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Trading psychology is, by far, the most underrated and overlooked aspect by crypto traders. It always seems easy and within reach. How difficult could it be that I should only control myself and not trade on my impulses? Heck! I am pretty sure I already do that. Right?
Actually no. Not even close. Trading psychology is one the most important and critical aspects of trading. Especially in the crypto market. Where huge spikes of volatility send waves of fear and hesitation across the market. Playing with the feelings of many traders and bringing their balances to zero. It’s in fact one of the main reasons why more than 90% of traders can’t stay in the game for a long period of time.
So, first, let’s define what we have here.
Trading psychology refers to the strategies adopted by traders to manage their emotions and mental state.
As we grow, we learn skills that allow us to earn high marks in school, advance in our jobs and lead our lives productively. We live by knowing that if we work hard enough, we will be rewarded for our hard work. We learn to recognize patterns and predict outcomes by referring back to previous experiences.
However, these skills are inappropriate for trading. This way of thinking should be disregarded in favor of thinking in probabilities.
It is a whole new way of thinking for anyone who's just beginning his trading journey. This is why it can be confusing and hard to decipher at first. Moreover, a lot of traders consider it to be a trivial part of trading and don't want to give it the attention and time it deserves.
Even if you master all aspects of trading including, but not limited to, fundamental and technical analysis of the different cryptocurrencies that you wish to add to your portfolio, you'll still be making poor trading decisions, if you don't pay enough attention to your mental and emotional state while opening, managing or closing a position on the crypto market.
This is why, today, we are going to see, in close details, 2 main behavioral factors that play a huge role in influencing your trading decisions.
The Outcome Bias:
To explain what the outcome bias means, let's have a little thought experiment first devised by Rolf Doubelli, in his book: "The Art of Thinking Clearly".
Imagine that you have 1,000 traders. All starting with the same capital and all are newbies. They never traded a day before in their lives, so they don't know the first thing about trading.
We will let them trade securities on the financial market.
Let's set periods of time, or cycles, on which we will check and see which traders were successful in their trading and which are the ones who failed.
After the first cycle you'll find that roughly half of the traders made a profit, and roughly half of them lost money on their trades.
So, we will eliminate the traders who didn't make a profit and only keep the ones who did.
Repeat this until we are left with one trader. This trader would have been consistently right and profitable for about 500 times in a row. A feat that the top traders in the world only dream of.
Now, imagine that we communicated to everyone the results that our successful trader got, what do you think would happen?
Because of his perfect record, everyone would want to copy our trader's trades. His words would be taken religiously among other traders. He would be the ultimate guru. The prophet that everybody was waiting for.
However, we know for a fact that our legendary trader's perceived success is based on a psychological error. What is commonly referred to as the outcome bias.
We are wired to evaluate the world around us based on the outcomes rather than the processes that allowed for certain results to come about. Because we are used to think that great outcomes are correlated with great skills. Therefore, we tend to overvalue the role of skill and underestimate the role of luck and pure randomness.
This way of thinking will not get you anywhere in the trading world. For the simple reason that it is a flawed way of thinking.
To avoid falling in the outcome bias trap, keep in mind that though trading is based on skill, there's always the component of luck. So, prepare for it and be proactive about it. Try to think of ways to implement it into your trading strategies to prevent falling prey to it.
When backtesting your strategy, try to apply it on a time span that will include enough market cycles. This will show you how your strategy does in different market conditions. Don't search for lucky runs. Look for consistency over the long term.
Bottom line: Never judge a decision purely by its results!
FOMO trades:
Every trader will definitely encounter the event where they wanted to buy or sell a security at a certain price but they did not take that trade for a reason or another. They will start seeing the price go the way they predicted without them. looking at this is incredibly painful and will ultimately lead you to enter the trade too late.
This is what we refer to as a FOMO trade!
FOMO is the acronym for the Fear Of Missing Out. It's not a new human experience. However, trading has a lot of channels that foster this fear. It influences our short-term decisions and, if not dealt with correctly, will solidify itself as a long-term habit.
But it doesn't have to be a bad thing. When we understand it and recognize it, it can guide us.
Developing a trading system that takes human emotions out of the game certainly helps. Greed can be a real problem when dealing with money. So, try to tame it as best you can.
Identifying the main causes of FOMO trades will also allow you to recognize them and deal with them easily. These causes include information overload, social media, poor risk management, lack of discipline, impatience and lack of trading rules.
So, what can you do to improve your trading psychology?
Start by looking into yourself. Be honest in evaluating your own existing psychology. If you're prone to act out of anger, fear or frustration, tame your impulsive tendencies.
Develop and abide by your trading strategy. It's the blue print to all of your trading. It should include important aspects like the technical tools used to determine entry and exit points, the fundamental factors that could influence the direction of the price on the financial market, money management techniques that will allow you to make money in the most difficult of times and last but not least a strong risk management strategy that will help you stay in the game for as long as it's necessary to be consistently profitable.
Have patience and discipline. Wait for the perfect moment and take advantage of it. However, know when it is too early or too late to get in.
Finally, accept your losses and learn from your mistakes by keeping a detailed and extensive trading log.
