The emotional and psychological side of Trading Trades

We promised that we would elaborate on what we meant by the emotional and psychological aspects of trading stocks and other instruments. So, here we are. We think that if you laughed or scoffed at that statement earlier, you will change your mind after reading this note.

Let us begin with the fundamental basis of a trade. What is really happening in a trade? Typically one trader is buying something what another trader is selling. You will say, well that is obvious. Yes, we agree it is obvious. But do we really understand what is going on when the trade happens? What is really happening is this: For the same stock (also true for any instrument, but we will just keep it simple and use a stock instrument as an example), at the same price, at the same time, one trader thinks the stock price will go up and so this trader is buying the stock and the other trader thinks the stock price will go down and so this other trader is selling the stock.

Hope we have not confused you. But what we are trying to say here is that one trader’s instinct, or whatever this trader is using to make a judgment, is telling him or her to buy and another trader’s instinct is telling him or her to sell. Remember that one thing that every book or expert in the world will tell you and probably the first thing that a trader understands is that you make money by buying low and selling high. And if you end up buying high and selling low, you end up loosing money. (We are talking of simple trades here and disregarding the fact that when you buy put options contracts, you make money when the stock price actually goes down. We will discuss more on that in another article).

So, one trader’s best judgment is telling him or her to buy and the other trader’s best judgment is telling him or her to sell. The reason why this is happening is because of the difference in temperament, psychology and emotions of the two traders. We do not realize, but unconsciously the trading decisions that we make are very much based on how we are feeling at the time. It is based on what we are thinking. Do we think that our future is bright and secure? Do we think that the economy and market around us is good or bad? Are we positive about the future or are we thinking that things are getting worse? Are we happy at work? Do we have a good work-life balance? Are we earning enough money or do we think we are not getting what we deserve?

It is our overall outlook at that point in time that unconsciously plays a part in our trades. This is why we have a trade in the first place. As the saying goes, one man’s food is another man’s poison. If we are nervous for some reason, then we think that things are going to go bad and end up selling. If we are feeling positive and confident, we think that things are going to get better and end up buying. Books and education and software can teach us all about trading and how to trade. But how we actually end up trading is very much based on our emotional and psychological state of mind.