November 1, 2023

Trading in financial markets is not just about analysing charts and following strategies, but also about serious psychological self-work. In this article, we will explore the main fears of traders and how to overcome them, discuss how to determine if you are ready to become a trader, and also share recommendations from gurus and influencers of the financial world.

Primary Fears of Traders and Ways to Overcome Them

What are traders most afraid of? Psychologists pinpoint four primary fears. Perhaps the most widespread is the fear of losing money. This is followed by the fear of missed opportunities, or in other words, the dread of missing out on a potentially profitable transaction. Thirdly, there's the fear of making a mistake, meaning the apprehension of misinterpreting data or making an incorrect decision. And finally, there's the concern of being misinterpreted or judged by fellow traders or investors. We can term this the fear of criticism.

Managing Fears and Psychological Preparation for Trading1

How can one overcome all these phobias? Undoubtedly, education and professional training play a pivotal role: the better you understand the subject, the less fear you have. For instance, Warren Buffett advises investing only in what you comprehend and not succumbing to panic. This advice is certainly worth heeding, given that Buffett is one of the world's leading and most renowned investors, with a net worth exceeding $100 billion according to Forbes. The importance of education and continuous self-improvement is also emphasized by Timothy Sykes, one of the youngest successful traders in the US, who managed to turn $12,000 into $2 million. World-famous trader and investor, George Soros, recommends being prepared for the unexpected and adapting to changing circumstances. Addressing the fear of mistakes and criticism, this billionaire states: "Financial markets, no matter how hard we try to predict them, will always be full of surprises. […] To others, being wrong is a source of shame; to me, recognizing my mistakes is a source of pride." Here, one can also refer to another quote by Soros: “It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong."

And, of course, when discussing how to significantly reduce stress levels and increase the chances of success, almost all financial market gurus advise strictly adhering to a pre-developed and tested strategy, minimizing emotional decisions, and not forgetting about money management.

Assessing Psychological Readiness for Trading

Is there a way to determine how psychologically prepared an individual is to become a trader? Certainly, there are. Let's list some of them and then delve deeper into what they are and how they work. Thus, to assess psychological readiness for trading, the following methods are used:

Interviews and Surveys. Personal interviews and consultations with professional traders or psychologists specializing in financial markets, as well as completing questionnaires about your attitude towards money, risk, and decision-making can be beneficial for evaluating psychological readiness for trading. Professionals can highlight the strengths and weaknesses of your psychological profile.

Risk-Aversion Testing. Taking psychometric tests can also help determine your risk propensity. These tests measure your reactions to potential losses and gains to understand how comfortable you feel when making financial decisions.

Demo Accounts. Practicing trading on demo accounts allows you to gauge your ability to manage emotions and make rational decisions without any real financial risk.

Trader's Diary. Keeping a diary where you note down your emotions and reactions to various trading scenarios can aid in analysing your psychological state. Over time, you can identify recurring patterns and make necessary adjustments.

Stress Tests. In some instances, specialized stress tests are conducted that simulate extreme market conditions. They help determine how you would react in high-stress situations.

Risk-Aversion Testing

As mentioned earlier, risk-aversion testing is a process aimed at measuring your propensity for risk, especially in the context of financial decisions. This valuable tool can be highly beneficial in the early stages of your career. Here's a typical breakdown of such testing:

– Preparation for the Test. Before the testing begins, you're usually provided with instructions and clarified on what's expected from you. Sometimes, a preliminary interview is conducted to gather basic information about your financial experience and understanding of risk.

– Questions and Scenarios. The test includes a series of questions or hypothetical scenarios depicting various financial situations and offers multiple-choice answers. Here are some examples of possible questions: How would you describe your relationship with money? What would you do if you won a large sum of money in the lottery? How much of your savings would you be willing to risk? Do you make decisions intuitively, by analysing the situation, or by taking someone's advice?

– Reaction Assessment. Your response to each question or scenario is analysed to determine your risk propensity. Answers are often graded on a scale, and the final results are summed up to get a comprehensive risk-aversion score.

– Results Analysis and Feedback. After completing the test, specialists analyse the results. They may interpret your answers and provide you with recommendations on risk management and further steps for development as a trader.

– Retesting. In some cases, it's recommended to periodically retake the test, especially if there have been significant changes in your life or financial situation.

Risk-aversion testing can be taken in various formats and venues, depending on your needs and resources. Numerous free and paid psychometric tests specifically designed for measuring risk propensity can be found online. Such tests can be a good starting point. Many financial advisors, psychologists, and coaches offer risk-aversion testing as part of comprehensive financial planning. This can be helpful if you wish to receive a more personalized approach and expert consultations, who can also provide professional recommendations.

Some universities and scientific organizations conduct research in financial psychology and might offer risk-aversion testing as part of their research projects. At times, tests are available as part of specialized educational seminars or webinars. The key is to ensure that whatever method or platform you choose for testing has a good reputation and offers a scientifically backed approach to measuring risk-aversion.

Demo Accounts

Trading on demo accounts offered by the brokerage company NordFX is designed to acquire basic skills and is conducted on a real trading platform but with virtual money. This allows users to familiarize themselves with the platform's interface and functionalities, practice trading without financial risks, and test various strategies and indicators.

Trading with virtual money does not invoke the same emotional stress as trading with real funds. However, practicing too long on demo accounts can lead to unrealistic expectations and a disregard for risks. Therefore, it's essential to understand that success on a demo account does not guarantee success in the real market.

Trader's Diary

A Trader's Diary is a tool that assists in organizing and analysing your trading activities. It can be maintained electronically, for instance, through an Excel spreadsheet or Google Sheets, or traditionally in the form of a paper notebook. Common entries in the diary include the date, time, and price of opening and closing positions, their volume, the direction of the trade, the asset or currency pair being traded, stop-loss and take-profit levels, and the resulting profit or loss from the trade.

It's crucial to document the reasons for entering a trade, such as market or news analysis, indicator signals, and so forth, as well as the reasons for exiting. Incorporating screenshots and charts that depict the market's condition when opening and closing a position can be valuable. Additionally, it's beneficial to describe your emotional state before, during, and after a trade. Any extra notes that dissect the mistakes made and lessons gleaned can be insightful.

Such a diary not only provides insights into your trading strategy's effectiveness but also sheds light on your risk management skills, discipline, and psychological responses to various market situations. Regularly maintaining this diary, ideally right after each trade, can help in preventing repetitive mistakes in the future. However, of course, the frequency of entries largely depends on your trading style. While it's straightforward to document each trade for long-term and mid-term trading, it becomes challenging with intraday trading and nearly impracticable for scalping and pips trading.

Stress Tests

Stress tests for traders are specialized scenarios or models designed to assess a trader's response to extreme market conditions that closely mimic real-life situations. These tests measure a trader's ability to effectively manage risks and make decisions under intense external pressure.

During these tests, extreme market scenarios are simulated: unexpected sharp price fluctuations, changes in volatility, and other complex situations. Throughout the simulation, the trader makes decisions about buying, selling, placing orders, and so forth. After the test, an analysis is conducted on the decisions made, the level of discipline maintained, stress resilience, and risk management effectiveness. Such training can enhance your ability to act appropriately under extreme conditions, identify vulnerabilities in your trading approach, and, as a result, make necessary adjustments.

Reliability of Test Results

What is the risk of error in all the methods listed, and how reliable are they? Can a novice trader, who has successfully passed all types of tests, actually be completely unprepared to trade with real money?

First and foremost, it's important to note that questionnaires and psychological tests rely on self-awareness and the honesty of the responses. They may not always accurately reflect an individual's actual state of mind. Moreover, real trading often involves high emotional stress, which is difficult to fully simulate. No beginner possesses the experience that only comes with practice and time. Successful test results might lead him to overconfidence, which in turn can result in impulsive and risky decisions, potentially leading to significant financial losses.

It's also essential to recognize that financial markets are influenced by a myriad of factors, including the release of macroeconomic statistics, political events, natural disasters, and even mass psychology. These cannot be fully accounted for in tests or simulations. Hence, while the methods listed can be a useful tool for self-awareness and skill enhancement, they do not replace real experience and should be considered as just one of many factors in preparing for trading.

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