“How could I have just done that?” If you’ve never yelled that to yourself in fury, you’re not a Forex trader. Even the most intelligent Forex trader has done some centralex really stupid things when just starting out. To understand what went wrong, and why, it helps to understand what goes on inside your brain when you make decisions about money. When you understand it, you can stop making the mistakes you are wired to make.
Forex traders are often their own worst enemy. Everyone knows that beating the market is nearly impossible, yet just about everyone thinks they can do it.
How many times have you done any of these? Be honest now!
-Watched a trade go bad, hoping and willing it to turn around, until you have lost more than 10% of your equity?
-Closed out a trade and re-opened immediately in the opposite for an ultimate loss?
-Seen some price action and immediately jumped into the trade?
-Traded without a stop loss
-Placed a sure trade with 10 times the lot size you normally trade because you are sure it is going to be a winner?
Traded with more than 5% risk to your account?
If you have never made any of these mistakes, congratulations. However, these and other similar mistakes is why 95-98% of new Forex traders ultimately fail.
The thing is, our brains were originally designed to get more of whatever would improve the odds of survival, and to avoid whatever seems risky. The investing brain is far from the consistent, efficient, logical device we would all like to pretend it is. Even Nobel Prize winners fail to behave as their own economic theories say they should. Emotion gets in the way. We are wired to feel the rush of pleasure when we might make money and panic when we are losing it.
A lot of information about how everybody’s brain works has been determined through neuro-economics, and understanding those basic lessons will make you a better trader.
1. A momentary loss or gain is not just a financial or psychological outcome, but a biological change that has profound physical effects on the brain and body. Financial losses are processed in the same areas of the brain that respond to mortal danger. When you lose, your heart races, but you also get negative emotions like disgust and guilt. When traders are disgusted with their own blunders, their natural aversion to taking a loss finally breaks. Instead of grimly hanging on as usual, they now become desperate to get rid of any other losing trades. Desperate people do desperate things. That is why a market will often crash faster than it goes up. Traders tend to buy in dribs and drabs, but sell in one fell swoop. Many charting patterns are based on that trading psychology.
2. The anticipation of making money feels better than actually making the money. The brain is more aroused when you anticipate a profit, than when you actually get one.This drives illogical trading such as is often experienced by amateurs. They close down losing trades and immediately chase the trade in the opposite direction, or open illogical trades based on hope rather than a sound analysis and prediction of success. The feeling of anticipation is very strong, lighting up the brain much stronger than when a trade is closed for a profit. This drives illogical trading.
And, interestingly, the area of the brain that lights up when money is made is in a different location to the area lit up by anticipation. It is not the area linked to happiness, lending weight to the saying “money doesn’t buy happiness”.
3. The neural activity of someone whose trading is making money is indistinguishable from that of someone who is high on cocaine or morphine. Being a ‘trading junkie’ means that trades are opened for the thrill, the rush. Successful traders will tell you that trading is actually quite boring, because they have learned to limit their trades to high-probability opportunities. In other words they have conquered their neural addiction to the trading ‘high’. Amateur traders seek the rush, ignoring their plan, logic, and common sense in their pursuit of the rush.
4. After two repetitions of a stimulus, like, say, a currency pair goes down with two bearish candles of the same length, the human brain automatically, unconsciously and uncontrollably expects a third repetition. If that does not happen, fear and panic set in. Scalpers, who are watching the charts carefully, can overreact to this surprise by closing out the trade prematurely.
5. Once people conclude that a currency pair’s behaviour is ‘predictable’, their brains respond with alarm if that apparent pattern is broken. Amateurs respond to that alarm, cutting short trades that might have ended up profitable.
The other thing that works against us is our subconscious programming about money. Many of us are “taught” or programmed at a young age beliefs about money that do not serve us. How many of us have heard the following, let alone believe it themselves:
-Money is the root of all evil
-You must be a crook to be rich
-You have to work hard to earn lots of money
-I don’t deserve to be rich
-I’ll never be rich
-Money happens to other people, and you have to do something rotten to others to get it
Many of us are not aware of this programming and so continue to saboutage our efforts to get rich or at least make a lot of money unconsciously. We simply aren’t aware that we are responding to stimuli such as is described above and letting ourselves do it over and over without learning from our actions. We stop ourselves from not consciously behaving differently. We get in our own way, in other words.