Trading futures and options can be an emotional rollercoaster. The highs of an accurate prediction alongside the lows of an unexpected loss can create psychological complexity for even seasoned traders. However, your mindset plays a critical role in investment decision-making.
Understanding the psychology behind trades can help you react logically instead of impulsively. When faced with the unpredictable ups and downs of the market, traders who master psychology have an edge over those ruled by emotions.
This guide will explore the mental game you didn’t know you needed to win in futures and options trading.
What is Trading Psychology?
The stiffest challenge you would face as an investor in futures and options trading is your psyche. Understanding trading psychology, which refers to your emotions and state of mind, can help you achieve success or failure in trading.
The different aspects related to your traits, character, and behaviour directly impact your trading transactions. Some experts state that understanding trading psychology is as essential as your market awareness, reasoning ability, and experience. One should remember that both positive and negative emotions come into the picture during trading.
It is perfectly normal to experience both types of emotions while trading. It is essential to promote positive feelings and contain negative ones. With practice, you can overcome emotions such as greed, fear, nervousness, and anxiety.
Psychological Aspects: An Overview
While the occurrence of an independent event is random, a dependent event is a consequence of other related factors. You might be wondering why these terms are usually used in Mathematics.
Understanding these terms reveals that your trading activities depend on your psychological state. Just like computer algorithms use past data to make projections about the future, the human mind considers the outcomes of past events to estimate the future outcomes of existing efforts or events.
Let us further understand this point with the help of an example. Whether you toss a coin for the first time, the second time, or the tenth time, the probability of getting a head remains ½. If you believe the likelihood of getting a head is less than fifty percent in any of the tosses, you might be subjecting your thinking to irrationality.
Similarly, if a stock has been experiencing an upward trend for four straight days, while some investors might consider that there would be a definite downward revision, others might expect a continuance of the trend. Both investors are speculators. It is better to avoid these traps. Most importantly, always base your trading transactions on detailed research of financial data and technical research.
Common Errors and Biases
Here are some psychological errors and biases that you should avoid:
1. Overtrading
The urge to trade excessively is known as overtrading. The urge to indulge frequently in trades can lead to impulsive trading decisions, increasing transaction costs and eroding the possibilities of making substantial profits.
2. Fear of Missing Out (FOMO)
For some investors, FOMO never seems to fade away. This fear of missing out on profitable opportunities can result in hasty entries and exits. Instead of being a victim of FOMO and subjecting your trades to your gut feelings, you should go in for sound financial analysis.
3. Revenge Trading
Do you carry your feelings from one trade to another? If yes, then you could become a victim of revenge trading. You could indulge in emotional trading decisions to recoup losses from earlier trades. This approach could further compound your losses.
4. Confirmation Bias
Confirmation bias is not just limited to trading in futures and options. It is more of a country-wide sensation in India. The tendency to seek and interpret the information in a way that conforms with the existing beliefs is known as confirmation bias.
While this approach may work sometimes, there are cases where you contradict the existing evidence to confirm. The risk to your financial health is maximum in such cases.
Techniques to Avoid Biases
After familiarising yourselves with the errors and biases in futures and options trading, let’s examine the techniques for avoiding them.
1. Plan Based Trading
Develop a detailed plan that clearly outlines your trading strategy. Highlight important areas such as entry and exit criteria, risk management rules, approaches for hedging, etc. A plan can provide a structured approach to your trading decision-making.
2. Emotional Training
Did you know that you could also train your mind like strength or weight training for your muscles? All you have to do is seek professional guidance and teach patience in your daily routine.
It is very much possible to avoid impulsive trades governed by emotions such as gear, grief, anxiety, or regret. Inculcate objectivity in your approach and stick to the guidance that you have received.
3. Learning from past mistakes
It is said that the best learner is the one who learns from one’s own mistakes and those made unintentionally by others. Take some time to reflect on your trades and identify any psychological factors that could be at play. Adapt your trading strategy accordingly.
Most importantly, do not treat futures and options trading as a get-quick-rich gimmick. The sooner you realise it requires a balanced combination of discipline, financial skills, and emotional control, the better. Go for the marathon run instead of going in to focus on low-hanging fruits.
Conclusion
Several research studies have been conducted in the field of Psychology. Several of these studies highlight that Psychology plays a crucial role in decision-making. The impact of psychological aspects on futures and options trading remains relatively unexplored. In this article, we have attempted to highlight the psychological factors involved in futures and options trading. We’ve highlighted the common errors and biases and presented the approaches to overcome these mistakes. The next time you trade in futures and options, go prepared with a relaxed mind.