Psychology in everyday life studies thought and how wisdom governs behavior. Psychology plays the same role in trading but with more financial connotations.
It’s worth noting that, as a trader, psychology means I determine the lens of what’s going on in the forex market. This conclusion is ultimately brought about by a series of emotions and ego biases.
Why is trading psychology important?
- Of course, in today’s world, it’s common for multiple people to experience the same set of emotions. There are probably thousands of people who think like me. Still, there are enough differences between the thought process of a successful trader’s profit and the thought process of a subpar trader’s loss.
- The difference lies in the psychology of trading. I need to look beyond basic strategies and turn my perception towards the psychological barriers that affect the trading process. An example is affective disorders. These can be costly if not managed properly.
- I believe that emotions are the most important obstacle in the world of trading. Yes, emotions help me in my daily life, but they don’t matter when trading. If my emotions control my trading behavior, I will almost certainly have to suffer huge losses.
Now, I will define and explain some trading demons and how to avoid them.
- It’s typical of you and me. However, it’s the worst demon. This is because it will keep winnings for a long time, only to lose them over time. A small amount of greed is undoubtedly productive, but otherwise, it can backfire.
- If the market moved in the direction I wanted, I would quickly add too much to that position based on greed rather than analytical thinking.
- The best thing to do for me is to avoid scaling up and get the money management system right. Not taking too many risks in the first place also worked for me.
- Similar to greed, fear drives me out of a winning position and misses viable opportunities. Just like fear in real life, fear in trading takes patience, practice, and discipline to overcome.
- To avoid fear, I should stop and think about the decisions and situations that might lead to the fear and then slowly but surely overcome the fear. This can be done by placing protective soap and price targets before starting a trade program.
- With revenge comes fear. If I face more losses than I can bear, I will trade in revenge. The remedy for this is also a money management system like greed.
- It succeeds greed and happens if I develop a string of bonuses or one big win. I will most likely become unrealistically confident, which is never a good thing.
- Firming my footsteps and aligning my emotions with reality will allow me to bypass this trading demon.
What do you need to know about forex drawdowns?
- Who in the world is not always hungry for success? However, the question arises whether it is possible for good luck to prevail forever. Unfortunately, the answer is “no.”
- For traders, there are often times of loss or loss. Even the best poker players have to deal with defeat.
- The volatile economic environment has experts predicting tough times. In this case, you must understand what a drawdown is.
- Here, we’ll jot down everything you should know. We’ll also familiarize you with ways to deal with losses and strengthen your portfolio.
What is a forex drawdown?
- In Forex, a drawdown is a reduction in your portfolio equity. Forex pullbacks are inevitable no matter what trading strategy you employ.
- A drawdown occurs when your accumulated capital in the foreign exchange market decreases. But trust me, now is not the right time to walk away from the trade. A downturn can also be part of a successful business in the long run.
- But before that, you should determine if you can handle an economic downturn. You must also analyze whether your currency pair will regain profitability.
- Now let’s dig a little deeper into it and see how your drawdown is calculated and evaluated.
Calculation of Forex Drawdown
- The first step in this process is to identify capital peaks and valleys. We refer to the highest point of the peak, and the trough means the lowest point.
- To calculate the retracement, you must subtract the trough from the peak. Typically, this is a percentage of your entire portfolio.
- To better understand what the calculation means, you need to understand the types of drawdowns.
- Retracement Type
- In Forex, there are several types of retracements.
The absolute value of the loss
Absolute drawdown uses your startup investment as a benchmark. This is the difference between the starting payment and the minimum payment point.
This method calculates your losses by using your peak equity instead of your initial deposit. Therefore, the maximum drawdown is the maximum decrease in your account balance from peak to trough.
Maximum drawdown percentage is another name for relative drawdown. First, divide your maximum drop by its peak. Then multiply by one hundred to determine your relative loss.
Now, we will let you know the importance of retracements.
The meaning of withdrawal
- While drawdowns are not pleasant, they provide enough information about your portfolio. They can also help you determine whether your trades will be profitable in the long run.
- Retracements can be helpful if you want to know the most favorable time to trade. They also give you an idea of your sustainability in the marketplace. This is because a sharp slide can weaken your position.
- You can fight a recession by retooling your system or using the right mitigation strategies.
- When you experience significant losses, you may not be able to break even. But, at least you can mitigate any damage and save yourself from having to dig a deeper hole.