In this article, we will discussOptions are the most versatile and high-risk instruments in the financial markets. As much as it allows traders to leverage their position and multiply their returns, it also carries substantial risks due to their speculative nature. A trader who is beginning to invest in the stock market thinks that options trading is all about learning strategies and analysis and concentrates only on that. However, although the quantitative and technical aspect of trading is important, what separates a winning trader from a losing trader is their Psychological Mindset. We will learn all about that in this article. Behavioral finance theory says that Individuals are not rational and more often than not take irrational decisions despite having all the information, statistics, and research in hand which could significantly alternate their returns on investment. It says that investors have limits to their self-control and are influenced by their own biases. Cognitive biases like overconfidence, herd mentality, and loss aversion mainly occur from statistical, information processing, or memory errors, while emotional bias stems from impulse or intuition. This results in action based on feelings instead of facts.
So what should be the Mindset of a trader?
Here are some points to look at to have a winning mindset:
Self-awareness:Self-awareness is probably the most important part of trading psychology. A trader needs to understand his/her personality type. Whether they are a risk taker, focused, disciplined, emotionally detached, and able to learn from their mistakes, etc? These are all questions that a trader must honestly answer before starting to trade. This will help them to work on their weaknesses so that they can avoid making bigger mistakes later on. For example: If a trader identifies himself as someone who is afraid to take risks. Then he should always work with a stop-loss and place smaller orders that he is comfortable to lose.
Risk managementTrading in the stock market is subject to risk. Risk management is very important when trading options. Putting stop-loss on orders is one type of risk management. Putting all eggs in one basket is extremely risky therefore one should diversify their portfolio to spread their risk. Place smaller bets when in doubt to avoid huge losses.
Keeping emotions at bayEvery trader who sets out to trade will win some and lose some money in the financial market. One who cannot take a loss and gets too depressed after losing money, so much so that he/she is unable to pull him/herself together after, is not meant to be a trader. A trader should never get emotionally attached to any particular stock and be very objective when dealing with stocks. Greed and fear are two types of emotions. While greed will pull you towards holding your winning position for longer, fear will make you exit too soon. Therefore, learning to manage one's emotions is very important in options trading.
Quick decision makerFinancial markets are ever-changing. Numerous factors affect stock prices on a daily basis. A trader should be able to identify such shifts in trends and take appropriate actions quickly.
PatienceEntering trades on any and every market movement is a bad strategy. A successful investor is one who has the patience to wait for the right opportunity in the market. Timing the market is very crucial to make money which requires huge patience. An investor who can understand this is sure to win.
Self-discipleThis is one of the key factors that determine success in trading. A trader should be self-disciplined. They should not treat trading as gambling but rather base their stock picking on thorough research. They should calculate the potential risks before entering any trade. It is natural for an individual to get tempted to do risky trades in the spur of the moment which could result in huge losses. Self-disciple is important to avoid the temptation to do risky trades. Forming a trading strategy, profit calculations, entry and exit points are part of self-discipline.
Learning from your mistakeMaking mistakes is inevitable. However, it is important to learn from your mistakes and avoid repeating them in the future. Journaling your wins and misses in trading is one way to keep track of your performance. This will help one in identifying patterns for future reference.
Goal settingIt is important to set goals and have a path to achieve those goals. A successful trader is one who plans and does not place random bets on stocks. However, the goals should be reasonable enough. Setting unrealistically high goals often results in frustrations that further affect your performance.
Understanding your trading styleDifferent traders are comfortable with different trading styles. Some traders may prefer day trading over swing trading. Some may like position trading and so on. Each trader has their own personality and the trading style should be in line with that. One should understand their trading style and form trading strategies accordingly.
Read news but don’t chase top storiesIt is important to be updated about breaking news when dealing in stocks. However, one need not chase top stories and bet on those stocks all the time as it may not always give positive results since more often than not breaking news is over-hyped for sensationalism. A trader must rather look at the larger trends in the market and make sound financial decisions that suit his trading style. Investment should always be done after thorough self-research and conviction in the trade.