One of the greatest ways to lose money in the financial markets is to chase a trade after it has taken off. There are lot of different expressions used to describe this behavior, essentially revolving around the “fear of missing out.” This is very common to see during bubbles, as financial markets take off drastically. Essentially, you have the so-called “smart money” getting involved in the market at the very beginning, catching massive gains. As the markets continue to climb, there are a lot of people out there looking to get rich quick. They find themselves buying a move far too late, worried that they are going to miss quick profits.

One of the most common problems that a new trader will face is “paralysis by analysis.” Typically, what happens is that new traders tries to find trading systems that assure profits, but unfortunately don’t have the wherewithal to hang on through what will certainly be the occasional loss. Traders tend to put far too much pressure on themselves to be perfect, and of course systems are treated very much the same way. This of course is ridiculous, as perfection is all but impossible. Think of it this way: if your retirement planner averaged 11% a year, you are not going to be looking over their shoulder and complaining about any time there was a small loss. You must give yourself the same slack when it comes to trading. Unfortunately, most people don’t, and this is where they start to get paralysis by analysis. Paralysis by analysis is best summed up as having far too many indicators or rules for a trade set up. This leads to a lot of concern and mistrust, and far too many options to bailout of a trade. There are a lot of psychological issues when it comes to trading, but this is probably the most common, as it is easy to set so many rules that you can’t pull the trigger. While a lot of people think it makes sense to have a long list of rules, the reality is that this keeps the trader for making profits. After all, if you are not in the marketplace, you can’t make money. This isn’t to say the should be jumping into the market randomly, but rather that you should make it possible to get involved. One aspect of having a multitude of indicators on the chart is that it is used as a crutch to help with fear. It is a fear of loss that you ultimately are struggling with, which can be avoided by simply trading with the longer-term trend and using proper money management. If you can see everything but price on the chart, you may have an issue. Professional traders tend to use a very light number of indicators.

When trading with the trend, it certainly makes hanging onto a trade much easier than trying to fight it. Unfortunately, some people tend to take this too far. They’ll take a position to the extreme, hanging on to a position as the market goes against them. The first mistake they make is moving their stop loss, believing that the market will eventually “behave correctly.” The worst thing that can happen at this point is the market turns around and rewards them for their stubbornness. While that’s a bit counterintuitive, the problem is that eventually the trend that you are following will and eventually reserve. If and when that happens, the trader who has been rewarded in the past will be decimated by the market rolling over. This is especially true when you are talking about Forex or futures markets, which of course feature a significant amount of leverage. In other words, your losses pile up as the market moves against you. This is one reason that stop losses are to be honored, and never moved. There is no reason whatsoever to ever move the stop loss, because if the market has moved through that stop loss, something has changed, and your thesis is incorrect. By refusing to take a loss, you compound the losses from what once would have been a manageable hit to your account and have turned them into something much more nefarious. Looking at the USD/CAD pair, you can see that we had a brutal and sudden moved to the upside back in 2008. Had you placed to trade after the search higher, you would have felt that the market is most certainly looking positive for your thesis. However, we broke down rather significantly, and given enough time you were losing money if you did not get out of the market. Perhaps your stop loss should have been at 1.20, but you decided that since the move higher had been so strong, that we should continue to see buyers. While in and of itself it’s not a bad thought, the reality is that once you started to lose money and then you hit your stop loss, it’s time to wait for another opportunity and take your losses. By not doing so, any trader who would have refused to take a loss on this trade will have lost their entire account by the time it was over.

When it comes to psychology, overtrading is probably one of the most common issues the traders face. This is a combination of a fear of missing a move, and of course simple boredom. Unfortunately, most traders enter the Forex markets due to the desire to get wealthy, and normally are attracted to them originally by some type of advertisement promising easy riches. It is because of this that traders typically are not patient enough to wait for a promising trade, and they get involved in the market before it is wise. This typically means that they will break their strategy, and sometimes even trade against it. Looking at the USD/CZK pair, you can see plainly on this chart that the US dollar has been falling against the Czech koruna for a very long time. This is an exotic pair, but it shows the one thing that most Forex markets will do: trend over the long term. Clearly, this was an easy trade in hindsight, simply selling the US dollar was the way to go. Unfortunately, many traders do not simplify their trading to this point. When you look at the chart, you can see that there were occasional rally is that occurred, but at the end of the day they all sold off. By simply selling the rallies instead of trying to aggressively short every time you felt like pulling the trigger, you got better entries, and therefore better profits. Alternately, I can promise you that there were plenty of people out there willing to buying this pair because it had “gone too far” and figured that it was due for a bounce. Those people got hurt as you can plainly see. Both trades are born out of boredom, and the desire to get rich overnight. This leads to overtrading, which goes against proper money management, clear thinking, and most systems that I can think of. Overtrading is an absolute killer of trading accounts, because even if you are correct most of the time, at the very least you are paying more in transaction fees that are necessary.

When speaking of psychology, one of the most basic premises that the human mind will do is attempt to move away from fear, and head towards pleasure. Fear in the financial markets can cause sudden and violent movement. This is obvious, especially when you see a marketplace that has been broken down drastically. However, what is less well known is that fear can also get you out of the market when you should be looking at either adding to a position, or simply letting the market take its natural course of action. How many times have you been in a position, only to get out when it moves against you slightly, and then watch it go in your original direction? This is very common and is based upon fear. When you see a nice uptrend, if you look a little bit closer the one thing that you will notice is that it tends to pull back occasionally. This is the same in downtrends as well, and no matter which direction you are trading, the market can’t move in your direction forever. Every time the market pulled back, there will be people getting out of the market based upon fear.

Greed is a good force that drives you to achieve more and more. Also, greed can be the most dangerous thing that a trader has to deal with. New traders dream of earning millions of dollars by trading and they can quickly lose a significant amount of money. So it is very important to control your greed. The biggest problem with forex trading is that you may be rewarded for being greedy in the short term but you will be punished in the long run.

One of the hardest things for new traders to do is to trust themselves. Beyond that, they find it even more difficult to trust their trading systems. This is normally do to a lack of testing, which is one of the most important things that the professional trader will do. It doesn’t matter if you are trading with a robot algorithmic trading system, or if you are trading based upon written rules, if you do not trust the system, you are bound to change its implementation, and therefore get much different results than expected. One of the easiest ways to combat this is to test a system over a multitude of conditions, or at the very least a multitude of trades. There are a couple of ways to go about this, but all should involve demo testing. If your system performs well through demo conditions, it should perform the same in the real world. After all, you are using real-world data and pricing.