Demystifying Trading Psychology

Understanding Trading Styles

Many traders spend years in the game without fully grasping the nature of their trading style and what a typical day or week should look like based on their approach. Think of it as running a business:

• Some people deal in low-cost products, needing a high sales volume for profit.
• Some work with mid-range products, requiring a decent number of sales.
• Others offer luxury products, where just a few customers per year are enough for profit.

Each of these businesses has vastly different daily workdays and expectations:

1. The first anticipates a constant stream of customers.
2. The second expects a steady flow.
3. The third can thrive without customers for days, as even one sale every few days can maintain high profitability.

Trading works the same way. Traders have varying systems and different levels of risk and reward, leading to widely differing trading days.

Trading Psychology: The Panic of Unrealistic Expectations

Now, picture a luxury product seller expecting the same customer traffic as a seller of $1 products. If no customers enter the store for a couple of days, the luxury seller might panic. This panic can lead to critical mistakes: overspending on marketing, changing their inventory drastically, and feeling like a failure. This is when risk management spirals out of control.

The same principle applies to trading. Consider a trader with an extreme risk-to-reward ratio facing consecutive losing days. Even if this is typical for their approach, if they haven’t fully accepted it, they might panic. This is when they might overtrade, increase risk, become depressed, see “problems” everywhere, and things can quickly spiral out of control.

The Role of Risk Management

Now, we all experience emotions. Every trader faces the same emotional rollercoaster. These emotions persist whether it’s their first trading day or their 1000th. There is literally nothing you can do about it. It’s deeply ingrained in our primal instincts. However, major emotional swings and major damage are often the result of unrealistic expectations.

Better risk management results in better trading psychology, not the other way around. So, instead of fixating on emotions, focus on understanding the true nature of your trading approach and your expectations. Ask yourself:

• Is it normal for my trading approach to experience 5–10 “paper cuts” before nailing a big trade?

The best trader isn’t someone who lacks emotions or manages emotions but rather the one who quickly snaps back to the reality of their methodology and sticks to their approach without wasting time.