One of the major concepts in the financial market is Psychological but it is one about which traders are least aware. However, we have seen some experienced traders make significant losses generally due to failure to control their emotions. In this article, we are going to discuss the five most common psychological trading mistakes and how to avoid them.
Most traders and investors start thinking that their decision is correct most of the time, even when they are wrong Psychological Trading Mistakes. This is caused by the term is known as psychological as “cognitive bias” which always drag you towards the worst trading decisions will push you to lose money repeatedly again and again.
The real truth is that you will never overcome your cognitive biases (Psychological Trading Mistake) because it is our human nature. But we can create awareness in our self about Psychological Trading Mistake which improves chances of becoming better traders.
What is a “cognitive bias”?
We are putting efforts to explain the meaning of cognitive bias in a very simple and uncomplicated way. A cognitive bias is a tendency that distracts your thoughts away from the correct judgement and resultant of this is we make psychological mistakes.
Top 3 Most Common Psychologists Trading Mistakes
01 Fear of Missing Out (FOMO)
The full form of FOMO is Fear of Missing Out is a psychological mistake that is common between experienced and beginner traders. As the name suggested, this is the process of buying and shorting assets due to everyone seems to be doing it. The best example of psychological trading mistakes was seen a lot during a pandemic and the Wall Street Bets.
In the first four-month of 2021, densely shorted companies like Clover Health and GameStop increased significantly. As a result, various investors speed up to buy the stock even via the fundamentals were not proper.
As a result, traders who brought GME at close to $500 generated significant losses when the shares decrease to below $50. GameStop stock costs from January to June 2021. You can see a lot of FOMO in the cryptocurrency industry. As Bitcoin prices rushed, we also saw many other small coins rose due to investors wanted to be a part of the next huge thing. However, Coin Market Cap tracked the total market capitalization of all cryptocurrencies rose to more than $20 trillion in 2021.
Strategies To Avoid FOMO
There are various strategies to avoid FOMO in trading: Some of the most famous strategies are:
- Being Content: You must be satisfied with your average returns even when they are great as other people.
- Trading Plan: Must create your own trading plan and stick with it such as always focus on writing down a trading journal.
- Technical Level: You are required to look at key technical levels. Such as if the stocks increased from $09 to $13, you could look at key levels. One method of doing this is via doing a multi-timeframe analysis.
- Focus on what you know: The next strategy is related to what you know about. Do not switch to other strategies about which you do not have knowledge. Try to stay with our strategy.
You do not need to take stress about FOMO, It is a very common psychological trading mistake even the highly professional trader also go through it. An excellent example of FOMO has happened with Bill Ackman when he invested in Valent Pharmaceuticals companies. In the end, the shock crashed and he lost more than $ 4 billion.
02 Gambler’s Fallacy
Gambler’s fallacy is a very common concept that is also known as the Monte Carlo Fallacy. It takes place when traders or investors believe that a particular event will take place or not on the basis of a result of the previous events.
This concept is dependent upon two ways: First, there is the belief that if a particulate event happened multiple times in past, it is less likely will take place in the future. Second, there is a belief that if a particular event takes place less frequently in the past, It will more likely take place in future.
Every common example of this is when you have a dice with six sides. If you roll it three times and its stop on two, the chances of coming two again in future are ⅙.
Strategies To Avoid Gambler’s Fallacy
The same dice concept is seen in the financial market and is one of the most common mistakes, traders will ever do. You can ignore it using the following tips.
- All trades are different: You should know that all trades are different in the market.
- Have a plan: Always make a plan which is dependent upon a quantitative and qualitative approach.
- Try to deal in instruments with you are friendly.
03 Revenge Trading
You can easily understand this (Revenge Trading) Psychological Trading Mistake with an example suppose a few years ago, an investor had a good trading plan that estimated making $2000 per week. So, After a week of successful trading, his/her account had a profit of $1,980. But he/she was $20 short of their $2000 target.
So they do what other traders commonly do. The investor opened a trade with the target of making $20. And since he/she has not done proper research before then, It starts to lose. Within a few minutes, most of our earlier profits were undone.
As part of their revenge trading, He/she decided to open a bigger trade in the alternate direction. Fortunately, he/she will be able to recoup some of its loss. Therefore in some cases, investors who do that end up losing a significant amount of money.
With this example we are trying to explain to you that every decision you make must depend upon some analysis, we know that it enhances from experience. But it applies to everyone, generally on experienced traders, because sometimes too much confidence will lead you to heavy losses.
Strategies To Avoid Revenge Trading
There are various strategies you can use to decrease these risks are:
- Position sizing: When you create you trade well. Must ensure that you can be able to bear all losses comfortably such as if you have a $ 10,000 account, you can easily bear a loss of $100.
- Leverage: Decrease the amount of leverage that you are using because a high leverage account will lead you on the path of significant losses.
- Have a plan: Next, you must have an entry and exit plan for all trades that you consist of. This means you must know when to enter and leave a trade.
- Ready to bear your losses.
In this article we are discussing Psychological Trading mistakes which are done by both types of traders either a professional or a newbie. Here we explain three different types of psychological trading mistakes and how to avoid them. This article will help you to maintain your emotions at the time of trade.