Introduction – Psychology of Risk
In Russian, there is a saying: “Those who do not risk, do not drink champagne.” This emphasises that without risk, there is no reward. However, this does not eliminate the need for balance; it implies that understanding your risk appetite and managing it in a sustainable fashion is essential. With that being said, the aim of this short article is to explore some prominent elements of the psychology of risk in trading and offer insights on how these so-called ‘demons’ can be controlled and kept in check.
The Elements
The psychology of risk in trading can be a difficult concept to understand, acknowledge, and harmonise. However, its importance can never be underestimated. Among the most well-known factors in risk psychology are components such as greed, fear, impatience, confirmation bias, and lack of emotional control. We will examine some of these elements in detail as follows.
Fear of Loss
The vast majority of people have not been taught how to lose – neither at home, nor at school, or even in kindergarten. From childhood, we are raised with affirmations like “you should be the best no matter what,” “you cannot lose,” and “losing is failure.” In reality, we should have been taught the opposite: that losing and failing are two of the key forces that fuel us with the necessary power to achieve and sustain success. Without temporary defeats and setbacks, there is no gaining experience or winning in the long run.
In trading, losses are inevitable. One cannot – and frankly, should not – run away from them. Only through the correct application of risk management practices can this element be mastered for good. By acknowledging that losing is normal and that the long-term perspective is what truly matters, we can better understand our risk appetite and implement careful management techniques aimed at achieving consistent profitability.
Greed for More
Often referred to as ‘animal instinct,’ greed poses a significant threat to individual trader psychology. Everything we do regularly becomes encoded into our routine and feels normal. As a result, to derive more satisfaction from our activities, we tend to seek abundance or pursue new experiences.
In the market, some participants are forced to quit due to their lack of control. Constantly desiring more and failing to set clear targets often leads to an inability to stop at the right moment. This behavior can be detrimental and may push one toward the pitfalls of permanent failure.
To control greed, you should always define your targets in advance. If you prefer to let winning trades run, it’s important to secure partial profits by closing some positions or trailing your Stop Loss order. Additionally, controlling greed requires a clear understanding of your risk appetite and careful management of it. Otherwise, you risk over-trading and taking on too much risk.
FOMO (Fear of Missing Out)
“Let me risk entering this trade setup now, as I might miss out on it later.” If you’ve ever said something like this to yourself, it could indicate that you’ve experienced FOMO (Fear of Missing Out). By fearing the possibility of missing out, we often make rushed and irrational decisions. This behaviour fosters impatience and a lack of discipline – two key elements we will explore in the next section.
To control FOMO, apply the principle of acknowledgment. Recognise that there is always another opportunity. Understand that the market will continue to operate, and it is, in essence, infinite. As long as prices keep moving up and down, there will always be future opportunities to identify and profit from.
Impatience & Lack of Discipline
The risk of making irrational and rushed decisions is significant. If you cannot resist the urge to act impulsively and fail to adhere to your trading plan, achieving consistent profitability in the market will be challenging.
Successful traders cultivate patience and discipline, knowing that taking calculated risks within the framework of their strategy is far more effective than reacting to short-term market fluctuations.
Emotional De-stability
In times of indecision and emotional instability, we often lose control of our edge. Once again, mastering the art of staying composed and adhering to your risk management plan plays a crucial role.
Conclusion – Keeping Things Balanced
While applying proper risk management techniques and succeeding in doing so is one thing, retaining consistency and vitality is another challenge. Learn from mistakes, develop a solid plan, make necessary optimisations, and maintain consistency on all fronts.
Here are some key rules to follow to keep everything balanced:
- Maintain stable risk exposure: For example, limit risk to 1% per transaction.
- Avoid FOMO: Remember, there is always another opportunity.
- Refrain from trading: Do not trade during times of indecision and emotional instability.
- Control greed: Set and adhere to clear targets.
- Acknowledge losses: Accept that losses are an inevitable part of the process.
The psychology of risk in trading is a vital but difficult element to grasp. However, one cannot prosper without it. Remember, if you stick to these rules and stay committed, the chance of failure in the long run is minimal. Understand your impulses, work on managing them, and never give up!
