Quite often, the biggest challenge facing traders is themselves – not the markets. Understanding day trading psychology is essential for successful day trading.
Typically, the first time traders experience the psychological effects of trading real money, is when they hold on to a losing trade for too long.
Holding on to a losing trade for too long is something every trader will experience at one point, whether they’re successful or unsuccessful in trading the markets in the long run. No one likes to lose money; often new traders hold losing positions for too long, hoping for the best.
By now you should see the irony in what actually happens to traders. Most of us learn the hard way; you’ll end up losing big, if you’re unable to accept a small loss.
Anything more than a small loss is unacceptable to serious traders and investors. Losing big is always a result of poor money management.
Good money management is essential to profiting in the market, and is more important finding the right trading system; in fact, you can’t make a trading system work consistently without it.
Day Trading Psychology 101: Losing Gracefully
If you plan to only win… well, you’re too optimistic for starters. Everyone loses in trading, including professionals. The trick is to learn to lose small; that’s where money management comes into play.
Good money management is trading within your risk tolerance, budgeting, and generally managing your risk in a way that is profitable. For now I’ll focus on risk tolerance, or how much you are willing to risk per trade. Once you understand your personal risk tolerance, stick to that amount of exposure consistently.
If you are willing to risk 2% per trade, then risk that on every trade; no more or less. One quick way to blow out your account is to vary your risk from trade to trade.
When you get serious about trading, you will also need to start tracking and analyzing your trading with a trading journal. You will want to track and analyze the drawdown of your trading systems, and adjust your risk tolerance accordingly.
Risking to much per trade on a trading system with large drawdown periods can deplete your account just as efficiently as trading with no system at all.
Demo Accounts vs. Live Trading
Using a demo account or “paper trading” can be a valuable training tool. It can be used for testing new trading strategies and test trading during periods of drawdown, among other things.
It has been said that you can’t really learn trading until you’re trading with real money. As good as demo accounts are for training, demo trading has its shortcomings.
There is a sense of emotional detachment when demo trading; you will never fully understand the psychological trials of trading with real money, until you have the chance to really lose it.
Dr. Barry Burns, of Top Dog Trading, recommends demo trading your method successfully for at least six months before going live. I tend to agree with this strategy, as anyone can go on a lucky winning streak.
Being consistent is the key. After all, what’s the point of opening a trading account if you don’t expect to profit? Once you have a comfortable grasp of your trading system, as well as your day trading psychology, only then should you open a live trading account.