Forex Trading Psychology

Written by Marc Walton

I recently retired as a professional trader. I now focus on teaching others to trade my funds. My team and I have coached 1000's of home based forex traders. Along with trading psychologist, Rich Friesen & a former student of mine, turned full-time trader & now a mentor: Pierre du Plessis

January 2, 2014


Competing in the congested Forex market – like competing in any sphere of life – is a discipline.

It is a discipline that requires not just a knowledge and appreciation of what you are doing, but an innate psychological mastery; an ability to conquer fear, greed and, in many cases, addiction.

The latter three components can often counterbalance market knowledge, while introducing sentimentality into our trading strategy can have a demonstrable effect on your results.

That’s why an airtight trading strategy is needed and a methodology that is free of such emotional constraints.

The individual trader’s psychology can often be compared to that of a gambler’s, particularly when it comes to evaluating the odds and deciding which course of action commands the most merit.

Falling into the habit of making common mistakes, however, can wipe out profits and prevent you from ever making that gold run you envisaged upon first starting out. Whatever the mistake may be – whether you trade too big for your account size, fail to evaluate both the short and long-term picture of the market, or eschew use of your stop-loss order – conquering the discipline related to it can prevent such mistakes from ever reoccurring.

In Forex trading, as in life, optimism can be a healthy trait, but it can also prove fatal. We may move into the market thinking a trend has peaked and will reverse, and our optimism carries us along in this thinking despite all evidence to the contrary. Our optimism, at this point, is in danger of morphing into a rebellious streak; our bias against the direction of the market indicates a penchant for non-conformance.

On the Forex market, optimism is fine so long as it is contained; the moment the ceilings disappear, such emotion can become a personality trait and habit that supersedes trend analysis and logic.

Just as dangerous to traders as unconfined optimism is indecisiveness; a trader can evaluate a trend too long, and buy or sell too late in the game; we may enter a market after a period of ascent, and make our move when it is on the verge of a reversal. Whether you’re risk-averse or risk-happy, making sure you take a considered risk at the optimal time will generally trump patient waiting.

gambling or tradingIt is often said that traders are similar to gamblers, and never more is that evident than when they are losing.

Just like gamblers convinced their hand is the best, a trader will buy a position with confidence.

And just as gamblers fail to hit their flush on the flop, the trader will see the market start to fall.

What do these risk-takers do? Persist, of course. Gamblers stake their chips on the turn and river, and traders will buy more even as the market falls; the card-shark will go bust and the trader will be thrown out of the market by a margin call.

The reason for such failure is egotism. We follow a course of action and, when we learn that we were wrong, we panic. We refuse to face a loss of face; instead we turn away, buy more, and expect that a slight reversal will counterbalance the loss we made in the first instance. We are, in short, stubborn.

While in some situations buying when you’re losing could culminate in generous profits when the market turns, traders must ensure they don’t let their emotions cloud their judgements. If the market fails to react as you desired, don’t cast logic aside and follow your previous plan anyway. This God complex cuts little ice on the Forex market. It can, in fact, be the ruin of you.

Of course, instinct should not be altogether ignored. That is, unless your instinct is to live in the market. This is a danger that can befall new traders. Believing they will become experts if they ceaselessly scrutinise the flux and flow of daily trends, some traders fall into a dangerous pattern of behaviour. The trading platform is not a computer game that should be played until you have completed the final level; detaching from the market is not an admission of defeat, but necessary respite. In fact, there are times when it is just good to get away. We cannot risk simply trading for the sake of trading. We must ask ourselves why, consult our analysis and money management rules (never risk more than 5% of bank on any trade, for example, or always plan and place a stop-loss) and make an informed decision. Otherwise, we are simply chasing our own tails.

But is putting safety measures in place an easy solution to thoughtless trading? Well, not always. Stop-loss orders, for example, can be too close or too wide; in the case of them being too close, we will be concerned that the market may veer in the opposite direction and wish to cut our losses to a minimum; in the latter, we fear our stop-loss order will close our position before the market reverses back into our favour. In both cases, we must realise stop-loss orders are in place for a reason; we can’t just rely on them to protect us from losing money, and expect to be detached from them the moment huge profits are to be made.

Using stop-loss orders is smart, but letting your sub-conscious rule when employing them isn’t. The same rule applies to take-profit orders, also. Setting your take-profit orders too wide can be a simple reflection of optimism and greed, while setting them close reflects a desire for a quick profit. If you pay as much attention to your analysis as your instinct, you can be sure your orders are neither too wide nor too close, but just right.

However you set your orders, you will – if you’re smart – endeavour to learn from past mistakes. In a dynamic market like Forex, however, even this simple philosophy could lead to problems. After all, what was true in the past might no longer be true in the present. Each new trade is a fresh start. While learning from mistakes and successes is vital, such experience should not, as a rule, influence the next trade. You may think you have learnt from your mistake, and end up making an even costlier error. For example, you may amend your stop-loss order having made a small loss in your last trade; setting the stop-loss wide in your subsequent trade, you anticipate the market will move in your favour; it doesn’t. In this case, you could incur a more substantial loss than in the first instance.

In a dynamic market, the strategies must be dynamic. It’s that simple.

Of course, strategies must also be realistic, as must expectations. Bias cannot impinge on our ability to hear what the market is telling us. We could be biased, for example, about our profit levels. Setting goals is sensible, but expecting targets to be met time after time is not. If you want to make a profit of 7% each week, know that you will not meet this every time; your profit figure may vary, you may lose big one week, overshoot your target the next. Don’t let panic about not hitting your targets influence your trades; it’s the average profitability that matters.

Varying our position size in the market is no way to achieve huge profits, either. If we are on a losing streak, we may see fit to multiply our position to leverage our losses. Motivated by desperation, our ploy could simply result in bigger losses. Vice versa, we may shrink our position size to protect profits on our subsequent trades, but the alteration will only yield slight gains. Whether you’re in the former or latter encampment, you must realise that varying your position size is often motivated by panic, greed or undue optimism. Don’t just dream about what you can lose or gain, but what you can afford to lose, and what profit size is reasonable.

When it comes to Forex, you must strictly control the amount of money you are willing to risk on each trade. Often new traders will max out their bank in a short period of time. Why? Well, for a start they don’t impose limits on their trades. They double their money and think themselves invincible, or they simply don’t readjust their trading limits as their balance begins to fluctuate. For example, if you had set a limit of 5% of your balance with which to trade, you must realise that this is 5% of your total balance at the time of the trade.

Your balance may have been £5,000 yesterday, but it could be £4,300 today. Losing track of your limits is a sure-fire way to lose your bank – the gambler’s term ‘chasing it’ is certainly applicable in this instance.

Even if you are ‘chasing it’ – looking to recoup profits lost on a bad trade – you must do so sensibly. Keep an eye on the long-term chart (daily/hourly) as well as the short-term chart (30 mins/hourly) when it comes to deciding your course of action. Mentally, many traders write off their losses against the prospect of the ‘big one’ where they can win it all back. Revenge trading is perhaps the biggest risk to all traders. The prospect of ‘revenge’ can drive you to abandon your stop-loss order, while fear and overconfidence manipulate your view of the market’s next direction.

Conquer these common psychological aspects, master the disciplines, and don’t rely on lady luck. Trading needn’t be just a gamble, but if you avoid making the common mistakes, you might just hit the jackpot without having to risk your stake.

Here is an excellent video from our forex trading psychology expert Rich Friesen Rich is a 30 year trading veteran as well as being a clinical psychologist. If you have any psychological issues relating to your trading then he is definitely your man! Here is the article he wrote that goes with the video on “How to Let Your Winners run”

Here is an article for pro trader and keen poker player, Omar Eltoukhy who explains What Texas Hold em Can Teach us About Forex

Author: Marc Walton


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