Psychology of Stock Market Trading

Below are some advices that should benefit both veteran and beginning investors when trading in the stock market.

  • Formulate a game plan

    Map the particulars of your strategy, including the price parameters of your purchase and risks of your exit before you enter the stock market. Once you have defined the risk, focus on your trade. If you are not focused, you will be at a competitive disadvantage.

  • Manage risk rather than chasing the reward

    If you understand what your downside is before entering a trade, you are less likely to over-think your position or panic yourself out of the trade. Once that is quantified, the upside will materialise and you can adapt your reward parameters.

  • Play within your zone

    There are different methods for different people and your trading style should be an extension of your personality. If you are risk-averse, play smaller in size and tighter on price parameters. If you are more aggressive, you can loosen your grip.

  • Adapt your style to the market

    Different phases in the market require different trading approaches and applying the right methodology is half the battle. In a choppy environment, hit-it-to-quit-it often generates return while trading around a core position is often rewarded in a trending tape.

  • Discipline always comes first

    Regardless of how certain or confident you feel about any particular trade, you must defer to the principles of discipline when trading. Never fall into the trap of believing that you are smarter than the process of trading.

  • Respect the price action but never defer to it

    Our eyes are valuable tools when trading but if we deferred to the price action, stocks would be 'better' up and 'worse' down, and that is a losing proposition. Respect the volatility of the market and leave blind ambition behind.

  • Opportunities are made up easier than losses

    It is not necessary to trade every day. It is only important to have a high winning percentage on the trades you choose to make. In the end, your performance will be the cumulative sum of your trading decisions. Sometimes the ability not to trade is as powerful as a trading ability.

  • Emotions are the enemy when trading

    Take a deep breath before risking your hard-earned money. Decisions made in an excited or panicked state often come back to haunt you. If you are personally attached to a stock, the decision-making process will be inherently flawed.

  • Maximise reward relative to your risk

    If you identify the right entry, you will create an advantageous risk or reward. It is rarely smart to slap on an entire position at one price level. Scaling into risk is often smart, particularly if you are new to a stock and unfamiliar with the way it trades.

  • Perception is reality in the marketplace

    When it comes to the process of price discovery, it's not 'what is' that matters; it's 'what's perceived to be' that dictates the supply and demand in the marketplace. Identifying the prevalent psychology is extremely helpful in determining whether to take advantage of the momentum or not.

  • When unsure, trade in-between

    Not all trades are created equal, and your risk profile should be an extension of your confidence. If your relative conviction is muted or when trading during a period of heightened volatility, the size of your position should decrease in kind.

  • The reaction to news is more important than the news itself

    Most traders prefer to trade into a catalyst, but the reaction to the catalyst often provides valuable clues about the strength of the underlying stock. While the old saying is to 'buy the rumour and sell the news', opportunities emerge once the dust settles and the fast money trades out.

  • Trade to win, never trade not to lose

    If you enter a trade with trepidation or self-doubt, you will definitely second-guess your decision the moment it moves against you. Do not trade defensively but trade with controlled aggression.

  • Trade the market you have, not the market you want

    In today's digital world, news travel at the speed of light, trades are executed in nanoseconds, chatter abounds in social media, and central banks seemingly shift their stances in real time. You don't have to like it but you must respect it and incorporate the dynamics into your decision-making process.

  • Take time-outs

    Trading is all-consuming and emotionally draining. It is essential that you take a break from the flickering ticks and give your mind, body, and spirit a break from the continuous stress. Ensure a clear mind before returning to the stock market.