A large part of successful trading comes from mastering your mind and your thoughts that is why we present you 3 common psychological trading mistakes that a trader should avoid. Let’s talk about the three most common trading mistakes traders make and we also have some suggestions for you if you are struggling with any of these.
#1 Trading Mistake: FOMO Trading
FOMO is an acronym for fear of missing out. The FOMO trader is typically very optimistic about each and very trade because this trade could be THE ONE.
Something about this trade looks so much better than all the others so it has to be THE ONE.
If I miss this trade there may not be an opportunity like this one for a while.
We can all agree how silly that sounds, of course, there’s going to be more opportunity around the corner but although it sounds silly and obvious. The reality is that this type of thinking affects so many traders mainly because they don’t even realize it’s affecting them and it’s a huge problem because it can cause you to do two things:
- It can cause you to take every trade you see even if it is not that good of a trade setup;
- It can cause you to increase your position size on a particular trade because if this trade does end up being all that it’s cracked up to be, why would you only want to make a few hundred or a few thousand bucks on it. Screw that that’s chump change let’s swing for the fence.
However, what happens when this trade turns out to be nothing special and despite how much it seems like there’s no way you can lose money on it, it turns into a losing trade and now you have tons of your capital invested and are sitting on a huge loss that will be almost impossible to come back from.
You can see how this can be a huge problem. If you’ve ever struggled with this let me hit you with some wisdom from Charlie Munger who is Warren Buffett’s business partner. At a recent Berkshire Hathaway Investor conference Warren Buffett and Charlie Munger we’re talking about how they missed Google and Amazon because for some reason they had a blind spot and they didn’t see the opportunity. In fact Charlie Munger specifically said “we will keep missing them but our secret is that we don’t miss them all”. So just think about that for a second if the best and richest investors in the world aren’t worried about catching every single investment then why should you be. You just have to understand that missing trades is a part of the game and it will happen.
Therefore, if this fear of missing out is something you struggle with here’s our solution for you:
- Stay out of chat rooms and trade alone for a week or so and if you follow other traders on social media stay off of that as well. Basically seclude yourself and trade alone for a bit.
The reason for this is because often in chat rooms or on social media we see others making money and by nature this instills a fear of missing out in the future. We aren’t saying chat rooms and social media are bad by any means, actually chatrooms are a great tool for your trading. But even we realize that some traders might need to break away and trade alone for a couple weeks if they are experiencing FOMO.
During this period where you are trading alone if you feel like you can’t find trades or generate trade ideas without chat rooms or social media then you likely need to stop what you’re doing and become more educated on the strategy that you are trading, so you know the process to find trades, when to enter and exit them etc. Because you need to have an exact plan. Your trading strategies should not rely on the trade ideas of other people. Trade ideas of others should be a tool but not a crutch.
#2 Trading Mistake: Revenge Trading
These are the types of traders who can blow up their entire trading account and lose everything in just a day or week. After taking a trading loss Revenge Traders will throw everything they know about proper position sizing out the window and will trade like a madman just to make back that loss.
Now this may work once or twice and you’ll come out unscathed but if you keep this up you’ll get crushed bad and it’s going to hurt. The market doesn’t care about you or your money and if your revenge trading causes you to lose everything in your trading account you’re going to be the one 100 percent responsible for it. So, please, just be honest with yourself and if this is something you struggle with that all just get a grip on it before it really ends up hurting you.
The solution for this one is actually fairly simple, here’s our advice to anyone who struggles with this:
- If you’re having this problem where losses are upsetting you enough to get you to this point of seeking revenge on the market you’re likely trading way too big of positions in the first place. So knock that position size down and trade smaller size. This should allow you to not get so upset about losses and you’ll be able to start making decisions based off of logic rather than emotion.
With any trading strategy you’re going to have losing trades every now and then but the key is making sure your winners outweigh your losers. As Drake once said “you win some you lose some as long as the outcome is income” and if your position sizing is out of check and you are trading out of anger or revenge then the outcome will definitely not be income.
Now if you’re still having issues with this and you know that your position sizing is in check then maybe it’s your mindset or your expectations of trading that is the problem. You need to make sure you’re committing and focusing on the long term. try to look at the bigger picture and think about how the long term success is much more important than trying to make back that loss right now this very second.
Revenge trading can also be a result of expecting yourself to make money every single day. Anytime you are negative on the day you will do everything in your power to turn that around and be up money on the day. Well this is just not a realistic expectation, you should be focused on being positive on the year, quarter, month or at the very least week but being positive every single day is just not reasonable as markets fluctuate each day and you can’t control that.
#3 Trading Mistake: Gamblers Fallacy
This might not necessarily be a psychological mistake but rather just a very common misunderstanding of some basic probabilities. It will cause you to make very poor trading decisions and in some cases this one can also compound and cause very big losses.
Now this actually spans far past just the trading world and as you can probably guess by the name it’s most commonly associated with gamblers. We certainly don’t want to treat our trading as gambling so let me show you how to avoid this common mistake that so many traders make.
A quick Google search will show you the definition of Gamblers fallacy but let me put this in layman’s terms that anyone can understand. We all know that a coin flip is a 50-50 bet, so if you flip a coin 10 times the expected outcome would be five heads and five tails but although it’s expected that the same number of heads and tails will show up. We know that the actual number can deviate in either direction.
But let’s say we plan on flipping a coin 10 times and the first five coin flips all land on heads, what is the sixth coin flip more likely to land on heads or tails? If you choose tails then you my friend have fallen victim to gamblers fallacy.
Let me explain, the expected outcome of ten coin flips is of course five heads and five tails, we just covered that. But rolling five heads in a row does not change the probability of the next coin flip. The probability of the next coin flip is completely independent from the past results. So what is the sixth coin flip likely to land on after five heads in a row? The answer is that one is not more likely than the other, it’s still a 50-50 bet.
Gamblers fallacy refers to the thinking that a series of events will somehow affect the outcome of the next event as if there was some sort of balancing force at work and in this example the coin somehow knew that it just landed on five heads in a row so now it should land on tails. And this gamblers fallacy actually applies to many other parts of life as well. A few examples are:
- Someone who flies a lot thinking they are somehow working their way towards a crash even though each fly is independent of the last.
- People at the casino who see that the roulette wheel just landed on red ten times in a row so now they start putting their money on black even though the previous spins have no bearing on what the next spin will be.
And finally it also applies to trading and so many traders fall into the clutches of this fallacy. If you have five losing trades in a row this does not mean that the next trade will be a winning trade just because you feel like the losing streak has to end soon. Many traders tend to increase their position size after a losing streak because they feel their luck has to turn around soon but the reality is you’re just increasing your risk on a trade that has the same probability of success of all the ones you just lost money on. The market does not know or care if your last few trades were losers or winners.
The solution to this one is easy, it’s just as simple as understanding it as you do now and then exercising awareness. Now that you understand what gamblers fallacy is you should be aware of it and just make sure you aren’t affected by this type of thinking, try and treat each trade independently from any past trade you’ve made.
If you have a streak of losers that does not mean the next trade will be a winner and on the flip side if you have a streak of winners that doesn’t mean the next trade is more likely to be a loser.
Trading is a numbers game and you have to eliminate these psychological mistakes and focus on trading the numbers. Once you can do that you’ll take your trading to the next level. The stock or crytocurrency market is not a place for weak emotional people make sure your own worst enemy doesn’t live between your ears.
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