Trading builds up character; and if you stay long enough, you can improve your decision-making skills, including how you respond to specific market circumstances.
Why? The market holds different cycles that impact Forex traders psychologically. Over time, its effects can either make you a better Forex trader or make you realise you are progressing slower.
What is market psychology?
Market psychology describes how market movements reflect or are influenced by the emotional condition of its participants. Under this theory, analysts believe that prices go up and down as traders’ emotions change. In short, fluctuating trader sentiments create the psychology of market cycles. Traders typically have an overall feeling about the price actions of a market, which can be defined as market sentiment. For example, when the market is said to be bullish, this may result in positive market sentiment. Increased confidence and improved attitude of traders will make the market go up. A downward trend follows the opposite rule.
What are market cycles?
The trends or patterns formed over time in different markets are called market cycles. You usually find them between two latest highs or lows of a standard benchmark.
New market cycles often result from a significant innovation, a regulatory change, or new products that trigger trend formation in particular industries. In reality, trends are hard to spot until they are over. It is a challenge to identify the beginning and ending points of a cycle when you’re stuck in the middle. This may cause confusion in your assessment of trading strategies, so you need extra care. You may see market cycles that last for a few minutes or go on for years.
What are the stages of trading psychology?
You will see four typical stages in a market cycle. We’ll look at each stage to understand what typically happens in the market.
Stage 1: Optimism and Euphoria
The cycle always begins with a generally positive attitude. We usually make our first investments filled with optimism, and this confidence is the usual reason we decided to start trading. We expect good things to happen and then get rewarded for taking the risk.
This optimism goes higher and turns into excitement, as earlier buyers reap profits, and we view each pullback as another buying opportunity. We look forward to higher returns, and traders experience the thrill that trading brings. As the market cycle reaches its peak, euphoria starts to flow.
It is easy to make profits when everything seems perfect, and we ignore simple risk management principles. We believe nothing is wrong with anything and we beat the market. This is the most dangerous part since traders typically reach the optimal financial risk when they believe in inevitably high returns while tolerating more significant risks.
Stage 2: Arrogance and Fear
Without any warning, the market suddenly fails our expectations of getting high returns. This is the second stage. But we still say that the market will go back to the previous state, in denial of what is really happening.
Enter the stage of anxiety. While watching the market, we begin praying and hoping for it to head back up. As we see our trades declining in value, the stress turns into fear. This fear may cause traders to build a defence, even opting to transfer assets to those more defensive asset classes. Still, others may continue holding their risky positions despite the losses, hoping for the market to recover.
Stage 3: Panic
With the bull now changing into a bear, traders may be so desperate that they begin panicking. At this stage, all traces of optimism and confidence completely disappears, and investors now strategise to minimise their losses.
Yet, some may still be wondering when the market will rise again.
Stage 4: Caution
The lowest low finally comes to an end. At this point, the price rises once again, but the traders have become vigilant. They exercise caution in this phase, as entering the market once more triggers concerns that need strategies or solutions. The market may experience sideways movements, like insignificant drops and rises. Traders will have ample time to build their optimism once again, eventually restarting what seems like an ended cycle. With that, positive sentiment can commence, leading us back to the first stage.
While market cycles vary over time, you need to control what you feel and how you respond. Sometimes, emotions can get the best of us, and we become irrational as a result. The market will always be in constant flux, but you can stay focused by using a feasible plan you can work out with your trusted broker.