In his book, Come into my trading room, Alexander Elder talks about the three most important traits that a day trader should have. He talks about having analytical skills, quality money-management skills, and the mind. In his chapter on the mind, he focuses mostly on trading psychology and emotions. Let us look at several strategies you need to follow to boost your trading psychology as a day trader.
Why trading psychology matters
For starters, trading psychology refers to how you deal with emotions as a day trader. It seeks to address issues like nervousness, the practice of fear of missing out (FOMO), greed, fear, and doubt. It also aims to address concerns about whether you can address big losses or profits.
In the past, psychological issues have led to the destruction of many traders. A trader can have a winning trade and hope to replicate its success by opening other trades. For example, you can buy the EUR/USD at 1.1100 and set a profit target of 1.1170. After exiting the trade, you can be tempted to open another buy trade without any analysis.
Another example of how emotions can affect your trading is when you lose a substantial amount of money. Some traders react to this by opening a bigger trade, hoping to recover some of your lost money.
FOMO is also an important trading psychology aspect. It refers to a situation where you buy or short an asset just because other people are doing it.
Have a trading journal/diary
A popular strategy that will boost your trading psychology is having a good trading journal, also known as a diary. This is a document where you write down specific points for all your trades. These could be the asset, type of your trade, the reason for opening and closing the trade. The journal could be like a real hard-copy diary, a small book, or an online notebook.
A journal is important because it will help you implement your strategy on all your trades. It will also help you look back at your historical trading routine and identify your past mistakes. Most importantly, it will give you a sense of order and structure.
Always have a good risk/reward ratio
Another simple item that will boost your trading psychology is having a good risk/reward ratio. This simply means that you should always have in mind the amount of money that you are willing to risk to make a certain amount.
Ideally, you should always ensure that you are not risking a lot of money per trade. Doing this will give you peace of mind knowing that you can easily take a loss.
There are several approaches to having a good risk/reward ratio. The most popular one is using a risk/reward ratio and combining it with a payout rate.
For example, if you have $20 and you decide to put it all in a single trade. In this case, your risk is $20, which you can give it a coefficient of 1. If your goal is to make a profit of $60, it means that you have a reward coefficient of 3.
While you can stop there, this formula in itself is not enough because it does not include the payout rate. The formula of this rate is: P = [1 + (X/Y)] x Z – 1, where P is the success rate, X is the size of the average payout, and Y is the size of the average losses. Z is the payout rate.
Personally, having a good risk/reward ratio has made my day trading relatively easier. Unlike in the past, I never feel anything when I lose money. Why? Because of my risk strategy, I never lose a lot of money per trade.
In line with this point, you should always trade small sizes, have a stop loss on all trades, and use as little leverage as you possibly can.
Greed is simply the process where you want to make as much money as possible. While we all want to achieve this, having excess greed can lead to major losses, thus affecting your emotions. Fortunately, there are many ways of avoiding this and becoming a successful day trader.
First, you can overcome greed by having realistic goals in your trading journey. For example, while it is possible to double or even triple your money within days, only a few people can achieve this. Instead, your goal should be to make a small amount of money per trade for a long period of time.
Second, you should avoid the fear of missing out. This simply means that you should not rush to buy an asset just because its price is rising. In most cases, this approach will cost you money. A good example is what happened in early 2000 when everyone was buying dot com companies. Similarly, most traders who rushed to buy Bitcoin in December 2017 lost a lot of money when the price reversed.
Finally, you can avoid greed by just using a take profit that automatically stops your trade at a certain level. By combining a stop loss and a take profit, you will be able to actualize your trading plan and boost your psychology.
Have a trading routine
Another strategy that will boost your trading psychology is having a routine. As a day trader, I have created a routine that has worked for me for more than five years. I wake up, read the news, review my trading journal, and work to identify trades within the assets that I trade.
I normally spend several hours per day trading and then spend the evening with my family. In all this, I don’t over trade, I don’t implement untested strategies, and I always have an exit plan for all trades I execute. All this has given me peace of mind even in my worst trading seasons.
Having excellent trading skills is not enough if you can’t manage your trading emotions. In fact, in my career, I have watched many excellent traders fail because they can’t simply manage their emotions. While managing these emotions is hard, following the simple strategies I have mentioned here will help you make enough money for many years.