One of the biggest pitfalls that beginning traders encounter is giving in to their emotions when trading. Trading is an intellectual activity that you should perform dispassionately and based on a trading plan that you have developed based on your analysis of market conditions. The moment a trader becomes emotional, however, they start to ignore the guidelines they have set and start to make trading decisions that they will regret later.
There are two main emotions that the forex trader should be wary about in particular: fear and greed.
Fear comes in when the trader is afraid that the trade is about to go against them. The most common response a trader makes is to close a trade too early, before they have maximized their profits. At worst, a fearful trader is too anxious to make trades at all.
Greed, on the other hand, makes the trader stay in a trade when they should already have closed it and taken their profit. They believe that there is more money to be made and so they continue to chase it until the trade suddenly turns against them and they lose their investment. Greedy traders also ‘chase their losses’ meaning that after a series of losing trades, they continue to make trades in the hope that the next one would be the one that reverses the trend.
How can you deal with these emotions when trading? The basic way is to have a trading plan. This plan represents the guidelines you will follow that determine whether or not you will enter a trade as well as when you will exit. By sticking to these guidelines, no matter what happens, you will never let emotions determine your trading decisions.
Another important way is to create a risk management plan. This plan includes determining how much you will invest per trade as well as how much risk you are willing to accept per trade based on the amount of profit you will potentially make.
Finally, you need to develop self-discipline. You have to be able to tell yourself when to stop trading or even if you should make trades at all. Having a series of technical rules to follow greatly helps but you still need to have the discipline to stick with them.