Psychology of forex trading

I stumbled across a thread on forexfactory today that makes so much sense and pretty much describes where I am at with my trading psychology right now. After reading the post by an ex professional city trader called JupiterOGX / acrary I realised why I am feeling so relaxed with my trading these days, pure and simple, I just take small risk trades, 1% risk with tiny targets of 1 or 2%, most of the trades are over in 30 minutes, it dawned on me that I don't even know how many pips I make day to day now. I don't even care. That was the problem, needing 20 / 40 / 100 pips a day causes stress. This week I took an eur/gpb trade that I am almost ashamed to say netted me 6 pips, but it was 1% of my account, I have also taken a few UJ trades this week for 8 - 13 pips and they also netted 1 or 2 % each. Of course I do lose a few trades but losing 1% means nothing, it is a pain but I don't get stressed about it. JupiterOGX mentions having "an edge", the edge is what gives you the confidence to enter your trades without fear, my "edge" is the H1 reversal, 2b and 123 reversal setups combined with Vantages m5 HL / LH entry. They work on any timeframes but currently I like trading the 5 minute chart in the direction of the H1 chart.

Read the quote below from JupiterOGX, he is basically talking about what I have managed to do for myself in recent weeks, desensitise myself from the stress of trading by believing in "my edge".

Demo trading verses Live Trading

This is a bit of a contentious issue as well, so again take this as my thinking; others will make their feelings known in the discussion thread, I’m sure.

The value of a demo account can be summed up as having these main benefits;
It allows time for you to learn how irrational the FX market can be
It allows you to learn how a broker’s platform works, enabling you to understand the terminology used when placing, and managing, a trade
It allows you to master some of the finer points of Money Management
It allows you to test, and refine, new theories, systems or methodologies, without risking real money
The disadvantages of a demo account are these:
The data feed, compared to a live account, may, occasionally, vary just enough to confound your plans; this will be less of a factor in the long-term charts.
If your demo account size bears no relationship to the size of your actual trading account (when you go live) your expectations will be raised to an unreasonable level. If you’ve quickly turned $30K into $75K, or more, you may be tempted, on a smaller account, to try and emulate the same performance by the incorrect use of True Leverage. Unless you are very lucky you won’t, and, if you were, remember luck plays no part in successful FX trading. Always open a demo account with the smallest amount the broker offers.
Demo trading will never give you the same feelings that will hit you when there is real money on the table. Treat your demo trades as stepping-stones in mastering both the Money Management and Psychological aspects of trading. If you start saying to yourself, “I’ll stick a trade on here, because I think this is going to turn around, and if it goes wrong it doesn’t matter anyway” you’ll start developing habits that will be hard to break when you’re trading live.
Watching a demo account grow, assuming you’re doing things right, is hard. All the time you’ll be thinking, ”That could have been my money on that trade, I could have made $100 today”. You must clear your mind; at this stage you’re learning to trade correctly, not learning to make money. Learn to trade correctly and the money will come later.
As I mentioned earlier, I didn’t start on demo due to the way I was introduced to FX. I had a two/three week trial of the software and then I was live. The cost to me was more than just the money, which I could ill afford to lose; it has created a defensive barrier, mentally, that I’m finding hard to break. After little more than a year I’m sure in what I’m doing, although there are plenty of areas that still need developing, but the damage that early experience caused me is making me reluctant to invest more into my trading fund. I know this may sound contradictory, on one hand confident in my approach to trading, on the other scared to up the stakes, but this is why I wished I’d understood the value of demo trading.

Therefore, my main advice is that you demo for at least 3 months before going live. If you can’t make consistent profits on demo, you won’t make them when you’re live. If you feel you can’t wait, and you want to get into live trading as soon as possible then try and follow these guidelines:
Use as small a starting account as you can. Divide your funds into 3 or 4 smaller pots (i.e. if you were thinking of putting aside $1000 for trading, then start off with $250), put one of these pots into a broker offering a penny account, and trade with that.
Learn the basics of Money Management, and be happy trading with small lots while you’re getting your head around how to manage risk.
If you are successful after a few months, increase your lot size gradually as that first $250 pot grows. Resist the temptation to add in another $250 at this point; you may have had a good run, but things change fast in FX and a losing streak may just be round the corner.
If you’ve blown that first $250, don’t stick another pot in yet. Go back to your demo account, analyse what went wrong and start afresh. Don’t go live until you’re sure you understand any errors you made, and how you need to correct them. Then, and only then, consider starting up your live account again with the second pot.

Forex Psychology

It’s appropriate that the previous article should precede this chapter, as the psychology of trading is, for most of us, the hardest, and least studied, factor in our early forays in trading.

We want to know that this FX thing is easy. All the web sites we’ve seen promise us it’s easy. We’re told that all we have to do is wait for a signal and thousands of dollars will fall into our laps. Unless we’ve been very lucky (and I rarely see signs that many of us have) within a short space of time reality has set in.

It’s not unusual to read that the major emotions, that also govern many of our lives, are writ large on the psyche of the average retail trader. It’s common to see reports of the same emotions affecting serious commercial traders, as well.

I’m no psychologist, so all I’ll try to outline here are the emotions I’ve been through, during my early development as a trader. There are many I still haven’t fully come to terms with; most have yet to fully tested as my account goes from nano-lots to more serious amounts of money. I would hope (bad emotion?) that as my trading career evolves these emotions would gradually be mastered. If not, I’ve realised that there is no future for me in FX trading. That’s how seriously I take this subject. No trading method in the world, or Money Management rule, will save you from disaster if your head is not in the right place.

To get some expert advice, try reading some of the posts by well-known trading psychologists in the Forex Articles thread. Many articles will cover some of the stuff I’m writing here, but they will explore the subjects in greater depth.

Beat Forex Greed

Most of us start trading for the simple reason that we want, or need, more money than we have now. Those of us without a profession, or trade, that provides income stability now and in the future, see FX as a means to supplement our current wage, or provide a steady flow of funds to prop up an ailing pension in our sunset years.

Therefore greed, to a greater or lesser extent, is the key driving force in our approach to trading. Some of us are greedy, simply because that’s the way we are. Others are looking for small, steady, and regular increases in their bank accounts; they have no great wish to become millionaires, but their greed (whilst not voracious) will still temper their approach to trading.

Greed makes us break our Money Management rules. If you’ve just had a couple of home runs, you’ll maybe just up the risk to 5% for this next trade. You’ll justify this by saying to yourself – ‘the trend still looks strong, nothing seems to have changed, I might as well let this move add another decent gain into my account and then I’ll go back to my 1% rule’. Trust me, this is the moment when the market teaches you the BIG lesson. It never seems to happen when you’re going along, making steady gains. It ALWAYS happens at exactly that moment you let greed cloud your judgment.

Greed makes you change your Take Profit (TP) target, or remove it altogether, in the hope of making more pips. It also makes you stay in a trade when you’re within a few pips of the original TP just to squeeze a little more out of that trade.

Whatever your dreams, whether it’s a top-of-the-range Ferrari or a new mid-range family car, the only thing that FX must deliver, for you, is money. For trading to deliver money you HAVE to win more than you lose. Therefore, along with greed, the other mind-killer is fear.

Beat Forex Fear

Fear is the emotion that makes you jump into a trade, despite the fact that your system hasn’t quite delivered a signal yet. You’re afraid of missing out on all those extra pips that an early entry will give you. You stay in bad trades for fear that if you get out now, the trade will turn out right in the end. Fear of loss makes you move your stops further away while a trade is going bad. Fear of giving pips back to the market makes you get out of winning trades too early. Fear of missing out causes you to take every signal on every pair just in case this is the big one. Fear then stops you actually taking all that the market is offering because you close too early, again.

Once you start to lose the fear of loss, you will start to lose the fear of not maximising your gains. You’ll learn to accept that you cannot be on the right side of every trade. The losses, while still a disappointment, become a part of your trading day. If your method has positive expectancy (i.e. you expect, from an historical perspective, to have more winning trades than losers) you’ll know that the next trade has an equal chance of being a winner. Mastering fear allows that trade to reach its full potential, either at your designated TP, or where the market indicates that the move has run its course. You can close the trade and ignore the pips that may come afterwards.

Fear can only be overcome if you have faith in your method or system. If trades are being entered in a random manner there will be no pattern to guide you as to the likely success, or failure, of any particular trade. You’ll be on an endless wave of emotion – joy at a winner, despair at a loser. Eventually, you’ll find it increasing hard to press the trade button; fear of yet another loser will over-ride all other considerations. Even the very best signals will cause you to stop and fear the worst. When the trade starts to turn into a likely winner, fear of missing out can cause you to ‘jump on the move’, just to try and grab some pips. By which time, of course, it may be too late. And so the cycle continues.

Accept your losers. It’s the first step to overcoming fear.

Beat Your Ego when trading forex

Dealing with your Ego is the last factor I’ll cover in the Psychology section, simply because I’m not a qualified practitioner, therefore all I can hope to do is point out some of the pitfalls awaiting you.

All the trading articles I’ve ever read contain the quote – ‘leave your ego at the trading room door’ – or something very similar. The reason for this is simple. If we cannot accept the fact that we are capable of making mistakes, it will be practically impossible to practice the other regularly quoted piece of advice – ‘cut losers short, let winners run’.

There’s a subtle but important difference between
A bad trade placed outside your trading rules that’s turning into a loser
A good trade placed in accordance with your trading rules that’s turning into a loser.
In the case of trade (1) we’ve made a value judgement about where we think the market is going. Deep down we think we are going to steal a march on everyone else. Our decision isn’t based on any core logic supplied by our system, it’s based on what we know is going to happen. This one feels right. We can jump the gun here and let the market catch us up later. The problem here, of course, is we now have too high a level of emotional attachment to this trade. We called it, so it’s our sense of worth that’s on the line, not the system’s.

Some of these trades will work out, and your ego is given an unwarranted boost. Worst-case scenario is that you’ll continue down this route until you hit the inevitable roadblock, and the market proves YOU wrong. This is the moment when your ego won’t let you admit you’re wrong. This is the time when you start to move your stops further away, in order to give the trade time to prove you were right.

No-one truly likes to admit that they’ve made a mistake, and we all try to justify our errors by hiding the truth behind all manner of excuses. In the world of trading you cannot hide your mistakes; your account tells the truth about your decisions.

With trade (2) at least you can blame the system (assuming you’ve trading strictly to the rules) and this is another point at which ego can get in the way. In the learning stages of trading the tendency is to think – ‘I knew that I should have gone Long there, this system doesn’t work’. This all comes down to the hardest part of trading, accepting that you cannot win every trade. There is no guaranteed method that will ensure 100% successful trades. If there is, rest assured you’ll never hear about it, or, if you do, it will be so expensive as to be virtually unattainable for most people.

So, accept that you, and your system, will be wrong as often as you are right. Look to reduce that percentage by careful analysis of your trading style. Find out what your weaknesses are and eliminate them before the market eliminates your account.

Read the articles and threads I’ve mentioned in my earlier post in this section and as a final word of advice, I would suggest you invest in a book written by Mark Douglas. Its title is ‘Trading in the Zone’.

It will be the first step in helping you understand what you need to know in order to master the Psychological aspects of trading.