Market Psychology in Trading

Trading financial markets is not an easy thing to do and sometimes people fail to be successful not because they are not prepared from a technical or fundamental point of view, but because simply they lack the psychological ability to trade. The key to be successful when trading is to win over your worse enemy, and in trading, the worse enemy is you, the trader. Emotions are a key factor when trading and being able to control them is a key factor for everybody. Sometimes it is the decisive factor when taking a trading decision.

Markets are Sum of the Human Behaviour

It is important of course to look at markets as a sum of human behaviors. One of the key elements in trading is to interpret what market did at some point back in time and what they are supposed to do at a future point based on the reactions from the past. The recordings that are coming with this educational series are showing you the psychological levels in trading and how the market is reacting at them. I am talking about round numbers, and the examples offered are for the USDJPY pair when it broke the 100 level to the upside and EURAUD cross pair when it broke the all-important 1.50 level for the first time.

These levels are testing traders on each and every moment as round numbers have the tendency to attract people for entering or exiting a trade. Therefore, when they are reached, the probability for the market to move faster at those levels is quite bigger than otherwise. Knowing that in advance allows one to trade on the contrarian sign. For example, almost always when market is approaching an important level, like the 100 level was for the USDJPY on the move to the upside, it is worth noting that it is usually failing to break the level on the first attempt.

Each Day Before Expiry is a Test

This is being due to the human nature as round numbers attract sellers or buyers, but also due to the ordinary options that are set to expire and round numbers are the values. In other words, if a no touch option at the 100 level is set to expire in ten days then it is most probably that price will not break the level until the option expired. In turn, traders are going to be tested on the emotional part as it may seem impossible that the round number is not broken by a few pips, but again, it is actually most likely.

This leads to one of the biggest mistakes traders are making, namely overtrading and in binary options overtrading means taking more options that it was intended at the beginning. I mean why would 99.90 not be a good striking price for a call option as the 100 is going to deal eventually? This is the mistake that leads to failures.

Overconfidence Effect

Another human nature component that plays tricks on us is related to the feelings one has after the option is being bought and until it expires. This is important because if the option is in the money all the time until the expiration date, then the effect is a thrilling one for the trader and this leads to confidence being built up. Confidence in turn leads to overtrading and you know from the paragraph above what that means.

On the other hand, if the trade is out of the money all the way until the expiration comes and the option is a losing one, then traders have the tendency to lose faith, they blame something else or someone else for the failed trade, etc. In reality, the expiration date should be viewed like a stop loss is being viewed when trading the currency markets in the FX arena. The whole purpose is to get you out of a bad trade if that is the case. Normally one should be neutral but this is easier to tell than done.

All in all, trading is much about finding the right striking price and the expiration date as it is about self-control and discipline. Knowing yourself and what you can do with your mind is sometimes more important than the actual trade as markets are behaving irrational exactly based on the above. Trading the news is even more illogical as algorithms are buying/selling a news report by comparing the actual with the forecasted value. Well, not all news and the interpretation of the news most of the times it is invalidating the first reaction. Let me give you an example.

Let’s assume the Retail Sales in the United States are being released and the outcome is lower than the forecasted number. The logical reaction is that market is going to move to the downside so a trader should look into buying put options. However, a lot of times the first reaction is completely retraced as algorithms are all about hitting and breaking stops at important support and resistance levels.