The Psychology of Trading: Why Investors Make Irrational Decisions

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As an investor, you may have wondered why sometimes people make seemingly irrational decisions when it comes to forex trading or investing in the market. Trading psychology, the emotional component of an investor’s decision-making process, may help explain why some decisions appear more rational than others and why investors exhibit certain behaviors when trading currency or investing in the market. Understanding the factors that impact trading psychology can help you avoid unnecessary losses and take control of your financial situation by managing risk properly, planning and setting goals, cutting losses quickly, and exiting positions that are not paying off – which may lead to increased profitability and peace of mind for investors.


How emotions affect your investing
The emotions that drive investors come in many forms and manifest themselves in a variety of ways. Overconfidence can lead to poor decisions, while fear can be paralyzing. Emotions can easily cloud good judgment and make it difficult to differentiate between reality and fiction. In fact, emotions may play such a large role in trading psychology that can even have an impact on what kinds of stocks you buy. For example, companies with high debt levels are perceived as riskier than low-debt companies with similar earnings or cash flow.


How to Identify Emotions
First and foremost, you have to learn how to identify your emotions. Don’t let fear, hope, or greed cloud your judgment; even great traders in the currency trading market can succumb to these emotions. For example, what if Apple announces record earnings today and shares jump 20 percent? It might seem like a good time to buy; but if you don’t allow yourself to feel anything other than irrational optimism (you are experiencing greed), then you’re not thinking rationally. Be honest with yourself—is your decision based on an emotional reaction rather than a rational one? If so, think it through before making a move.


How to Manage Emotions
Emotions have a way of creating a bit of a burden for traders in the forex trading market. Whether it’s taking an investment loss and feeling regret or glee from short-term gains, emotions can be hard to manage when making decisions about your investments. For many long-term investors, keeping emotions out of investing is a good practice to implement in order to avoid impulsive decision-making that might lead to irrational choices. While it’s not possible to eliminate your feelings altogether (they are part of what makes us human), you can still try to look at your investment choices rationally, without letting how you feel influence how you think. This may mean setting aside some time apart from the market activity so that you can plan out your strategy without letting emotion rule over reason.


Tips for Managing Emotions
The fear that you’ll miss an opportunity if you don’t act immediately can be a powerful motivator, but often creates more problems than it solves. The easiest way to avoid FOMO is to develop a long-term outlook that makes you think about what it will take to achieve your goals. Then, when a new investment or product catches your eye, just ask yourself whether it’s worth putting in years or even decades of hard work to get there. If not, put down your hard-earned cash and walk away. The good news is that with
experience comes wisdom, so as you become more experienced in investing or making any other big decisions in life, you’ll learn how to say no more often—and stick with it! When we make decisions, two things happen: (1) we make judgments, and (2) our
emotions kick in. That’s where most investors get caught up; they focus on making judgments instead of managing their emotions. The key to successful investing is in learning how to manage your own emotions so that you can appropriately respond to new information as it becomes available. To help traders improve their skills at trading forex more efficiently, sometimes it’s best to use rules instead of letting our emotions control us. For example, an investor might decide that he will only invest in situations where his
research has led him to believe there is an 80% chance, that he will achieve a 15% return on investment over a 12-month period.

All investments involve some degree of risk. If you intend to purchase securities – such as currencies, commodities, stocks, bonds, or mutual funds – it’s important that you understand before you invest that you could lose some or all of your money.

Do you want to know more about trading currency and investing? There are more than enough learning sessions to get you started, regardless of your learning style. With Smartrade, you can pick from experienced-led courses and study at your own speed, with lifelong access to free forex training and one-on-one coaching. You’ll also learn the fundamentals of day trading forex, CFDs, Stocks, and Commodities. Learn more about Smartrade and get started right away.

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