While acquiring a thorough technical understanding of how the forex market operates (including how social, political and economic factors impact the volatility of the market) forms a vital part of any trader’s education, there is arguably no forex trading strategy more important than that of managing one’s own emotions. Given the size of the market, there is large profitability potential when it comes to forex trading – however, with big wins also come big losses, highlighting the importance of learning how to control your immediate, reactive emotions before they get the better of you.
Naturally, forex trading requires an element of acting on gut feeling, however this type of trading acumen isn’t something that can be taught – instead, it’s picked up from real-life experiences of working in the market. As such, it’s crucial that, upon making the most out of your demo account and deciding to turn your hand to the big game, you’re aware of your emotions and learn how to effectively manage them ahead of making your first trade.
A vital weapon in any successful forex trader’s arsenal, this blog post will talk you through the psychology that goes on behind every foreign exchange trader’s computer screen – helping you effectively manage your emotions like a pro before they have the ability to negatively impact your strategy and career as a result.
The big four emotions
While the term ‘emotions’ can cover a whole host of feelings, professional or otherwise, within the forex trading sphere, there are four key emotions that can amount to becoming obstacles if left unaddressed. Therefore, by ensuring you’re made aware of them prior to jumping into your foreign exchange career, you’ll be better prepared to manage any associated risks as a result.
These emotions take the form of fear, revenge, euphoria and greed and, when practised in the foreign exchange market, these emotions can have intrinsically negative connotations – often leading inexperienced traders onto a path of self-destruction. Contrastingly though, once you have the ability to identify these types of emotions, there are ways in which they could prove to be a valuable asset within your forex trading strategy.
Undoubtedly, one of the most fundamental feelings for any forex trader, novice or professional, is fear. As an emotion used to help us identify situations in which we feel threatened or under attack, fear can also drive us to make irrational decisions that could result in us putting ourselves at greater risk or harm.
When it comes to FX trading, letting fear influence your decision-making could result in you making uneducated trading choices that take you away from your strategy. This is because fear has the potential to introduce self-doubt into your thought process, resulting in you convincing yourself that you’re making the wrong decision and impacting your ability to analyse and assess situations with clarity as a result. As with everyday life, the common fear of missing out (otherwise known as FOMO) may also come into play during key moments of trading, whereby you struggle not to act impulsively on trades that have the potential to win big. However, by doing so you could find yourself deferring from your technical strategy and entering deals without doing due diligence on whether there is real profitability for you.
In spite of this, we all require a small amount of fear to ensure we analyse risks appropriately in situations. When effectively controlled and combined within your other, more theory-based forex trading strategies, fear can become a valuable asset that helps you to make more informed trades.
The first stage is having the ability to recognise what it is you’re afraid of and why that is – which, for most of us, is likely to be potential of making a financial loss. Once you’re aware of this, next you need to construct a well-thought-through forex trading strategy that works to minimise the risk of fear by taking measured risks. This could include implementing a cap on the amount of currency you trade in one given day so that you have a better handle on any potential losses.
Taking a calculated, educated approach that executes a controlled level of fear to analyse both your own personal liquidity as well as the markets is sure to put you in the best possible position to make more rational decisions as a whole. As a result, even if losses are made, so long as you have considered all decisions in advance, such losses should be easier to recover from.
Above all else, the reason why the majority of traders get into the forex industry is to make money. So, when the markets are starting to work in your favour, this desire to increase your income further still can be a brilliant motivator. Contrastingly, it can also turn into greed – an emotion that in some cases can be more dangerous and lead to bigger losses than those brought on by fear.
Like fear, if left untreated greed can become a significant emotional factor with potentially devastating consequences. Common sense and rationale are often amongst the first things to be omitted from your mindset when greed comes to force, instead fuelling a yearning to make substantial profits from risky trades. Naturally, this type of trading isn’t sustainable, as it can lead to you emptying your account. Luckily, however, there are some ways you can manage this emotion more effectively to ensure it doesn’t hold damaging, long-term effects on your career.
When it comes to creating a forex trading strategy, it’s vital you recognise signs of greed from the off-set, questioning yourself as to whether you’ve always been driven by monetary gain. If this is the case, this could suggest that you are perhaps more susceptible to lapsing in moments of greed when opportunity arises.
To overcome this obstacle, we’d encourage you to stick to a robust and tested trading plan – helping to ensure your forex trading strategy is based on analytical decisions to best manage the risks associated with each and every single trade. This includes regularly reminding yourself not to trade portions of capital that you couldn’t afford to lose.
When trades don’t go the way you expected, you can feel notions of resentment and subsequently blame the market for your downfall – sparking the urge to revenge trade as a result. This can drive you to make aggressive and irrational trades, driven purely by emotion as opposed to business-based analysis – making these types of trades synonymous with that of gambling as opposed to actual forex trading. With this in mind, vengeful traders disregard logic and their well-crafted strategy in search of what’s owed to them – invariably leading to them making further ill-informed trade deals that eat away at their account balance.
As a result, as is the case with any type of business investment, by entering a revenge trade you are exposing yourself to the risk of not getting the return on investment (ROI) you were sold or, worse still, you could find yourself suffering heavy monetary losses.
While there will always be a level of risk involved in financial investments, revenge trading needs to be made aware of at an early stage in order to ensure it can easily be identified and stopped before it’s too late. As with the other emotions, to combat revenge trading it’s important to highlight the importance of using rationale combined with data analysis to ensure your judgement isn’t impaired by any frustration caused by previous losses.
To contrast the above points, the silent but deadly enemy of a forex trader will always remain the overwhelming sense of euphoria and excitement that naturally occurs after a succession of lucrative trades or one big win. The result of this? Overconfidence, which creates a false sense of security in your abilities and can cause you to abandon your forex trading plan without fully assessing the small print involved in the trade deal. Unsurprisingly, this can lead to more losses than wins which, like with all the aforementioned emotions, can quickly spiral out of control.
To combat this, no matter how successful your trade, ensure you always remain level-headed and grounded in your decisions post-trade – giving yourself a break after the trade and coming back to the market on another day, once you’ve had time to process your success and after writing down what decisions you made to help you win. This will ensure that even when you win big, your focus remains on your strategy instead of your ability – helping you to approach every deal with a clear and level perspective.
When it comes to educating yourself on forex trading strategies, it’s essential to look beyond the theoretical aspects of trading – erring on the side of caution always and considering all the psychological elements involved, too. For those of you looking to find out more about how to hone in on your skills, or how you could further your forex education, contact us today or sign up to one of our free forex workshops.