Fear, greed and hope … psychology explains FX behaviour

  • EWP contends that expectations rather than “news” that determines market prices
  • Psychological rather than technical factors usually decide trading success
  • Emotions – such as fear, greed, hope and even despair – play a big part in trading

By Max McKegg

At the core of the Elliott Wave Principle (EWP) is the premise that collective trader behaviour, as manifested in the underlying market price, moves in a continual and never ending sequence from optimism to pessimism and back again, within ever expanding and contracting degrees of wave progression – and that it is this phenomenon that depicts the mass human psychology of people and their behaviour en masse. Therefore, the EWP contends that it is not “the news” per se which determines market prices, but the expectations of traders and other market participants to the news that has the greatest influence.

I strongly suspect that the reasons most traders fail to achieve long term trading success are psychological rather than technical. In other words, they do a lot of the “trading mechanics” right but trip-up on failing to achieve control over their own emotions.

For example, assume a novice trader has advanced to the point where he has devised a trading plan and has “tested” it through paper-trading. He then begins to implement this plan in “real time” with actual money. Initially, starting with earnest intent and respectful of all he has read, the trader follows his plan to “the letter” and despite some gains and losses, he is executing effectively. However, after a while he becomes less resolute and loses his discipline.  Consequently he deviates from his trading plan and embarks upon a “slippery slope”.

So what are some of the psychological “pitfalls” for traders?

Fear: This is a natural emotion which arises from a perceived threat and takes produces a response in both humans and animals of either “fight or flight”. In fx trading, fear can manifest itself in the form of a fear of failure, causing the trader to be reticent in trade execution or slow to close (stop-out) of a losing position. Also, after taking a loss, this fear of failure can prevent the trader from executing the next worthwhile trading because he is afraid to take another loss so soon.

There is also the fear of “missing-out” on potential gains, causing the trader to second guess his trading plan and approach because of this strong emotional urge to “participate”, regardless.

Greed: This is also a natural human emotion, of wanting more than one needs or requires. In fx trading this can manifest itself with the trader staying in a position too long (overstaying his welcome), in the quest for still greater profits (when objectively the position should have been liquidated earlier), resulting in either a less than satisfactory profit result or at worse, a loss (where the winning position is allowed to turn into a losing one).

Hope: It is said that hope and love are the two most important human traits of all but in fx trading, hope is of no value whatsoever and in fact, can prove extremely costly. Hope is often associated with the laudable human condition of optimism. But whilst it is fine to be optimistic in as much as this implies a positive and motivated attitude and disposition, this must be tempted by a strong dose of reality. A lot of novice traders incur greater losses than they “should” due to a false sense of hope that the market will justify their trading position, if they just give it a little more time. This is the wrong approach to trading. The market has deeper pockets than any individual and it is never a good idea to “fight the market”.

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– Edited by Robert Ryan

Max McKegg is managing director of Technical Research Limited. If you would like an email notice each time Max posts a trade, then click here to follow him

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