Why Many Traders Lose Their Profits Soon After Winning
A common scenario experienced by many traders is suffering losses right after having struggled to make gains. Does this ring a bell? You follow your technical analysis and enter a trade at the right time and win. Then you enter again and win another one, and maybe even another one. It feels like you are well on your way to make some serious gains when all of a sudden you lose quickly and you lose big.
You start scratching your head how did that happen so quickly and where it went all wrong for you. This article will examine why many traders, novice as well as professional, tend to lose their winnings so quickly and easily.
The psychology of winning and the Recency Effect
As many of you already know trading is not only knowing your technical and/or fundamental analysis. It is also psychology. Many will argue that the psychology and the state of mind of a trader is actually more important than any other aspect of trading. Understanding how our brain functions and makes decisions is a crucial element that needs to be addressed.
Psychology tells us that there is a thing called the Recency Effect, a state in which people tend to assign more value to the most recent events and experiences, as opposed to those experiences that happened long ago.
Taking the Recency Effect into account a trader who who has just experienced a big win or a nice streak of wins is much more likely to remember that experience and believe in similar outcome.
Main reason for losing is trader’s overconfidence
The problem with the recency effect is that it plays a dirty trick on the mind and makes the trader lose focus and objective reasoning. Many traders hyped by the recent wins and the recency effect and influenced by the increased levels of dopamine (Read The Worst and the Best Times To Trade Binary Options for more information) are very likely to follow up with the wrong moves and possibly lose their winnings, if not more. This happens to traders very often.
Main reason for losing after having won a few trades is trader’s overconfidence. Overconfidence can destroy any trader without the skills and the know-how to recognize and control it. Overconfidence can make you believe many things which may not necessarily be true.
Defined by psychologists, overconfidence effect is a strong bias in which subjective confidence in your own perception of a situation is greater than the objective accuracy of that perception.
In simple terms overconfidence effect can distort the traders view of what is really happening, and more importantly, it can lead to bold actions that can turn out quite badly. General studies have shown that the margin error of an overconfident subject is about 20%.
When feelings of overconfidence run through your head when you’re trading it’s a sure sign to stop. A good idea is to look at your trading plan again at this point to refocus your attention.
Virtual money is much easier to part with
When you have $200 in your pocket and you lose it, psychologically it feel more painful that if you lost $200 of virtual money. The reason is that tangible items make a greater impression when they are lost than virtual items that we never touched or used.
Trading profits are always virtual at first, they simply appear as additional numbers in your account. Until your profits are cashed in, they are virtual. Since these virtual profits are intangible, traders are more likely to risk them than if that money was in their pockets.
As a solution, a good advice for traders is to transfer and cash in some of the winnings regularly.
This will keep your ‘head in the game’ because you will need to preserve your baseline trading capital and make new profits. In addition, if you cash in your winnings you will also have a tangible connection to your trading practice in the form of cash.
Without a doubt losing your trading profits can be painful to any trader. The whole experience can be even more frustrating when the profits are lost quickly and recklessly. The situation can be often times avoided by sticking to the trading plan with each trade. Overconfidence is the main cause of errors that lead to losses so try to be aware of your emotional and state of mind at the time of trading. Of course it’s easier said than done but then who said trading was easy.
Published in Education