Wednesday, September 19, 2007

Trading Psychology

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Have you ever wondered, as I have, what makes this kind of difference in people`s trading? It is not always a native intelligence, talent or dedication. It is not that one person wants success and the other does not.

The difference lies within your psychology. Your psychological mindset is likely to play a larger role in your trading career than your chosen technique or any other details associated with your day-to-day practice.

Now, I am not the only one to discover this... In his book, Trade Your Way to Financial Freedom,

the renowned American psychologist Dr. Van Tharp discusses the role psychology plays in your trading success. He divides trading into three "Ingredients of Trading." In his pie chart, System is 10%, Money Management is 30%, and psychology is 60%. He discovered that the trader`s psychology has more to do with his success than anything else does.

What exactly is your psychology?

In short, your psychology refers to your emotional responses to a given situation... In trading, fear, greed, vanity, pride, hope, jealousy, and denial can all affect investment decisions. Although your aim in the market is to maximize your profit and minimize your risk, emotions often make this easier said than done.

For example, traders who react emotionally make the wrong decisions, such as the common mistake of holding a losing position in the belief that someday it will become a winner.

This classic mistake is called loss aversion. Loss aversion refers to the tendency for people strongly to prefer avoiding losses than acquiring gains. Some studies suggest that losses are as much as twice as psychologically powerful as than gains. Loss aversion compels most traders to hold a losing stock while it plummets downward. This clouded judgment clearly contradicts the trading adage "cut your losses."

These investors also engage in other forms of irrational behavior, like attributing success to skill and losses to bad luck. Worst of all, this is just the tip of the iceberg when talking about the other devastating effects of trading using your emotions.

The truth of the matter is, without controlling your emotions, most new traders lose all their money very quickly in the markets. In fact, most are completely wiped out within the first year of trading. So, as you can see, your emotions do play a big part in determining whether you fail or succeed...


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