What goes on in the mind of a Trader?

Trading and investing can be an engaging experience involving both triumph and turmoil, similar to that of a rollercoaster ride. Have you ever imagined what goes on during the swings between victories and disasters of a trade? The psychology of a trader can give us a much-needed insight into the mental and emotional state of a trader and the factors that influence the success or failure of a trade. Understanding these psychological aspects is crucial for developing discipline, handling risk, and making indispensable decisions in the capricious world of trading. The key components of any trader’s psychology are emotions and cognition that lead to their corresponding behaviour: 

1. Emotions during Trading

When trading is involved, emotions tend to run high and can directly affect the mental state of a trader. The three predominant emotions that traders experience during and after they make a trade include:

• Fear: As the world of trading is highly unpredictable, traders often experience fear or anxiety due to losses or unreliable market situations. This restless feeling can influence them to make impulsive or reckless decisions. For example: Selling too early or avoiding trading altogether due to the fear of uncertainty.
• Regret: After a missed opportunity of trade or poor decisions that lead to any kind of loss, traders could feel the heavy turmoil of regret. This churning feeling can lead them to aggressively re-enter the market and overcompensate on the next trade, which can in turn result in a lot of excessive risk-taking or unfavourable outcomes.
• Greed: Greed is the emotion that a trader experiences when they have an insatiable desire for more profit, driving them to take extreme risks. It can result in trading more frequently than necessary or holding on to their profits for too long, in the hope that the market will be favourable to them.

Emotions are a fundamental part of trading, and understanding them can either boost or hinder a trader’s performance. A great start would be having clarity on how influential emotions like anxiety, fear, regret, greed, frustration and hope can affect crucial decisions. To navigate the market profitably, controlling emotional reactions and relying on strategy or logical decisions will be beneficial. Traders should practice discipline, cultivate risk management techniques, and develop a strategic trading plan, to avoid the interference caused by emotions. 

2. Cognition during Trading

Cognitive processes in trading are the thought patterns that determine decision-making and information analysis. It plays a substantial part in modelling a trader’s behaviour and understanding the reasoning behind their choices. Knowledge of the cognitive processes behind trading is crucial to avoid undesirable consequences. Here are some of the cognitive processes that can influence trading performance: 

Perception

How we view and make sense of the information in the world we live in can heavily influence how we tend to act or behave. Traders also perceive the world and make sense of various things such as financial metrics or market trends, trade and industry reports, etc. Perception encompasses identifying patterns, forming judgments, and evaluating the significance of the acquired information. For example, if traders perceive a particular market to be facing challenges, they may be hesitant to indulge in it.

Attention

Attention is the cognitive process that helps us focus on necessary information and screens the unnecessary details or distractions. There is a surplus of information in the trading world that we process on a daily basis, so focusing on only the relevant data and avoiding distractions is paramount to a positive trade. A lack of focus will make traders lose sight of the bigger picture and miss out on the profit opportunities coming their way.

In fast-paced markets, traders might be unable to process the information efficiently and this information overload results in a lot of errors in decision-making and failure in judgment.

Problem-Solving

Problem-solving is the approach we take when identifying an issue, looking for possible solutions, and then making a decision. This skill is much needed to adapt to changes in market environments, to enhance trading plans and to make informed decisions. Some traders take creative approaches to trading and solve their problems innovatively which can also highlight the potential inefficiencies or outdated strategies in their trading plan. 

Decision-Making

In trading, decision-making entails systematically evaluating and making a decision based on choosing among different courses of action, especially in uncertain market conditions. Traders tend to rely on mental shortcuts (heuristics) to quickly make decisions and adapt to changing environments. While heuristics can benefit them, it can also lead to cognitive biases.

Cognitive biases often impact traders in their assessment of risk and reward. When they think that the reward is high, they are more likely to take needless risks that can lead to instant regret. When influenced by heuristics or cognitive biases, traders can make poor or erratic decisions that will cause negative outcomes. 

Cognitive biases

Cognitive biases are thought patterns that do not have any rationality or logic and heavily affect the process of judgment. Flawed or incomplete data can cloud thinking and affect decisions related to trading. Some of the distortions that commonly affect traders are given below:

• Selective Attention: Traders are more likely to place emphasis on information that confirms their already existing beliefs. This will make them actively ignore any information that challenges their own beliefs or thoughts. This lack of objectivity is known as confirmation bias.
• Loss Aversion: Traders feel the discomfort brought about by losses more intensely than the pleasure that their gains bring to them. This is known as loss aversion. They may not be willing to sell losing positions and rack up more heavy losses as a result of this.
• Bandwagon effect: The term “bandwagon effect” is a phrase taken from American politics. In trading, traders tend to act based on the actions taken by the majority of people rather than making important decisions based on logic or innovation. They would trade during a market decline or market rally because they see others doing the same.
• Attribution bias: This is a cognitive distortion that makes us attribute our successes to internal factors (like skill, and ability) and blame failures on external factors (market conditions). Attribution bias can reinforce overconfidence in traders after winning trades and shift the blame on the market despite making the decisions themselves. Traders with this mindset might refuse to learn from their mistakes and hence make riskier trades due to the euphoria they gained from their previous wins.

3. Metacognition in trading

We are all capable of thinking about our thinking and this is called as metacognition. Developing self-awareness and self-reflection on your strengths and weaknesses is a sure-shot way of improving trading performance. The best way to do this is to regularly review your previous trades and to reflect on your decision-making patterns. Regulation and evaluation of emotions are also indispensable to boosting your trading outcomes.

How to train our trader mindset?

• Self-control is one of the most essential traits that a trader should hone to avoid making impulsive or emotional decisions.
• Use a well-defined and innovative trading plan that can be adaptable to new and fast-paced market environments. 
• Adhere to risk management techniques to reduce the emotional strain of trading and to prevent demoralizing losses.
• Ensure that you take care of your mental health as continuous sessions of trading can lead to fatigue. Burnout is fairly common when you’re constantly evaluating information, so managing your health is a priority.
• Having a resilient and growth-faced mindset can help you to face the losses that are inevitable in the world of trading and take them as opportunities that help you learn from your mistakes.

Conclusion

The mind of a trader is a fascinating and multifaceted one; blended with experience, cognitive processes, emotional reactions and other behavioural patterns that influence their actions. Being aware and having clarity about the cognitive processes happening behind the scenes of trade can encourage a person to psychologically strengthen themselves (in addition to having strong technical skills or knowledge), avoid common pitfalls and enjoy the fruits of their trade.