October 7, 2013

Psychological Problems of FX Rates Trading

fx rates

Every FX rates trader will encounter a trading mistake at some point in their career.  The majority of them will experience a financial loss because of this mistake.  While many of these errors are due to the trade, there are many that are due to the trader’s mindset.  In this article we will look at the three most common psychological difficulties all traders face.  Generally these difficulties are unconscious, which is what makes them even more of a hazard.

1. Overconfidence in trading

One of the most important characteristics of a successful FX rates trader is confidence.  If you are unsure of your decisions there and insecure in your trading abilities there is a greater chance of you experiencing losses.  However, there is also the danger of becoming overconfident should you experience too many profitable trades.  When a trader faces a series of successive profits they will experience the emotions of greed and overconfidence.  These traders will believe they are infallible and sure of what they are doing when trading with evidence to back this up.  However, this overconfidence generally leads to them taking short cuts in their analysis and can lead to detrimental losses.

2. Following the FX rates trading crowd

The majority of traders choose to move with the trend when trading instead of against it despite the latter providing greater profits.  However, this can often cause a mob mentality as you will be following a trend along with a mass of other traders.  When moving in a group there is the risk that you will agree to group decisions which can lead to serious losses.  This is generally seen when social trading occurs.  Social trading refers to the instance when a trader looks to forex forums for trading information.  The majority of new traders fall victim to this as they take an experienced traders word as law, blindly following the potentially inaccurate data.

In order to avoid this difficulty you should always double check information learned from external sources.  Never consider ‘tips’ or ‘rumours’ as fact.  Rather complete detailed analysis to the data before trading and eliminate the risk of loss.

3. A confirmation bias

It is important to research and analyse information before using it, however it is important to look at both sides of the coin when doing this.  Many new traders will fall victim to a confirmation bias when looking at data that only confirms their analysis.  Only when looking at contradicting data as well will you make an informed decision on the correct trade.  The only way to avoid a confirmation bias is through training yourself to look for both confirming and conflicting information.

Another problem with confirmation bias is that the trader will only see favourable sections of the confirming data.  This is due to the psychological need to be correct and knowledgeable, thus they will look for the items that fulfil this need.  By ignoring all conflicting data you will create an inaccurate position and incur detrimental losses.




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