If you are new to Forex and are itching to get your feet wet, you're probably thinking that the last thing you want to do is read about some psychological mumbo-jumbo. However, you will learn over time and through playing the market that what ultimately determines your success as a trader is your mental approach. Make light of this section at your own risk!

Emotions are what drive people’s decisions in their everyday life and are the most destructive component that stifles success in the financial markets. Oddly enough, they are the very thing that the markets are based on. Within the financial markets there are two types of psychology and most of the time the general trader really does not understand what each means to any great depth, and how a better understanding of them both would significantly improve their trading results.
Market Psychology:

The emotional pricing in the market 

First we need to understand that the markets sentiment is the pure reflection of the psychology of all the investors who are both in and out of the market at any given time (crowd psychology). The action and price movement of the market is a complete representation of the crowds emotions; fear, greed, hope and ego. These are the emotions that drive the market and push the prices up or down, since these emotions dictate the supply and demand. The current price at any time is the purest reflection of the expectations of the investors as a mass. It shows if there are more sellers than buyers, and if the traders as a group are more fearful than optimistic.

The financial markets work like any real estate auction; the price is determined by ‘supply and demand’. If there is a single property that is in a location of high demand, and has many people wanting to purchase it – the price at the auction will rise. Whereas, on the other side; if there were many similar properties in a new development in an area that did not have many interested investors the price could very likely be negotiated down below what the vendor was hoping to sell for.

During market crashes fear and hope set in, and the traders who either are not trading via a Trading Plan, or do not have the internal emotional control to follow their trading plan rules (come rain, shine or high water) will react to their emotions and base their decisions on urgent and desperate feelings they are experiencing. 

The Wall Street Crash in 1929 was the greatest and most devastating stock market crash throughout history.  The ‘roaring 20s’ had been a period of euphoric buying, where every man and his dog became a stock market trader; pushing the prices higher and higher, so much so that the Dow Jones Index rocketed from 60 to 400 points.  Greed was all consuming; egos were inflated and the traders felt invincible. Anyone can make money in markets that are rising like this, and there are many overnight millionaires. But not for long. 

Very few even realized or dreamed a crash was possible. Then, as the stocks finally became massively overpriced, a wave of panic selling proceeded. Over a period of 3 days, starting on the 28th October 1929, the New York Stock Exchange wiped 5 billion dollars worth off the total share value. By the end of November 1929 the Dow Jones had fallen from 400 down to 145 points with 16 billion dollars of value gone!  Many speculators, who had gone bankrupt, committed suicide by jumping out of buildings.

This sort of extreme euphoria is exactly what leads to financial crashes. The whole scenario is entirely based on people’s irrational expectations and highly emotional decision-making.

Investor Psychology

The psychology of the trader can be summed up as the emotional control (mental habits) of the individual. Around the world and across the many varied trading styles, time frames, tools and indicators, the common denominators for success always illustrates that the trader has a high degree of emotional control. Another common characteristic is that the trader has found a trading plan that suits their own style. Too often are traders trying strategies that suit their friends or fellow traders. This is discussed in detail shortly.

It can be extremely difficult for a novice trader to understand exactly what the meaning of ‘emotional control within the markets’ is if they have never traded before or have had limited trades. I remember how I initially thought I had great emotional control. Now looking back over the years, I have seen countless traders who also start with the same misconception about themselves, only to reflect upon their own bizarre and irrational behavior much later. A trader can only ever understand the different emotional states that they will experience once they have real money on the line, in the live markets. Traders are put through so many emotional states within short time frames – from high elations to depression, sometimes within the same day or even one hour!

Investing in the financial markets is a journey of introspection, where the trader must do serious looking at their internal dialogue, emotional (mental) habits, perceptions of events and their automatic reactions. The market is like the wind; it blows at its own free will to whichever direction it pleases. No one can really predict where the market is going next; the only thing we know for sure is that it will go up, down or sideways. Like the wind that can blow softly, then change suddenly with the force of a hurricane, the market is always in continuous motion; it doesl not stop to wait for anyone, nor care about anyone and how they might feel. So if you procrastinate, hesitate or are too quick to jump in or out, your actions can have a disastrous effect. 

A trader must have great internal control to become disciplined and create good habits which will facilitate their journey to the high level of competence required – to the level where they automatically know what they need to do next (this can only be acquired through study and research).  Great internal control will enable you to effectively execute your trading plan rules regardless of any external influences (news events, other traders' opinions, family pressures, etc).

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