Trading psychology is the set of emotions and mental shortcuts that shape how you open, hold and close trades, and it often decides the result more than the strategy itself. Fear of missing out (FOMO), fear of losing, greed and overconfidence push many traders to buy after a jump, sell in a panic or trade too often. The good news is that these reactions are well studied, and a few simple habits can make them less costly.
In brief
- Trading psychology is how emotions and biases change the decisions you make once real money is at stake.
- FOMO, fear of losses, greed and overconfidence are the most common traps, and they tend to appear together after a sharp price move.
- Studies of individual investors link frequent trading to weaker results after costs, so doing more is not the same as doing better.
- Rules written before you enter a trade, such as the size, the stop loss and a daily limit, take many decisions out of the heat of the moment.
- No habit removes losses: crypto is volatile, losing trades are normal and you should only trade money you can afford to lose.
In this article · 11 min read
What trading psychology is, in one sentence
Trading psychology is the study of how feelings and thinking habits affect trading decisions. Regulators describe the same thing in their guides to investors. The securities regulator CNMV (Comisión Nacional del Mercado de Valores) writes in its guide on the psychology of investing (in Spanish) that many financial decisions are emotional, and that anxiety, fear of loss, excess optimism or a state of overexcitement can dominate them. The guide adds that biases cannot be made to disappear but can be largely mitigated, and that becoming aware of them is the first step.
The idea has an academic root. In their 1979 paper on prospect theory, the psychologists Daniel Kahneman and Amos Tversky showed that people do not weigh gains and losses in a symmetrical way: a loss tends to hurt more than an equal gain pleases. This is called loss aversion, and it explains a lot of what traders do under stress.
The emotions that move trades
Most traders meet the same handful of reactions. Naming them is useful, because a feeling that has a name is easier to spot.
- FOMO (fear of missing out). The urge to buy because the price is rising and everyone seems to be making money. In crypto it is amplified by social media, where fast moves are shared within minutes.
- Fear of loss. The urge to sell at the first dip, often just before a rebound, or to avoid a trade that your plan told you to take.
- Loss aversion in action. Holding a losing position for too long, hoping it will come back, because closing it would make the loss real. The CNMV guide notes that this can mean keeping an investment with very little chance of recovery.
- Greed. Keeping a winner open beyond your plan, or adding to it, because the move looks like it will never end.
- Overconfidence. The tendency to overestimate your own knowledge and judgement. The CNMV describes the overconfident investor as someone who underestimates risks and overestimates expected gains.
- Revenge trading. Trading again right after a loss, with a bigger size, just to win the money back.
- Herd behaviour. Copying what the crowd is doing because it feels safer than thinking alone.
The financial regulator AMF (Autorité des marchés financiers) lists loss aversion and herd behaviour among the main behavioural biases in its investor guide (in French), and says that the best way to correct such reactions is to be aware of them.
FOMO is also a sales tool
FOMO is not only a feeling that arises by itself. It is used on purpose. The regulator BaFin (Bundesanstalt für Finanzdienstleistungsaufsicht) explains on its page about meme coins (in German) that some offers create the false impression that you must act quickly or miss the promised gains, and that the aim is to make people act in a hurry instead of checking how large and how likely the risks are. If a message pushes you to decide within minutes, that pressure is itself a warning sign.
Trading psychology in numbers
Feelings are hard to measure, but what they lead to can be. Three sources are worth knowing.
In a well-known study, the economists Brad Barber and Terrance Odean followed the common stock accounts of over 60,000 households at a large discount broker from February 1991 to December 1996. In the paper, published in the Journal of Finance in 2000, the average household turned over about 80% of its portfolio a year and earned an annualised 17.7% before trading costs, against 17.1% for the market index. After costs the average household earned 15.3%, and the 20% of households that traded the most earned 10.0%. The authors link the weak results of frequent traders to overconfidence. The data are from the 1990s, when trading costs were higher than today, so read the numbers as an illustration of the pattern rather than a forecast.
A second study looks at people who try to trade for a living. Fernando Chague, Rodrigo De-Losso and Bruno Giovannetti studied everyone who began to day trade in one large equity futures market between 2013 and 2015. In their working paper, they report that among those who persisted for at least 300 days, 97% lost money and only 0.4% earned more than a bank teller (US$54 per day). They also found no evidence of learning by day trading. This applies to persistent day traders in one market, not to every person who has ever traded.
A third reference concerns leveraged products. When the European Securities and Markets Authority (ESMA) restricted contracts for difference (CFDs), leveraged contracts on the price of an asset, in March 2018, it noted that between 74% and 89% of retail accounts typically lose money on them. Our guide to leverage in crypto trading explains why leverage makes every emotional mistake more expensive.
John Bax's view
In Lazy Investor, Smart Investor, John Bax describes a day trader's bad day hour by hour. At 6 AM, forums and self-appointed gurus fill the head with "hot tips". At 9:30 the first trade drops, and the trader panics and sells just before a rebound. At noon there is no lunch, for fear of missing a trade. At 2 PM the trader doubles down to win back the morning's losses, and at 4 PM comes exhaustion and regret. He also writes that fear can make you leave trades too early and greed can make you hold winners too long, until the profit disappears. His point is that the stress of fast trading works against the person doing it, and that this is why he favours lazier, rule-based alternatives to day trading.
Behavioral finance and the role of psychology (Yale lecture) (in English)
How to build discipline, step by step
Discipline is not willpower. It is a set of rules that you write while calm, so that you do not have to invent them while stressed.
- Write a plan before the trade. Note why you enter, where you exit if you are wrong and where you take profit. If you cannot write it in three lines, the idea is not ready.
- Decide the size first. Choose how much you accept to lose on the trade before looking at the potential gain. Our article on risk management in trading shows how to size a position.
- Place the stop loss at the start. A stop loss is an order that closes the position if the price reaches a level you chose in advance. Setting it before the trade, and not moving it further away when the price gets close, takes one emotional decision out of the day. See how to set a stop loss and a take profit.
- Set a daily limit. A maximum number of trades and a maximum loss for the day give you a reason to stop that does not depend on your mood.
- Pause after a loss. A simple rule, such as no new trade for an hour after a stop is hit, makes revenge trading less likely.
- Keep a journal. Write the entry, the exit, the reason and how you felt. After a few weeks, patterns appear: the hour when you overtrade, the news that makes you chase.
- Check your source of ideas. Ask who gains if you act now. Be cautious with hot tips, countdowns and promises, and remember that the CNMV lists social proof and authority among the biases that influence decisions.
- Use money you can afford to lose. Pressure falls when the amount is small enough that a loss would not change your life.
Checklist before every trade
- I wrote down the reason, the stop and the size before entering.
- I am not buying only because the price has already jumped.
- I am not trading to win back a previous loss.
- I know the most I can lose today and I will stop there.
- I checked who is promoting this idea, and why.
- The money is money I can afford to lose.
Where a bot fits
In our experience, the hardest part of trading is rarely finding an idea; it is following your own rules when the price moves against you. That is the case for automation, and also its limit. A bot applies the same rules at every hour without getting tired or scared, but it does not remove risk, and a poor rule is simply applied faster.
Crypto Go Bot, which we built, runs on your own server and trades on your own Kraken account through a Futures trading API (application programming interface, the access key that lets software place trades) that you create. Its take profit and stop loss are real orders placed on Kraken, and the bot cannot withdraw your funds. It is still futures trading: losing trades are normal, volatility and leverage remain, and no setting rules out losses. You can read how it works in our crypto trading bot overview.
Who it is for
Trading psychology matters to anyone who makes decisions with money on the line, whether they trade every day or only now and then.
- Beginner who bought after a big jump: learning to recognise FOMO, and to wait for your own entry rule instead of the crowd's excitement, helps you avoid buying at the moment of greatest enthusiasm.
- Active trader who overtrades: a daily limit and a journal show how much of your activity comes from boredom or from the wish to win back a loss, so you can cut it.
- Long-term holder tempted by the news: writing down a plan and a review date helps you resist selling in a panic or adding in a rush, as long as the money can stay put for the planned period.
- Person who prefers rules to screens: automating part of the process, with a small amount at the start, suits those who accept that losses still happen and want less daily emotional load.
Key terms
- FOMO: the fear of missing out on a gain that others seem to be making, which pushes people to buy late.
- Loss aversion: the tendency to feel a loss more strongly than an equal gain.
- Overconfidence: the habit of overestimating your own knowledge and your ability to predict the market.
- Revenge trading: trading again, often with a larger size, right after a loss to win the money back.
- Trading journal: a written record of each trade, its reason, its result and the emotions around it.
- Stop loss: an order that closes a position when the price reaches a level chosen in advance, to limit the loss.
Frequently asked questions
What is trading psychology?
It is how emotions and thinking habits influence trading decisions. It covers feelings such as FOMO, fear and greed, and biases such as overconfidence and loss aversion.
What is FOMO in crypto trading?
FOMO means fear of missing out. It is the urge to buy because the price is rising quickly and others seem to profit, and it often leads to entering late and without a plan.
Why do most traders lose money?
There are several causes, including costs, leverage and a lack of experience, and emotions play a part. Studies of individual investors link very frequent trading to lower results after costs, and supervisors report that many retail accounts lose money on leveraged products.
How can I control my emotions when trading?
You cannot remove them, but you can reduce their effect with rules written in advance: a plan, a fixed position size, a stop loss, a daily limit and a journal. A pause after a loss also helps.
What is revenge trading?
It is trading again right after a loss, often with a bigger size, to recover the money quickly. It tends to turn one loss into several, which is why a pause rule is useful.
Can a trading bot remove emotions?
A bot follows its rules without fear or excitement, which removes the emotional reaction in the moment. It does not remove market risk or the risk of a poor rule, so start with a small amount.
Sources
- Wikipedia, Behavioral economics
- Wikipedia, Loss aversion
- Kahneman, D. and Tversky, A., Prospect Theory: An Analysis of Decision under Risk, Econometrica, 1979
- Barber, B. and Odean, T., The Common Stock Investment Performance of Individual Investors, Journal of Finance, 2000
- Chague, F., De-Losso, R. and Giovannetti, B., Day Trading for a Living?, working paper, FGV EESP
- ESMA, ESMA agrees to prohibit binary options and restrict CFDs to protect retail investors, March 2018
- CNMV, Psicología económica para inversores (in Spanish)
- AMF, Mieux connaître ses réactions pour mieux investir : comprendre les biais comportementaux, 14 June 2022 (in French)
- BaFin, Memecoins (in German)
