Psychology of trading and capital management

Often, for some traders entire process of trading and analysis is subject to several other algorithms of behaviour which are not fundamentally different from gambling. We offer you to get acquainted with some obvious signs of such behaviour and to correct yourself, if necessary:
  • You have received one or more losing trades and then rush to the market with a view to urgently rehabilitate and fight off losses;
  • You worry before entering the market, and then "hypnotize" the graph and worry even more;
  • You get a loss, and relate it to the "irregularities" of the market;
  • You actively monitor forums and other places of communication of traders to indirectly obtain confirmation of your rightness in relation to the prospects of a particular tool;
  • Before going to bed you run to the monitor. And the first thing you do after sleep - also run to it;
  • You check your account balance on open positions in your terminal every 5-10 minutes;
  • You begin to criticize other traders and systems
How is it treated? Dramatically – by loss of deposit. Here are correct and softer ways to handle it:
  • Take breaks. Take a break from the market for a few days, weeks or months, and allow your mind to relax. During this time, try to avoid exposure to market information;
  • Keep a diary. Most people with an addiction plunge into it. Writing down your trades, thoughts and ideas, you can clearly see what you do and when to stop and check yourself;
  • Assert yourself in research.
  • Create a strategy, shorten it as much as possible and stick to it. The simpler your strategy is, the easier it is to follow it.
We suggest you pay attention to the fact that even in the presence of sustainable trade systems, the trader is influenced by a number of risks of the personal psychological problems:
  • The risk of boring trade
Many are attracted to trade not only because of the possibility of large movements of capital in a short period of time. Adrenaline "injections" are often the stimulus. And in times of high volatility and sudden movements, reflex of a "racer" can be triggered. And if the strategy available to the trader does not work in periods of high volatility, the traders often enter bypassing its rule. This is quite dangerous, because in the trade there are often long periods of non-directional lateral movement with sharp bursts of activity. In this case, the trader must either change the strategy or change himself and understand with what purpose he came to the market-to earn or to feel emotional pleasure.
  • The risk of recession of trade
Ideal systems do not exist! It is necessary to understand right away, once and for all! Any strategy with a high level of profit will periodically give a series of several losses 2 to 3 times in average of 100 transactions. And if a trader is trading not only within the day, these series can lead to months of decline, albeit moderate.
The trader who understands this and understands how his system operates, will not give it up in times of such recessions and will not rush to look for a "Holy Grail."
  • The risk of too rapid growth of capital
Similarly, there is a possibility of revaluation, if the system of the trader did not give a series of losses, but a series of good trades. As a result, the account has grown, so has the trader in his own eyes. Traders usually become too self-confident after a significant rise, and resize positions, trade more freely, rejecting created strategies. It is becoming increasingly difficult to outwait the inevitable period of sideways trend following the period of rise and as a result good profit earned at good trend "dissolves" in a series of stupid trades in other phases of the market.
  • Risk trade planning
Even with a ready and profitable strategy and defined profit losses, we cannot know in advance the sequence of winning and losing transactions. The account gradually increases during the year, but the time is spent both on the return of losses and the growth of the account. Most of the profit was obtained in a relatively short period of time - but we do not know exactly at what point it will happen. This means we should be able to outwait periods of recession, in order to make money.
Risk of planning is definitely a psychological risk, even if you trade methodically. The best therapy against psychological risks is a comparison of psychological risk (the risk that we perceive) with the actual market risk. We must maximally improve knowledge of the market, due to the history of the trading strategy. Many programs and platforms give results on trade and calculate statistics, such as those used for assessment in trading systems. Statistical indicators are collected to enable modelling of the decision-making process, facilitating for the traders determination of the point of entry into the market.
Despite apparent crucial importance of the fact that the trader must know when to enter the market, many professional traders consider criteria for capital and risk management of personal trade paramount! Only they are paramount, and nothing else! Markets are constantly changing and different periods and phases come and go. Accordingly, systems and patterns of trade, which worked yesterday, today can fail. That's why rules of capital management are the only reliable island in the storming oceans of markets. And professionals will never back down from them, because it's the only thing that will save you in case of complete lack of understanding of the changes taking place in the markets. Models and methods of management of risk in trading and management of commercial capital perform the most important basic function for a trader - saving capital.
Here, everything can be represented in a unified and universal form - cut your costs and increase profits!
Almost all, without exception, rooky traders are beginning to think about their trade route, only in terms of profit. And the emotional question of how much I earn immediately gives way to the question, how much can I lose. Although the second question is more important. If potential losses of any operations make up half of your capital, then a couple of unsuccessful operations in a row will instantly kick you out of the market and possibly for a long time. Therefore, it is important to understand that for stable and long-term results, avoiding losses is more important than getting big profits on the basis of two main mathematical principles:
  • The greater your account or investment portfolio becomes, the more your capital depends on any particular reduction of percentage ratio.
  • Much higher percentage of profits will be needed to recover any losses percentagewise.
It sounds simple and uninteresting for a rooky trader dreaming of a new car or a boat. But usually, the time comes and people start thinking about it, when a series of losses is sobering you and makes you think. Indeed, to make up for 50 – per cent loss, 100% of profit is required, and 33% of losses can be saved by 49 - per cent profit. Aggressive operating plan, which assumes effective return, but is not based on the management of your capital or control of risk is always doomed to failure. Do not believe me? Check it out!
Therefore, development and debugging of personal trading system should be approached with caution. Without fear and greed. With understanding of a few basic principles. To reduce the risk the trader, in principle, can choose from the following options:
  • Close (or do not open) position (completely eliminating the risk);
  • Sell a portion of the position or buy a smaller share at the initial purchase;
  • Increase the "stop-order" until risk is reduced to an acceptable level;
  • Wait until the market comes close to a reasonable stop and if the grounds for the operation still exist, execute the operation at this point (valid until cancellation order to limit purchase, similar in meaning to "stop order", is able to automatically solve this problem, but it should be carefully controlled so that the signal for purchase remained in force).
Even if each entry to the market is ideally calculated in time, a series of losses can reduce to zero any account. The best option of risk management approach can be a system that includes the following components:
  • You need to have a plan in case things do not go the way you planned;
Lack of good risk management plan is the main reason why new traders fail. Then come disappointment, accusation of the market and leaving financial markets. We believe that the plan should be not just in mind, but also in writing. For example, there are specialized tools that allow you maintaining, planning and keeping of statistics of accomplished trades. Ideally, you just have to take each planned transaction as a working hypothesis. And if something goes against your hypothesis, immediately get out of the deal.
  • You must follow the principles of diversification on financial instruments.
In 1990, Harry Markowitz won the Nobel Prize in economics for having demonstrated how possession of a portfolio of financial instruments with high standard deviation, but at that with negative correlation (when some instruments rise, others fall), can lead to greater profitability compared to lower total standard deviation. His work has denied the common knowledge that the price of higher profits is always an increased risk, and showed that apparently risky financial instrument can alone paradoxically, reduce the risk of the portfolio. In the same category of financial instruments holding of several positions is less risky than holding a dollar equivalent of one. Traders can reduce the risk by dividing their capital between unrelated markets. The likelihood that the transactions at the same time will fail in all markets is less than the probability of failure in one market.
  • You must follow the principle of diversification of trading systems
Markets are constantly in motion and market phases replace one another. Naturally, some systems work better than others in some phases of markets. Diversification of 2-3 systems can reduce the volatility and the "gaps" in your portfolio to a less profitable but more stable growth.
  • You have to observe loss limits
For example, you can set for yourself that under no circumstances you can risk more than 2% on any given transaction and more than 10% in respect of the investment portfolio as a whole. This does not mean that you cannot use your entire portfolio for operations. You just set the limit or insure your capabilities in such a way that your maximum loss on any transaction could not exceed 2% of your portfolio. Such a commitment would mean that if in any month, your losses will be more than 10% of the total amount of your capital, you should stop the operations and review your approach more carefully, and give yourself time to put your emotions in order.
RISK WARNING: Trading of complex financial products, such as Stocks, Futures, Foreign Exchange ("Forex"), Contracts for Difference ("CFDs"), Indices, Options, or other financial derivatives, on "margin" carries a high level of risk, and may not be suitable for all investors. The possibility exists that you could sustain a loss of some or all of your initial investment and, therefore, you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with trading these markets, and seek advice from an independent financial advisor if you have any questions or doubts. Please carefully read our full "Risk Disclosure" and "Risk Disclosures for Financial Instruments & Investment Services". FXFINPRO Capital is the trading name of PFX Financial Professionals Limited, a limited liability company formed under the laws of Cyprus, registered with the Registrar of Companies in Nicosia, Cyprus, under nr. HE 237840 and regulated by the Cyprus Securities and Exchange Commission with license number 193/13.