The term investing psychology or trading psychology refers to the state of mind, a set of rules, and a set of behaviors that someone must have in order to become successful in the market.
Having the right trading mindset helps you to be continually mindful about all the complexities that involve an Exchange Traded Fund (EFT). If you are trading without the right trading mindset, the odds can be stacked up against you.
Not only do you need to have sound technical analysis and a good fundamental analysis while trading, but you also ought to have patience without the involvement of your emotions. The right mindset can boost your chances of success. If you walk into the market with the “I need to make big money” mindset, the chances are that you can lose big money.
The psychology of investing requires hours of research and studying the market. Before you learn your own personal trading strategy, learn how to forget about making money and focus on making a sound trade with while being mindful of risk/reward and risk management.
The psychology of investing is important because it explains why people make irrational decisions when they invest. To be better at trading, it’s important to eliminate emotions and biases and utilize your intuition that may open you up to new trading ideas. So, how can you develop your trading psychology and have a plan for investing?
Be Willing to Lose Money
Capital preservation and risk management are key; however, there are times when there is no reason to not place a sell order at a predetermined amount to limit a potential loss (also known as a stop-loss) in case a stock goes below a certain price point that is part of your trading strategy. An all-too-common thought process for inexperienced traders is “When Lambo?”, or “I am going to do all of this trading research and find the next meme stock or short squeeze, and it’s going to moon, and I’ll be rich.”
It is true that you can find potential trend changes and buy-and-sell opportunities. However, if you are not willing to lose money, or at the very least use a stop loss order as previously mentioned, then you may need to reevaluate your trading methods and psychology. The reason is because some traders who are unwilling to lose a little money, end up in a trade where they lose a lot more because they fail to control their losses and manage their risks.
Some experienced traders use the only-invest-what-you-can-afford-to-lose approach as part of a trading strategy. You must know how much each trade can potentially cost you as well as the maximum amount of capital that you would be willing to lose on a single trade. Always assume that the price can move in the opposite direction you want it to.
What is Investor Risk Tolerance?
Even though education is important, it’s not the only resource one can rely on in the stock market. Many people fail at financial investing because they rely too heavily on education. The problem is education does not prevent investors from taking unnecessary risks without understanding what they are doing. Just because you have studied a company to invest in doesn’t mean that other factors could cause their stock to fall. For example, a cargo ship that gets stuck in the Suez Canal could affect the price of a supply chain stock.
Although education is important it must be used together with an analysis of your risk tolerance. If you have extensive education but are not willing to do any risk analysis then education alone may not generally produce good results.
When it comes to risk analysis, traders must understand their financial goals, what they are willing to risk in order to pursue those goals, and how much their financial goals are worth if they were to lose it all. An education alone does not prevent you from thinking you cannot lose. You must be mentally prepared to handle certain risks, whether seen or unforeseen, and understand there is a potential for a loss. Education and risk tolerance should therefore go hand in hand as part of a successful trading strategy.
Before investing in anything, it’s important to know what kind of assets fit your plan and how you can lower risk through diversification.
Risk Tolerance goes beyond education. Investors who have been trading for years spend countless hours doing research on particular stocks, industries, and currencies to find the one best trade – or better yet – a trade that fits their profile for risk tolerance.
Despite the experience of many successful traders, it’s their risk management skills that may set them apart from most other traders out there. Knowing what your risk tolerance is separates an effective trader from the gamblers who basically have with no control over their own success or failure navigating market volatility. You can’t just leave it up to fate.
Should I Hire a Financial Advisor Instead?
Many potential investors often rely on financial advisors to assist them in making decisions when it comes to their investments. Advisors are trained professionals who have specialized knowledge about the type of investment vehicles that suit their client’s risk tolerance, education about diversification, and education about investing styles. Financial advisors can also help their clients create a detailed plan for investing while identifying their goals based on how much risk they can tolerate.
People start investing because they’re looking for ways to grow their finances, trying to prepare for retirement, save for a child’s university tuition, or just to have more spending money each month; however, many traders are incapable of achieving long-term success in the market because they lack education and patience among other things. This lack of education prevents them from designing an efficient plan that will mitigate risk during both upswings and downswings in the market, and unfortunately, new investors may blow up their accounts and get washed out of the market.
No matter how much research you do, no one knows everything there is to know about trading stocks and other financial instruments. This is one of the reasons why financial planners use technical indicators and sophisticated software which monitors fundamental factors that may impact a stock’s performance.
By hiring someone to manage your wealth, you can alleviate the stress associated with investing and making trades on your own; not to mention saving the years it usually takes to become successful at trading.
The take away is that investing involves risk including the loss of principal. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.