too early and keeping a losing position for too long. Nowadays, I have a clear risk management strategy in place in which I set a hard stop loss and stick to it. I never hold onto a losing streak simply out of hope for a bounce back.

This takes – you can guess it – discipline and control over emotions.

4. Control over emotions (especially tilt)

This is one of the biggest hurdles that all traders must deal with. Trading profitably requires a strong ability to manage your emotions. A trader who can’t control strong emotions, like frustration or desperation, will trade on a tilt, trying their hardest to beat the market. This sort of irrational behavior, if not stopped promptly, will end up destroying their trading account.

When interviewed for the book Market Wizards, Marty Schwartz said the following about losses:

“Learn to take losses. The most important thing in making money is not letting your losses get out of hand.”

– Marty Schwartz

Suffering a big loss can sway your emotions, thus affecting your decision-making or even making you reconsider your trading career.

Even a big win can cause you to trade recklessly out of euphoria. So it’s essential to be aware of the emotions you go through as you trade. Here are the most common feelings experienced by traders:

• Fear of losing money

• Fear of missing out on profits

• Greed

• Frustration

• Self-doubt

• Pressure during moments of high instability

You don’t have to completely suppress your emotions. Instead, you just have to be aware of your emotions and try to stay as rational as you can when you trade.

Admittedly, even long-time traders can find this challenging, and it’s no different for me. But I no longer let emotions like panic or frustration impact my decision-making.

5. Overcoming bad habits, biases, and other psychological pitfalls

You shouldn’t make a decision solely out of habit, bias, gut feeling, or external influence.

Bad habits are hard to break after they become second nature, so make sure to spot them before they lead you to poorly-thought decisions.

One example of bad habits is to keep taking bad trades just because one bad trade in the past ended up profitable by luck.

There is also the issue of external influence. There are traders who blindly follow the opinion of an authority figure or buy stocks that other traders are flocking to.

Another negative aspect of psychology is when traders fall victim to their own biases like overconfidence or blindly. Other common biases include the bandwagon effect and attribution bias.

The best way to prevent bad habits, biases, and other psychological pitfalls from influencing your judgement is to be aware of it. So take the time to learn about the many pitfalls that plague traders and look back to your past losses to determine which ones were caused by them.

Now that we went over what psychology in trading entails, it’s time I explain to you how to master trading psychology.

How to Develop a Winning Trading Mindset

Here is how I have mastered the mental game of trading.

1. Journal your activity

I can’t stress this enough: there is no successful trader who doesn’t keep a trading journal.

You need to consistently document your trading activity, goals, market conditions, outcomes, plan, thoughts, and emotions. Making notes helps you become more aware of your habits, biases, and emotions, thus allowing you to avoid big mistakes.

Journaling will also help you:

• Build discipline

• Analyze your wins and losses to determine their causes

• Develop attention to detail

• Find patterns in the market

• Reeavalute and adjust your trading strategies

Your journal is your best tool to always keep learning and improving. You will find numerous insights on your psychology in your notes and that will help you trade more mindfully.

2. Create your own rules

As I mentioned above, creating rules helps you develop discipline, which is key to trading sensibly and profitably. You also develop patience and resilience against emotions and bad habits.

I mentioned some personal rules in the discipline section. Below are more rules that many trading agree on:

• Determine your level of risk tolerance

• Set clear target profits and stop losses

• Set clear entry and exit strategies

• Document and reevaluate your trading plans

• Think of all possible outcomes before executing a trade

• Set specific actions for different scenarios

• Don’t break your own rules

You don’t have to follow every rule out there. Instead, you should determine which rules fit your trading methodology and risk tolerance. Start each trading day with the goal of sticking to your rules. Eventually you will revise them and add new ones based on the market conditions and your judgement.3. Understand your emotions

This is one of the most important elements of mastering psychology in trading. It’s crucial to be aware of your emotions before they influence you and keep a rational outlook on the market. This self-awareness allows you to foresee and prevent the negative outcomes that could result from an emotional decision.

Now, like I said before, this doesn’t mean shutting down your emotions completely. But you need to stay in control of them, not the other way around.

Let me give you some tried-and-true recommendations for managing your emotions:

• Set realistic expectations

• Don’t look too much at your profits and losses

• Stick to your trading plan

• Have a risk management system in place to mitigate losses

• Write notes on how you feel while trading

• Do market research (more on that right below)

• Take a break from trading to relax and do an unrelated activity like sports

I find these tips to be highly effective for keeping emotions in check and building resilience against tilt, and I’m sure other successful traders would agree as well.

4. Conduct research and analysis

Research and analysis are necessary to find patterns in the markets and predict changes. The more knowledge you have and the more rational your trading decisions will be.

So make sure to always stay up-to-date with the latest news and events in your industry of choice. Find timely and reliable information provided by national organisations, industry organisations and associations, and specialized press.

On the analytical side, study charts and read research reports. Use your preferred trading software to conduct in-depth technical analysis. When possible, attend conferences and talk to your mentor.

Personally, I like to catch up on news in the morning, read trade journals, and listen to trading podcasts.

Remember that markets always change and that the consensus can end up wrong. So always try to find new sources of information that will give you an edge.

5. Hone your mindset

Honing your trading mindset is all about being aware of your state of mind and not letting it influence your thinking and decisions in a negative way.

When you start having feelings like doubt or fear, you need to switch your thinking. Instead of telling yourself “What if this ends up a losing trade like last time? Am I just gambling here?”, you should be thinking something along the lines of “Losses are part of trading. I just need to make sure I don’t lose more than I can afford. Let’s stay focused on my trading plan”.

It’s important to reframe the situation and keep a positive outlook on it. As long as you stick to your stop loss, you’ll live to trade another day. Here is what Dr. Brett Steenbarger, renowned trader and author of the TraderFeed blog, says about trading and losses:

“Every trade should be accompanied by a very specific idea of what would tell you you’re wrong and how much you’re willing to lose on the trade.  It’s when losses surprise us and become too large that they’re likely to create disruptions in our mindset.”

Dr. Brett Steenbarger

To build a winning trading mindset, you need to develop the following traits:

• Always be disciplined and patient

• Have a firm belief in your ability to achieve your trading goals

• Don’t take losses personally 

• Never get swayed by strong emotions like thrill or panic

• Have the flexibility to make a snap decision in response to a change in the market

At the end of the day, trading success doesn’t depend on a ‘holy grail’ strategy, but rather a strong mindset that stays clear of psychological pitfalls and has the resilience to keep learning and improving.

Mastering Trading Psychology: Closing Thoughts

It takes time and effort to become a master at the mental game of trading, but it’s necessary for a successful trading career. Being aware of your psychology and keeping your emotions under control will help you avoid destructive behaviour and impulsive actions.

As I have explained in this article, you need to develop discipline, patience, acceptance of losses, control over emotions, and resilience against psychological pitfalls like bad habits, biases, and outside influences.

The best way to work towards mastering your trading psychology is having an online trading journal. So sign up for a free trial of Tradervue, the top-rated trading journal recommended by SMB Capital.

You can import trades in minutes, analyze your performance, make notes, and even share these notes with other traders or a mentor. You will understand your psychology, improve your trading strategies, and find your edge in the market.