Monday, May 5, 2008

Psychology of Trading

Trade with a DISCIPLINED Plan:
The problem with many traders is that they take shopping more seriously than trading.
The average shopper would not spend $400 without serious research and examination of
the product he is about to purchase, yet the average trader would make a trade that could
easily cost him $400 based on little more than a “feeling” or “hunch.” Be sure that you
have a plan in place BEFORE you start to trade. The plan must include stop and limit
levels for the trade, as your analysis should encompass the expected downside as well as
the expected upside.
Cut your losses early and Let your Profits Run:
This simple concept is one of the most difficult to implement and is the cause of most
traders demise. Most traders violate their predetermined plan and take their profits before
reaching their profit target because they feel uncomfortable sitting on a profitable
position. These same people will easily sit on losing positions, allowing the market to
move against them for hundreds of points in hopes that the market will come back. In
addition, traders who have had their stops hit a few times only to see the market go back
in their favor once they are out, are quick to remove stops from their trading on the belief
that this will always be the case. Stops are there to be hit, and to stop you from losing
more then a predetermined amount! The mistaken belief is that every trade should be
profitable. If you can get 3 out of 6 trades to be profitable then you are doing well. How
then do you make money with only half of your trades being winners? You simply allow
your profits on the winners to run and make sure that your losses are minimal.

Do not marry your trades:
The reason trading with a plan is the #1 tip is because most objective analysis is done
before the trade is executed. Once a trader is in a position he/she tends to analyze the
market differently in the “hopes” that the market will move in a favorable direction rather
than objectively looking at the changing factors that may have turned against your
original analysis. This is especially true of losses. Traders with a losing position tend to
marry their position, which causes them to disregard the fact that all signs point towards
continued losses.

Do not bet the farm:
Do not over trade. One of the most common mistakes that traders make is leveraging their
account too high by trading much larger sizes than their account should prudently trade.
Leverage is a double-edged sword. Just because one lot (100,000 units) of currency only
requires $1000 as a minimum margin deposit, it does not mean that a trader with $5000 in
his account should be able to trade 5 lots. One lot is $100,000 and should be treated as a
$100,000 investment and not the $1000 put up as margin. Most traders analyze the charts
correctly and place sensible trades, yet they tend to over leverage themselves. As a
consequence of this, they are often forced to exit a position at the wrong time. A good
rule of thumb is to never use more than 10% of your account at any given time.

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