How to Manage Your Emotions When Trading Forex?

Even the most successful traders have had times when they allowed emotions to dictate their forex trading decisions. But what they learned from these experiences is to prevent feelings from affecting trading decisions. They set certain rules to avoid falling into traps such as revenge trading, FOMO trading or grudge trading, which then increases their chances of long-term trading success.

George Soros once remarked, “Imperfect understanding is the human condition.” Once you are comfortable with that, managing how you feel about a trade and its outcome becomes a lot easier. Emotions are an unavoidable part of being human but managing them can be learned. It’s important to not deviate from your long-term goal and yet be flexible enough to alter strategies as and when the situation demands it.

So, here’s a look at how emotions impact forex trading and how to manage them better.

Understanding and Processing Emotions

The importance of making this distinction cannot be stressed enough. For instance, as a trader, what you might consider a good mood could actually be detrimental because it might impact your objectivity during decision-making. But that doesn’t imply that a certain frame of mind or emotion is ideal for staying at the top of your game. Neither does it mean that traders must go numb to undesirable outcomes.

Learning to be more self-aware and not letting all the feelings you go through impact your trading is the way to go about it. The renowned forex trader, Bill Lipschutz, recommends staying totally focused and not getting deterred by the pain of loss or a bad trade. While trading forex, the two main kinds of emotions that you need to guard against are fear and greed. Here’s a deeper dive into these emotions.

The Fear Frenzy

Fear is decidedly a crucial, caution response, to danger and enables us to recognise the need to act and protect ourselves. In forex trading, however, letting fear get the better of you is to consciously choose to forgo gains that you could have made. For instance, it’s common to see traders closing a position even before the price has reached the target due to fear of a trend reversal. Consider the hypothetical situation where you’re trading the EURUSD. Now, the price has begun to decline and you’re down 15 pips. You’re scared that the losses will mount, so you exit your trade before the price reaches the support level you identified. But fear might have forced you to close early. What if support holds and price ends up reversing and gaining value before long? So, you closed a trade because you were nervous, rather than wait for your stop loss to kick in. The stop loss would have cut losses short anyway and if the support held, you might have even made a profit.

The Greed Impulse

The other key driver of the forex market is greed. The old Wall Street saying, “Bulls and bears get rich, pigs get slaughtered,” holds true simply because the tendency to hang on to trades, leading to overtrading, is experienced by many traders. Greed can manifest in two major ways:

1. Greed to make money on every trade, where one essentially indulges in chasing the market or overleveraging.
2. Greed to avoid parting with the earnings you’ve amassed, and therefore holding on to a trade that you should ideally let go as predetermined by your strategy.

The good news is that regulated online brokers will limit the level of leverage you can use, in compliance with the regulatory guidelines. But you need to be aware of the emotions you are experiencing while making a decision too. Greed can also show up as euphoria or overconfidence after a streak of successful trades. Needless to say, such emotions can severely cloud one’s judgment.

Rein in the Overambition

Being ambitious about your long-term goal is desirable. It can help you keep your drive up and last through rough patches. Having said that, unbridled ambition, by sheer force of desire, can precipitate a string of bad decisions and bring about disastrous results. A major downside of letting too much ambition affect your trading is that you might find it hard to accept losses and move on.

It might come to a point where you may even find it unfair and lose faith in your own plan. Often, traders who fall prey to this feeling might even commit harakiri and turn to revenge trading, which is a scenario where a trader tries quickly to earn back the string of losses with random trades, even though the indicators and market analysis might say otherwise.

Wishful Thinking and Irrational Exuberance

Hope is a good thing, but there’s a thin line between hope and wishful thinking or anticipation. Constant manifestation of a certain favourable outcome could distract you from the basics of how the forex market operates. It can blind you to the downside of clinging to an unfavourable situation in the hope that a miracle will occur, and your losses will turn to gains.

For example, wishful thinking is behind the trading behaviour known as gambler’s fallacy. It relates to an equation in which if you toss a coin ten times, probability says 50% of the times the coin will land on tails and 50% on heads. Traders often lean on this philosophy while trading and think they don’t stand to lose any more than they win. However, too much hope blinds us to the fact that probability acts on each instance in isolation, so you may also end up with all tails or all heads. In the worst-case scenario, the trader might give in to something known as the “martingale bias,” doubling one’s position size after each losing trade to make up for the preceding losses. This is usually done under the impression that with each loss, you’re due for a win. Unfortunately, such expectations can be potentially catastrophic. 

Let Go of FOMO

FOMO is a major stressor in most facets of life, but in forex trading, it could prove disastrous. It is a pattern of thinking that can lead traders to make riskier choices than normal. Also known as FOMO investing, this style of trading leads to traders becoming blindly optimistic about every trade. You basically fear missing out on a potentially advantageous proposition in the forex market, which can be a tragic flaw. Giving in to the temptation of winning with every trade, the trader ends up increasing their position size in the hope of an even bigger profit but ends up losing money.

In most cases, this is triggered by excitement around a particular investment or under the influence of fellow traders or the so-called herd mentality.

Emotions and Trading

Often, emotions come into play when traders expect unreal outcomes (hoping to get rich with every trade) or play too conservatively. Both mindsets are driven by the wish to get rich quickly and then getting out with as much profit as possible (short-term trading). No doubt, forex is a fertile market, where anyone with the right mindset and knowledge can participate. But it shouldn’t be viewed as a get-rich-quick hack. There are no shortcuts to success in any aspect of life and forex trading is no different. The only way to maximise chances of long-term success is to be patient and disciplined while trading.

How to Keep Emotions in Check

Human beings are prone to biases and guesswork, so it is important to stay cognizant of that. As a trader, you might be gravitating to a particular standpoint, based on research or sources, which might not be without their share of biases either. The curation of the source material for your knowledge might also, in some cases, be selective and constitute confirmation bias.

Likewise, avoiding the unknown could also seriously impact your chances of success. For instance, when you gravitate towards certain currency pairs due to your comfort levels (also known as anchoring bias). Anticipation, on the other hand, might lead you to focus more on the outcome (on the basis of a cognitive bias) than the strategy needed to make the trade. To steer clear of these biases, read educational guides available on your forex broker’s website, hone your strategy with a demo account and stick to the plan regardless of emotions.

Rules to Prevent Falling Prey to Emotions

If an emotion suddenly seizes control of you and starts influencing your trading decisions, it’s most likely guided by an inherent bias. Even if you recognise and try to double-check your decisions while trading, the process can be too time-consuming and complicated in real time. The solution is to follow a few simple rules that will keep you out of the danger zone.

1. Work on cultivating the right mindset: In his 2012 book, Tradingpsychologie, journalist and stock market expert Norman Welz proposed the trading mindset and stated that trading is completely dependent on psychology. The key takeaways from his postulation of this mindset include documenting your trades and strategizing pre-determined entry and exit points. This is where a trading journal can prove extremely useful. It can help you keep track of your emotions, decisions and outcomes. This, in turn, will help you recognise patterns and understand how to avoid unhelpful tendencies.
2. Use stop loss and take profit orders: Always have a trading strategy in place, which includes risk management strategies such as stop loss and take profit. For this, understand your own risk tolerance levels and the capital you can afford to lose.
3. Stick to the plan: Emotions might tempt you to give up your strategy and react spontaneously. This can spell disaster. Always follow the rules of your trading strategy, even if you are scared that the position might turn to losses.
4. Tame your confidence: To counter greed as an emotion clouding your forex trading judgment, start with taming your ego and curbing the impression that you know the market well enough to predict trends. Let the market and robust analysis, rather than psychological biases, dictate your moves.
5. Learn from losses: Even George Soros faces his own share of losses. What separates successful traders from the crowd is their ability to learn from their mistakes. Again, keeping a trading journal can help with this. It will help you identify what led to the loss and fine tune your strategy accordingly.
6. Use social trading: Community and chat rooms are great. Discuss your moves, ask for opinions and share your experiences. But make your own decisions. Not everyone will have the same risk tolerance or trading goals as you. This will prevent you from falling prey to FOMO. The solution is to remind yourself that there will always be another great opportunity to capitalise on.

Bonus Tip: Position Sizing

Position sizing refers to determining how many units of a currency you wish to buy or sell. Traders usually choose their position size according to their risk appetite. Choosing a position size wisely can help yield better returns and keep the risk to a minimum. For instance, choosing a position size larger than the funds you can afford to lose could harm your trading capital. However, you must not let the fear of losing make you set a position size so low that your investment becomes ineffective.

Take your time and assess the position size depending on your risk tolerance, and skill and experience level. As a beginner, it is best to start small and slowly increase position size as you learn more about trading the forex market.

It takes time and patience to learn how to keep emotions in check. For those still testing the waters of forex trading, a demo account can be an excellent way to learn. And remember, continue to learn. In the world of trading, knowledge is power.

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