Lesson 28: Forex Trader Psychology

You've certainly heard about it if you've been able to listen to experienced traders: Psychology is emotion management is one of the biggest difficulties a trader can encounter.

By investing one's own money and taking risks, one inevitably intervenes many emotions: Greed, hope, fear, even panic!

When one begins to trade in real conditions, one quickly realizes that it is these emotions that are the source of the greatest losses and the worst operations.

Most of the time, your emotions will lead you to make the wrong decision.

Rather than detailing the mistakes that emotions can cause, we decided to rely on the words of a famous trader, Jesse Livermore, who operated at the beginning of the 20th century, presenting and explaining excerpts from His biography, Memoirs of a speculator.

"In fact, I always made money when I was sure I was right before I took a stand. What was losing me was to want to constantly take on new positions "

"It is the need to act incessantly and for no good reason, which is the cause of so many losses on Wall Street, even among professionals"

"No one can have valid reasons for buying or selling every day"

Here, the trader brings to light a common bias in many traders: Not being able to stay away from the market . If we have all the right reasons to take a position, we will go. Otherwise, we simply abstain ...

Because it is unthinkable that truly profitable opportunities arise every day, unless you really have an eye on all markets and currency pairs ...

Sometimes the market is very undecided, and expects important events before deciding, and in this case the variations can be irrational, and in these cases it is necessary to abstain to preserve its capital, and its nerves!

"The one who is right always has two allies at his side: the basic conditions and all those who are wrong"

With this sentence, Livermore summarizes the reasons why some "panic winds" in the markets can be extremely profitable for some ...

By "basic conditions", the author hears "fundamental", ie balance sheets and results for companies for example.

Thus, if a wind of panic drops the price of a share below its "real value" (the real value of the company / number of shares), this creates great opportunities for those who have remained marble, And rely on tangible elements instead of giving in to panic.

Because once the panic has passed, all the "sheep" will want to buy back as quickly as they wanted to sell (and therefore quickly increase the prices), but for them it will be too late.

It's the same thing for currencies, sometimes, some pairs rise or fall irrationally, and those who have trusted the fundamentals are doing remarkably well.

"Without confidence in one's own judgment, no one can go far. "

There, we join what was said just before: In order not to give in to unjustified panics, one must have self-confidence and one's judgment , and have certainties strong enough not to be disturbed by contrary opinions. It can however be difficult to trust, once the position taken, and the best tools to overcome this problem are the stops and the limits.

"The only thing we have to do when we realize that we are wrong is to be right in ceasing to be wrong. "

A trader can sometimes be proud, and the pride in the markets accentuates the losses ...

If we realize that we are wrong, it is better to cut the position and move on. Knowing that admitting one's mistakes in trading can help avoid heavy losses, and paves the way for big gains.

"It is the fact of being wrong, not the losing, which most harms your wallet and your soul. "

Jesse Livermore explains here that it is not serious to accuse losses, the important thing being not to let them swell .

One may be wrong, but as he said in the previous quotation, one is right as soon as one knows that one was wrong ... The important thing is not to win every time , but to often enough reason For the balance to be positive. The trader also highlights the defects of many traders of which we spoke earlier: pride .

"I did exactly what was not to be done. I was losing on the cotton and I kept my position. I won on wheat and sold my position "

"You always have to sell the losing position and keep the winning one"

With these two quotes, Livermore highlights the most common mistake in trading: Selling too early a winning position, and holding too long a losing position.

A trader who keeps too long a losing position does not want to admit that he was wrong , he says that the wind will turn based solely on hope.

A trader who cuts too soon a winning position lacks confidence in him , and almost astonishes himself at being right. Then he cuts, saying that what he won is already good, then realize that he was really right and that he could have won three times more, when it is not ten times more.

"Of all the errors of speculation, there is nothing more serious than trying to mediate a losing position. "

Again, we agree with the principle that we must admit that we were wrong when we did.

The author thus highlights a common mistake: to increase the size of a losing position in order to reduce mathematically the average purchase price, in the hope of a future rise.

It may be a good idea in some cases, but you have to be sure you're right when the majority is wrong-

However, in general, it is better to cut early, and move on to something else, especially when trading in the short term.

"No reasonable person can complain about paying for his mistakes"

Errors forge the experience, which Livermore seems to mean here. An error would be less significant if it did not cause a financial loss ...

It may also be thought that the author simply paraphrases the popular expression "one can only blame oneself , " which is particularly relevant when one speaks of trading error ...

"Everything that happens on the market today has happened in the past and will happen in the future"

In this sentence, the author sheds light on the basic postulate of "original" technical analysis: What happened in the past will happen again in the future.

This is the underlying principle of the whole doctrine of technical analysis: For example, resistance is based on the fact that if the courts have failed to cross a threshold several times, there is a high probability that the situation endures.

"In practice, one must be wary of many things, and especially of oneself, that is to say of human nature"

The enemy number 1 of the trader is his psychology, his emotions . Greed, fear or even hope can drive investors to make irrational decisions.

"A large part of the disasters made by brilliant men can be directly attributed to the claim, a very costly disease everywhere and for everyone, especially for a speculator"

As we have already pointed out, a defect that can cause a lot of money to lose is pride. Nothing is more penalizing than not to admit that a bad decision has been made, to believe itself necessarily stronger than the market.

You have to be humble and quickly admit that you are wrong to succeed in trading ...

"There is no one on Wall Street who has not lost money trying to get paid by the purse that a car, a jewel, a boat or a painting"

"What does a man do when he takes it into his head to make the purse pay an urgent necessity? Well he only hopes: he bets "

"Of course, I sometimes let myself be won over by the excitement of the game, and I was losing all judgment"

Greed, which the author evokes directly with these sentences, is also a defect that can be detrimental ... When one is in a hurry, one takes the risk of making mistakes, or taking positions with a suspicious conviction Because we want to give ourselves the maximum chance of winning fast.

And all we can do in the end by doing this is losing money at least as quickly as we hoped to win ...

"You will find many people, reputed to be intelligent, who are bullish simply because they have shares"

Jesse Livermore pointed here a common bias among some investors, who try to reassure themselves by persuading themselves that the market will go in the right direction. It is indeed much more psychologically comfortable to think that it will go up when you bought ...

But once again, we do nothing good in this way, we remain blind and deaf to the evolutions of the market, and when the error becomes impossible to conceal, it is too late and we have already lost a lot ...

"Getting angry with the market because it does not react as you would expect, or because it is irrationally changing against you, makes no more sense than blaming your lungs for pneumonia"

The author recalls here a principle which is dear to him: "We can only blame ourselves" when we were wrong ...

"When you understand what you need to do to not lose money, you begin to understand what it takes to win"

When one manages to limit losses, when one can quickly abandon bad positions and take no positions at all costs, one has traveled 90% of the path that leads to success in trading. Then, everything is about optimization and risk management.

"Being on the straw is an excellent school"

In the same way that a boxer will learn much more quickly to raise his guard if he takes blows, a trader will learn much more from his errors if they hurt the wallet ...

Speaking of the virtual interventions on the market, and quoting a duelist to fight the next day and claiming to be able to reach the foot of a wine glass twenty meters away: "Can you reach the foot of a wine glass, Even wine glass puts you at stake? "

Here we are talking about a situation that many have experienced on Forex. Indeed, most brokers offer "demo accounts", which allow to trade virtual money in real market situation.

And many very profitable traders in demo become machines to lose money by passing to the real ...

Just because money is at stake, and emotions come into play.

If you recognize yourself in some of the errors mentioned above, bravo! You are a normal trader!

Only a superman could totally elude his emotions in the face of the risk of loss. However, just knowing these common mistakes can help you avoid them.

But there are tools to guard against certain psychological errors, such as the stops and limitations that we have already seen.