The Effects Of Emotions On Trading

One thing that, though can be suppressed but can never be taken away from traders is their emotions.

A trader may decide not to allow their decisions to be influenced by their emotions either negatively or positively.

However, according to a recent study and research conducted by Hans-Rüdiger Pfister and Gisela Böhm from the University of Bergen, it was concluded that traders cannot make an optimal decision without their emotions being involved.

This means, from their research, emotion is needed by every trader in order to make the best decisions when analysing.

In this article, we are going to discuss the positive and negative effects of emotionally influenced trading.

Emotional Bias In Trading

Emotional bias is the influence that emotions which comprises our feelings and mood such as greed, fear, overconfidence etc have on a trader's decision-making process.

Emotions are commonly known to cloud the judgments of traders leading to irrational trading decisions.

Types Of Emotional Biases That Affect Traders

Below are three major emotional biases observed from traders.

  • Overconfidence Bias

From the word overconfidence, overconfidence bias is the tendency for traders to exhibit excessive confidence sometimes unwarranted in their skill, knowledge and analysis accuracy.

This sense of overconfidence in traders leads to Euphoric feelings which in turn, causes them to forget some of the rules guiding their trading and lead them to make irrational trading decisions which is one of the negative effects of emotion-influenced trading.

  • Loss Aversion Bias

Loss aversion bias is a situation when a trader really prefers not to make any losses than to make more gains. This type of bias that affects trading is a result of either continuous losses or a losing streak as the case may be.

Traders are often found in a state of despondency after a series of losses or a losing streak which is another negative effect of emotional trading.

  • Self-control Bias

Self-control bias is a dilemma that traders are faced with when trying to abide by their rules to avoid impulsive trading decisions. This type of bias is directly linked to indiscipline in many traders.

Indiscipline in traders leads them to make impulsive, regrettable and irrational trading decisions and it is another negative effect of emotional trading.

Positive Effects Of Emotions In Trading

Though, generally believed that emotions only have negative effects on traders in trading, below are some of the positive effects of emotions in trading in ways you might not consciously think of. 

  • Preference Construction

From the study that was referred to earlier in this article, it was discovered that decisions made are based on information and one’s emotional state. These help one in deciding between two decisions.

For instance, a trader wants to invest in either the S&P 500 or buying of cryptocurrencies such as bitcoin for an extended period. It is the information gathered and one's will (influenced by emotions) that ultimately matters.

Emotions and information at hand helps trader weigh their options well and decide what trading move to make.

  • Decision-Making Speed

From time immemorial, our emotions have always played a significant role when making decisions within a limited period of time.

Though we do not require our emotions all the time, our emotions however, speed up decision-making and hence, is a positive effect of emotion in trading since most of the traders need to make a decision on how to place trades within a period of time (when the opportunity is still available).

  • Guidance in Assigning Relevance

When making our decisions, we often evaluate factors we think are relevant, and emotions guide this selection process. 

Traders, influenced by their emotional experiences, may prioritize certain strategies, trade setups or factors over others.

Whether it's the joy of a successful trade or the regret of a past loss, emotions contribute to the trader's focus on specific elements crucial for decision-making.

  • Commitment

Commitment is an important aspect of decision-making that requires traders to stick to their choices despite conflicting motives. 

Confidence in a trading plan, fueled by positive emotions, empowers traders to cut losses even in the face of anxiety.

Emotions such as shame can act as a motivating factor, preventing traders from succumbing to greed and encouraging reasonable position sizes.

From this article, we have learnt that emotions are so much part of decision-making that we can’t just “remove” or “avoid” emotions when trading.

Conclusion

From the article, we learnt that from a recent study, it has been shown that though, traders may try their best to remove totally emotional influence from their trading, it is fortunately not possible because optimal decisions require a balance that incorporates emotions.

Also, though many focus on the negative influence emotion has on trading, it was also established that emotions are integral to decision-making when trading.

Therefore, traders can use the positive aspects of emotions to improve their decision-making process while mitigating the negative effects through self-awareness and discipline.

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