How Emotions impact your Forex Trading

David Rodriguez, quantitative analyst at FXCM considers why human emotion affects our trading styles:

Heavy marketing efforts frequently bombard traders with promises of an effortless road to riches via black box systems available for purchase. Of course, what sounds too good to be true invariably is.

However, we recently measured the number of manual trades across our most popular currency pairs from 2009 to 2010 to analyse the impact of human emotion. In our most popular pair — EUR/USD about 59% of all manual trades were closed out at a profit.

This is quite impressive and a positive sign for our traders. Yet a closer look shows that the average loss per losing trade was nearly twice that of the average gain.

The problem likely comes down to one issue: trader emotions. We find that traders are less likely to close trades out at minor losses before they escalate and become much larger. On the flipside, many traders are too quick to close out winners and thereby limit the upside on successful trades.

Better trade management comes down to controlling one’s emotions: admitting when we’re wrong on losers and seeing winners through to full profit potential.

Automated FX trading offers a key advantage: emotions play a much smaller role in managing individual trades.

Finding worthwhile automated trading strategies can be difficult, but even the simplest strategies will work given correct market conditions. Thus are markets volatile? Simple currency breakouts can offer strong returns. Is the Euro trending lower? Then running a system that follows trends may offer good trading opportunities.

Understanding trading conditions may allow the trader to find the appropriate trading strategy with which to automate trading. Our client statistics show traders have good ideas but sometimes fail because of emotions.