Hi there, Welcome to this byte-sized tradeducation series from Researchfin.ai. Here we share our thoughts and ideas about trading, in under 5 mins. This is for educational purposes only. This is not investment advice. Today we will talk about trading psychology.
What is trading psychology? Trading psychology is the study of how traders think and behave in the markets.
The steps in mastering trading psychology include:
- Becoming aware of one’s own biases and emotions.
- Understanding how these biases and emotions can affect one’s trading decisions.
- Learning how to manage one’s biases and emotions in order to make more informed trading decisions!
The biases and emotions in trading can include:
- Cognitive biases, such as confirmation bias and sunk cost fallacy.
- Emotions, such as fear and greed.
- Decision-making processes, such as loss aversion and overconfidence.
How do biases and emotions impact trading? There are various forms of cognitive biases that impact trading.
- Confirmation bias is the tendency to focus on information that confirms one’s beliefs and ignore information that contradicts them.
- Sunk cost fallacy is the tendency to continue investing in something as a result of the money or time already invested, regardless of whether it is rational to do so.
- Gambler’s fallacy is the belief that a random event is more likely to happen if it has not happened recently.
- Herding bias is the tendency to follow the actions of others, even if they are not rational.
- Availability bias is the tendency to place more weight on information that is readily available to us.
- Anchoring bias is the tendency to rely too heavily on the first piece of information we receive when making a decision.
- Framing bias is the tendency to make decisions based on how a problem is presented, rather than the facts of the problem.
- Overconfidence bias is the tendency to overestimate our abilities and knowledge.
- Illusion of control bias is the belief that we can control events that are outside of our control.
- Hindsight bias is the tendency to believe that we could have predicted the outcome of a situation after it has already happened.
Fear and greed can both impact trading in a number of ways. Fear can lead to traders becoming risk-averse, and selling winning positions too early. While greed can lead to traders holding losing positions for too long and taking on too much risk. These emotions can also lead to poor decision-making and irrational behavior.
How to overcome biases and emotions in trading? The 5 steps to overcome biases and emotions in trading are:
- Define the goals of trading, whether it is to generate a full-time income, augment current income as a side-hustle, grow wealth, and so on. The goals differ based on the personal and financial situation of traders.
- Identify the trading style that aligns well with the goals, like day trading, swing trading, and position trading. It is important that the trading style also matches the risk tolerance of the trader.
- Create a trading plan with setups that match the trading style and mitigate the effects of the biases.
- Backtest, forward test, and simulation test the trading plan to understand performance under different market conditions, and identify decision boundaries of when to trade and when not to trade.
- Trade systematically as per the trading plan. Practice self-control and discipline to not deviate from the plan and to overcome fear and greed.
Researchfin.ai app can help you trade systematically, and overcome biases and emotions.
We use state-of-the-art AI and machine learning to identify trade setups automatically. The AI also helps identify the optimal exit point to maximize the return and manage risk better.
Researchfin.ai app helps identify the trade setups that align well with your trading style. The AI automatically backtests, forward-tests, and simulation test these setups to help pick the ones that fit the performance criteria. This saves traders a lot of time and helps improve productivity to do high-performance trading.