TL;DR
Trading psychology addresses the emotional aspect of a trader's decision-making process. Every trader, to some extent, has emotional triggers. The two main emotions that affect traders are fear and greed — both can lead to bad decisions, such as going all-in on an asset or selling quickly and irrationally out of fear (panic-selling).
Even if a trader has an excellent understanding of fundamental and technical analysis, a weak or anxious mind, easily influenced by emotions, can be highly detrimental to your portfolio. — especially in a volatile trading environment, such as cryptocurrencies.
What is trading psychology?
Trading psychology refers to the psychological factors that influence how people trade in markets such as cryptocurrencies or stocks. It is based on the idea that emotions can significantly impact a trader's decision-making process.
For example, greed can lead a trader to make a high-risk decision, such as buying a cryptocurrency at its peak due to the rapid increase in price. On the other hand, a trader's fear may cause him to exit a market position prematurely.
FOMO is a feeling that is particularly prevalent when an asset appreciates significantly in a relatively short period of time. This feeling has the potential to cause a person to make market decisions based on emotion rather than logic and reason.
Every trader is affected by emotions. Of course, for most people, losing money is painful, while earning money provides a feeling of joy.
Why it's important to understand your mind when trading
In trading, fear and greed are the two primary emotions.
Fear can lead a trader to avoid all risks and possibly miss a good trading opportunity. On the other hand, greed can result in taking excessive risks in an attempt to maximize profits, such as deciding to buy an asset at its peak because the price is rising rapidly.
Experienced traders can find a balance between fear and greed. Fear protects traders from taking unnecessary risks, while greed motivates them to capitalize on opportunities. Any of these emotions in excess, however, will result in irrational trading decisions.
Learning to trade with the correct mindset is as important as performing fundamental analysis or knowing how to interpret a chart. By understanding and controlling their emotions, traders can make informed decisions and minimize losses.
Obviously, making decisions without the influence of emotions is a very difficult task. Traders deal with a variety of daily challenges that can provoke an emotional response. Let's see some examples.
Unrealistic Expectations: Trading is not a get-rich-quick scheme. People who trade with this mindset are likely to experience major disappointments. Like any other skill, trading requires years of practice and discipline.
Losses: Even the best traders have dark days. Less experienced traders have more difficulty understanding the reason for their losses. This often leads them to even greater failures in their attempt to "outperform" the market.
Winning: While winning is good, the downside is that some traders feel overconfident or a sense of invincibility. This can lead to riskier decisions and result in significant losses.
Market sentiment and social media: Beginner traders are easily influenced by what people say on the Internet. Negative feelings on social media can generate fear and result in a large volume of sales (a phenomenon known as panic selling). It is equally unwise to blindly follow an influencer's advice regarding purchasing a specific token. Especially if the influencer is sponsored by the token project and paid to promote it.
How to use trading psychology to become a better trader
Think long term
Set achievable goals. A realistic plan of what you want to achieve helps you avoid excessive trading or emotions due to unrealistic expectations. This also helps you stay focused on your long-term goal and give less importance to short-term gains or losses.
Take breaks
Regular breaks can give you a better, clearer perspective on the situation. If you get a good streak of positive trades, take a break. Avoid excessive trading and don't get carried away by emotion. Some traders sacrifice nights of sleep to follow the market. This can cause stress and burnout and, consequently, cause you to make poor decisions. Taking breaks are beneficial not only for your portfolio, but also for your health, physical and mental.
Learn from mistakes
Everyone makes mistakes when making trades. Instead of feeling angry at yourself, or worse, trying to recoup your losses by investing even more, go back and analyze what went wrong. Implement new strategies based on what you learned from previous mistakes and you will be increasingly prepared.
Set rules
Create a detailed trading plan and follow it. Your plan should define how you approach different situations and will help you keep your reactions under control during stressful times. Some examples include using stop-loss and take-profit, which limit how much you can make or lose in a day, and a risk management strategy that you are comfortable with.
With a clear plan in mind, you'll know exactly what steps need to be taken without letting an emotional response derail your decisions. This way, you avoid deviating from the initial plan you set for yourself before entering a position.
Is trading psychology different in the crypto sector?
The psychology of trading is valid for any asset class, including cryptocurrencies. In this context, human beings are relatively similar, especially in relation to money. Most people, for example, don't like losing money. Another example: virtually all traders get excited when they are on a positive streak of trades, regardless of the currency.
However, there are some more specific psychological challenges that cryptocurrency traders face.
Unlike the stock market, which is closed on weekends, the cryptocurrency market is open 24/7. As a result, cryptocurrency traders always have access to trading tools, their assets and, most importantly, potential opportunities. 24/7 access can be costly for a trader who is more prone to making trading decisions under the influence of emotions.
The crypto market is highly volatile. On certain occasions, prices double and then return to where they started — all in a single day. These drastic fluctuations require discipline and agility from traders in relation to their decisions.
For example, professional traders don't make large investments in a rising asset simply because everyone is talking about it. They also do not risk their capital on a particular market just because it closed the day with a significant increase.
Final considerations
When it comes to cryptocurrency trading, emotions are one of the most common pitfalls. Learning to control your emotions by understanding your mindset and emotional triggers is an invaluable skill that will protect you from chasing irrational gains or hitting the panic button and liquidating your portfolio.
After all, becoming a good trader requires years of consistent learning and practice. There is no shortcut or easy way to get rich from trading. Follow a strategy that suits your financial situation, keep practicing, and don't let fear or greed make you make decisions you wouldn't normally make.
Further reading
The psychology of market cycles
What is the Crypto Fear and Greed Index?
What are behavioral biases and how to avoid them?
What Are Stop-Loss and Take-Profit Levels and How to Calculate Them?
How to Trade Cryptocurrencies Responsibly
Risk Notice and Disclaimer: This content is presented to you “as is” for informational and educational purposes only, without warranty of any kind. The content should not be construed as financial advice and is not intended to recommend the purchase of any specific product or service. Digital asset prices can be volatile. The value of your investment may fall as well as rise and you may not get back the amount invested. You are solely responsible for your investment decisions and Binance Academy is not responsible for any of your possible losses. This is not financial advice.
