In our previous lesson on how to improve your trading psychology, we looked at how to change your thinking about the financial markets.

We learnt that successful traders get in tune with the ebb and flow of the market, and don’t judge price movement.

In this lesson, Trading Psychology Pt 2, we take trading psychology one step further, and look at two common emotions which affect all traders – fear and greed.

We learn what both retail traders and prop traders can do to make fear their friend, and how to stop greed from ruining your chances of trading success.

Trading Psychology Pt 2 – how to make fear your friend

Fear is a very basic, fundamental emotion, which evolution has equipped us with to keep us safe.

If the caveman didn’t fear the sabre-toothed tiger, his body wouldn’t produce the adrenalin needed to run away from it – fast!

Over thousands of years, the human body has developed a physical reaction to fear, known as the fight-or-flight reaction.

All traders experience fear at some stage.

When fear is experienced, a series of chemical reactions occur within the human body to help prepare for the threatening event.

There are two choices:

• to either stand and fight the sabre-toothed tiger or,
• run away from it as fast as possible

These fear-induced chemical reactions trigger the central nervous system to stimulate the pituitary gland and the adrenal glands.

This triggers them to release catecholamines (which are neurotransmitters) such as adrenaline, noradrenaline, cortisol and dopamine.

This leads to an increased heart rate, plus a rise in blood pressure and breathing rate.

If you are experiencing fear, you may notice your skin becomes flushed due to the increase in blood supply to it.

Your hands may start trembling, because your muscles are being flooded with hormones to prime you for physical action.

This bodily reaction to fear, the physical ‘fight-or-flight’ reaction, can last up to 30 minutes after the perceived threat has vanished.

Why fear can be a good thing

It’s a fact of life that trading produces a whole basket of stress responses in the trader, which are all based on fear.

The fear of losing money (or the ego’s fear of being ‘wrong’ when a trade goes the incorrect way) is very powerful, producing a sudden release of hormones in the human body.

All traders will experience fear whilst trading

But nature doesn’t get it wrong very often.

This physical reaction to fear can be very useful, because it means your brain is working at its peak.

The increased blood flow your body produces in reaction to fear also increases blood flow to your brain.

This means you are fully prepared to perform at your best.

You feel sharp and alert. Your thinking is quick and clear, and you feel able to make decisions easily and decisively.

This is why fear can be a good thing for a trader! Experienced traders can learn to make fear their friend. 

Learn how to deal with stress caused by fear

While the stress response can temporarily be a good thing for a trader, it is not healthy to live in the ‘flight or fight’ state for prolonged periods.

Therefore, it’s vital to develop relaxation techniques to help your body calm down from the stress response.

Develop self-awareness to recognise stress

It’s important to develop the self-awareness to register that you are feeling stressed.

This is the first step to dealing with stress – to recognise that you’re feeling stressed in the first place.

It can help to write down and record what your body feels like when you are experiencing stress.

Physical symptoms of stress

These are some of the physical symptoms I experience when I feel stressed:

• I bunch my shoulders up tight, close to my neck
• I tend to sit at the front of my chair, leaning forward, which eventually leads to back pain
• I often develop an eye-strain headache, as if I’ve been staring at a screen for too long

Some people experience stress in their stomachs, and they feel nauseous. Others experience stress in different part of their body. 

Being self-aware about how your individual body experiences stress is the first step to dealing with it in a positive way.

Develop healthy coping mechanisms

It’s important as a trader to develop healthy coping mechanisms to deal with stress brought about by experiencing fear.

In my experience this is one trait that all successful traders have in common – they have learnt how to deal with stress in a healthy way.

You can learn more here about successful day traders. 

Everyone is different when it comes to relaxing and coping with stress.

There are many different ways to relax and calm down, depending on the type of personality you are.

Some techniques that people find useful include:

• meditation
• prayer or silent internal reflection
• physical exercise
• listening to calming music
• playing with a loved pet
• doing a favourite activity or hobby

As someone who loves plants and nature, my way of relaxing when trading is always taking a walk around my garden.

Adrenalin can be addictive

These fear and stress hormones are also the reason why trading can become addictive.

The human body can get accustomed to receiving these fight-or-flight hormones, and the human brain can find this experience pleasurable.

Therefore, it craves more of these ‘happy hormones,’ potentially producing an addictive cycle.

The fact is, some people really crave excitement, as their bodies appear to need high levels of stress-response hormones.

Successful traders are aware of this, as they become more in tune with their personal trading psychology. 

If they know they have an ‘addictive-type’ personality, they may find other ways outside of trading to satisfy their brain’s need for hormone stimulation.

For example, they may choose a hobby that involves a certain degree of risk, such as rock climbing, paragliding or big-wave surfing.

Such physically exhilarating hobbies can help produce the ‘excitement hormones’ that some people crave. 

By satisfying their body’s need for excitement through another means, they can then trade without feeling the urge to take risks in order to get that ‘adrenalin high.’ 

It’s all about understanding and learning how to master your own trading psychology.

The role that greed plays in trading

In addition to fear, greed is another common emotion that can negatively impact traders and lead to poor decision-making.

In Jack Schwager’s classic book ‘The New Market Wizards: Conversations with America’s Top Traders,’ Market Wizard Mark Ritchie said:

“The successful trader must be able to recognize and control the greed. If you get a buzz from profits and depressed by losses, you belong in Las Vegas, not the markets.”

The potential effects of greed

The potential effects of greed may include:

• Overtrading: Greed can tempt you to trade too frequently, chasing potential profits instead of sticking to your trading plan. This can lead to increased transaction costs, emotional decision-making, and ultimately, higher chances of losses.
• Ignoring exit signals: When a trade goes your way, greed can make you hold onto a position for too long, hoping for even bigger gains. This can backfire if the market reverses direction, wiping out your profits or even leaving you with losses.
• Not setting stop-loss orders: Stop-loss orders are crucial for risk management. Greed might make you avoid setting them, but this exposes you to potentially catastrophic losses if the market moves against you.
• Chasing your losses: After a losing trade, the urge to recoup those losses can be strong. However, this frequently leads to rash decisions and further losses.
• Too large position size: When experiencing winning streaks, greed might entice you to increase your position size on subsequent trades, amplifying potential gains but also significantly increasing potential losses.

In short, greed can cloud your judgment and prevent you from sticking to your trading strategy or cause you to fail a prop firm challenge. 

Recognising and managing feelings of greed is essential for maintaining discipline and making rational trading decisions.

It is another fundamental aspect of mastering your trading psychology. 

Learn to recognise feelings of greed

Greed is a fundamental emotion, similar to fear. It can also produce chemical responses in the body, such as a feeling of euphoria.

However, there isn’t such a clear-cut evolutionary reason for why humans experience greed.

Some argue that greed may have played a role in human evolution by motivating individuals to secure resources for themselves, potentially enhancing their survival odds.

However, this is a complex hypothesis, and there’s ongoing debate about this issue.

It’s worth recognising the physical feelings you experience when you have a sizeable win.

Again, it can be helpful to write down how you feel when you experience a large win.

As I detailed in a previous lessons about becoming a rules-based trader, when I first experienced a big win, my heart was beating so fast I thought I was going to have a heart attack.

Learning to deal with feelings of greed

Getting accustomed to managing your feelings of fear and greed (and all the other strong emotions that trading will cause you to experience) is something that can be learned and mastered. 

You can find out more about changing your trading psychology here. 

You’ll get better at it as you practice and become a more experienced trader.

Just like learning emotional detachment to deal with fear, learning how to recognise and deal with greed becomes easier over time. 

This is why I believe demo trading (also sometimes called paper trading) is a good idea.

Using demo trading to gain experience in controlling your emotions

Demo trading is when you go through the all the motions of trading, but using a ‘demo’ or ‘paper trading’ account, with no real money involved.

Think of demo trading like taking a bike ride on a training bike, using a virtual reality headset.

You sit on the bike, pedal away, and your eyes tell you that you’re going really fast.

You see the countryside flashing before your eyes. All your senses are involved! You see fast-moving scenery and hear the spin of the wheels.

Your heart pumps fast, and your legs ache, but in reality, you’ve never left the safety of your own home.

You can then take off the virtual reality headset and analyse your cycling performance through your heart-rate monitor etc.

Demo trading allows you to go through the process of trading without any real money being involved.

It can be a valuable way to gain practice at recognising and controlling your emotions.

The benefits of demo trading for your trading psychology

Demo trading also has other added benefits. These can include:

• Testing entry signals: Demo trading allows you to test your trading system to see if it works. For example, as a gold trader, you may have identified certain chart patterns that indicate an upward trend in price movement. In your trading plan, this triggers an entry point for you to take a long position. By demo trading, you can count how many times that chart pattern occurred in a month, and how many times it would have resulted in a successful trade ‘in real life.’
• Testing money management principles: You may have worked out a system for calculating the size of your positions based on sound risk management rules, like only ever risking 2% of your trading capital. Demo trading allows you to test if your risk management system works over multiple trades.
• Giving you experience opening and closing trades: When you first start trading, you may have to search around for the correct button to select in your trading platform to buy or sell. However, with experience and practice, you’ll get very familiar with your trading software, and know exactly how it works. You’ll become confident opening and closing trades, and placing stop-loss orders until it almost becomes second nature to you.

This repetition and practice can help you to learn to experience strong emotions like fear and greed, and to practice dealing with them.

Some traders feel demo trading is not worth it, because you have no real ‘skin in the game.’

However, this has not been my personal experience when teaching others how to trade.

Most of the people I’ve taught to trade have found demo trading to be a worthwhile exercise.

As well as demo trading, prop trading can be a good way to experience this without risking your own capital. 

You can find out more about how prop trading works here. 

Add some skin to the game

You can also try adding some extra incentive by devising a personal reward system to encourage you to stick to your trading plan when demo trading.

For example, you could promise yourself a special treat that’s important to you if:

• you complete 30 trades in a row without making a mistake, and
• you stick to all the rules of your trading plan for entries and exits

A special dinner out with a friend, a present to yourself, or a similar reward could just give you that extra incentive to take your demo trading seriously.

What is trading psychology?

The psychology of trading is a vast field of study, which some people have spent their entire lives studying.

There are also thousands of trading psychology books available on the market. 

For example, you could read ‘The Consistent Trader: How to building a winning trading system, master your trading psychology and earn consistent profits from the forex market,’ which was written by my colleage and MarketMates co-founder Sam Eder. 

It is all about understanding the way you think, and the way your thinking patterns affect your trading decisions. 

It’s far too big a subject to cover in just these two short lessons.

However, if you do develop self-awareness about the emotions you are experiencing when trading, and then learn how to deal with those emotions effectively, you’ll be well on your way to becoming a successful trader.

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