Discipline and risk-taking are the two of the most important aspects of trading psychology. The two most important emotions commonly associated with trading psychology are fear and greed. Moreover, things like hope and regret can also play a role in trading psychology.
Many skills are required for trading successfully in the financial markets. They include the ability to evaluate a company’s fundamentals and to determine the direction of a stock’s trend, which we explain in great detail in the home study course but neither of these technical skills is as important as the trader’s mindset.
So trading psychology is the emotional component of an investor’s decision-making process which can explain why trading decisions seem more logical and rational than others.
“Many skills are required for trading successfully in the financial markets. They include the ability to evaluate a company’s fundamentals and to determine the direction of a stock’s trend, which we explain in great detail in the home study course”
WEALTH TRAINING COMPANY
Trading psychology is characterised by the two main emotions experienced in trading which are greed and fear
A trading decision that is motivated by greed will tend to be excessively risky. So the size of the bet, which is often highly leveraged, could be an indication of excessive greed.
Overconfidence driven by greed is often the reason for significant leverage positions.
Greed is explained as an excessive desire for wealth, and it can be so excessive that it clouds rationality and judgement at times. So the characterization of the greed-inspired investor or irrational trading is that the traders’ emotions can lead to suboptimal behaviors. For example, this could entail making high-risk trades, buying shares of an unproven company or technology just because it is going up in price rapidly, or buying shares without researching the underlying investment.
“overconfidence driven by greed is often the reason for significant leverage positions”
WEALTH TRAINING COMPANY
Moreover, the trading psychology of greed causes traders to spend more time in profitable trades longer than is advisable with the goal of squeezing out extra profits or taking on more speculative positions.
“The VIX is a real-time market index, which signals the level of fear or stress in the stock market” – Wealth Training Company
The trading psychology of greed is more apparent in the final phase of a bull market when speculation is rampant. It is also when investors act recklessly
Conversely, the trading psychology of fear is apparent when the trader is always avoiding risk and generates low profits.
Fear tends to drive decisions that avoid risk and generate poor returns
The trading psychology of fear dominates in bear markets, and as explained above, fear emotion can cause investors to act irrationally and quickly exit the market with losses. The emotions of fear can often morph into panic, which can trigger panic selling in the market.
The dominant emotions that makeup trading psychology are fear and greed, which is measured using the CBOE Volatility Index or VIX
The VIX is a real-time market index, which signals the level of fear or stress in the stock market.
In general, a VIX reading below 20 suggests a perceived low-risk environment, while a reading above 20 is indicative of a period of higher volatility. The VIX is currently posting 31 at the time of writing this piece, which indicates the trading psychology of fear dominates the market.