29th Oct 2020

Trading Psychology 101: Impact of Fear on Trading

To be a successful trader, you need knowledge of the market, experience, and the right trading tools. But that is not enough. You also need to keep a check on your emotions. Warren Buffet once said, “The good news is that to be a great investor you don’t have to have a terrific IQ. What you need is the right temperament. You need to be able to detach yourself from the views or opinions of others.”

Emotions can play havoc on trading decisions. But the one emotion that is notorious for its adverse effect on decision making is fear.
Fear is among the most basic human responses. It is an emotional response to a perceived threat. It has developed as a way for us to ensure survival by avoiding anything that might harm us. But, among human beings, fear is not always limited to actual threats to safety. There is an entire array of irrational fears and phobias that can take hold of even the best of us, leading us to make equally irrational decisions.

For many traders, financial loss is one of the biggest fears. In fact, studies have shown that losing on a trade can generate an emotion that is twice as strong as the joy of winning. So, the first step in mastering trading psychology is to understand and then control fear, keeping it out of our trading decisions.
There are 4 different types of fear experienced by traders. These are:

1. Fear of Losing
The fear of facing losses makes investors hesitate to execute of their strategy. This can cause them to not take timely action, in terms of entry and exit. This inability to take quick and confident decisions can lead to missed opportunities or trades running on too long and accumulating losses. Although losses should be avoided, it is important to understand they might be unavoidable at times. The important thing is to ensure robust risk management to minimise the loss.

2. Fear of Missing Out
The phrase Fear of Missing Out was first coined during the internet and technology boom of the late 1990s. Many traders heard from their friends about the potential to earn great sums during this era. They feared missing out on the next big opportunity and hence the phrase came into being. However, FOMO became an extremely commonly used term only with the advent of cryptocurrency trading. This fear closely resembles greed. Here, the trader is so fearful of missing out on a potentially large profit that they turn a blind eye to the glaring downsides. This fear is particularly harmful for traders who take positions when the uptrend of the market is nearing maturity.

3. Fear of Letting a Profit Turn into Loss
One trusted strategy in trading is “let your profits run but cut your losses short.” But fear can make traders do the exact opposite. They decide to take quick profits for fear of the trend reversing but let their losses run on in hopes of the market turning favourable. Additionally, for some, a paper loss is better than realised loss. This causes them to run their losses in the hope that their fortunes might turn.

4. Fear of Not Being Right
Some traders are focused too much on being right, rather than earning a profit. This is often a result of the ego overtaking decision making. To be a successful long-term trader, you need to be ready to bear losses at times. But this goes against the perfectionist mentality of being always right. In other words, by trying and expecting to always be right, you are setting yourself up for failure.
The first step to overcoming fear is realising that it is affecting your trades. Some traders, due to pride, ego or ignorance, decide to not acknowledge this emotion. This makes the situation even worse. Go through your past trades in your trading journal and analyse whether fear or any other emotion was a deciding factor.

Next, have a trading plan that you trust and follow. It will be the blueprint for your trading actions. It should include your available trading funds, time commitments, the risk to reward ratio and a reliable trading strategy. The trading plan should also take into consideration your biases, personality traits and emotions. Sticking to your plan can help keep emotions in check. Additionally, if you are coming on the back of a large loss, it is best to take some time off. It can be difficult to not be afraid of further losses at such times. Gradually get back to trading, using your demo account to build confidence and fine tune your trading strategy. Start with small positions and increase them slowly.

Fear is something you might not be able to completely get rid of. But it is possible and, in fact, necessary to minimise its hold on your trading decisions. Learn from your losses and hone your trading decisions.
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