Gambling Psychology In Trading
A lot of people decide to start trading because they think it is an easy and quick way to earn money. They treat trading as a game, falling victim to the so-called gambling psychology. In this article, we’ll learn what gambling psychology is, how it can affect your trading and ways to avoid it.
- Gambling psychology makes traders take on more and bigger trades without thinking them through.
- Gambling in itself is very different from trading as it doesn’t require much skill or knowledge.
- Gambling while trading inevitably leads to a series of losses and may even cause traders to blow up their accounts.
- To avoid gambling psychology, traders need to carefully research their trades and have a strict trading strategy in place.
What is a Gambling Psychology?
The term “gambling psychology” refers to the mindset that is common among gamblers. Gamblers bet their money on a random outcome in a game in hopes of winning and multiplying their money. They don’t take into account the probabilities of winning or losing in this game, nor do they learn the mechanisms behind it to develop a winning strategy.
What gamblers do care about is the excitement and rush of adrenaline they get from taking the risk. They win sometimes, of course, which rewards their unsystematic approach to gambling. But the majority of the time, gamblers lose their money only to gamble over and over again. The reason is that even the smallest chance of winning is enough to keep them on edge and ready for more. This is why there are compulsive gamblers who sometimes end up losing their whole estate to gambling.
Unfortunately, a lot of new traders come into the trading world with this gambling mentality. They don’t consider trading a skill, but another way for them to get quick wins with a minimum amount of effort. And even more experienced traders can fall into this mindset, trying to get as much profit as possible in short amounts of time without consulting their strategy. This causes them to make impulsive decisions that usually lead to loss of profit and can sometimes end with them blowing up their account.
How Gambling Psychology is Expressed?
There are certain behaviors that traders with a gambling mentality engage in.
When new traders decide to start trading, they usually have a very vague understanding of what this activity requires. They don’t know about strategies and patterns, technical and fundamental analysis, how economic news and geopolitics can affect asset prices. For them, the easiest way to make money is to buy an asset and then sell it when the price goes up. Sometimes, this method does work out and they win, which reinforces the idea that trading is intuitive and predictable.
Like in true gambling, traders with a gambling mentality tend to steadily increase the sizes of their trades, hoping that this will bring them more profit. What they overlook is that trading large amounts of assets in one position also amplifies the risks and their potential losses.
The Martingale strategy is a prime example of gambling psychology in trading. This strategy is based on the assumption that by doubling the amount of money traders put into their next trade, they have a 50% chance to recover their previous losses. If this trade doesn’t work out in the trader’s favor, they double the amount of the traded asset again and again, until the strategy works and the losses are recovered. But this one-sided game of tag can last for a very long time and the trader has a higher chance of running out of their money than recovering the losses.
What’s the Difference between Gambling and Trading?
The main reason gambling psychology is so prevalent in trading is because trading is often portrayed as a game by the media. People treat trading and investing as a hobby, a side hustle they keep for when they are bored. A lot of newcomers decide to try it simply because everyone does and they need to keep up with appearances. This rarely ends well as trading requires lots of time and energy being put into research and preparations for the trade.
Of course, both gamblers and traders rely on odds and probabilities. But the natures of both activities are vastly different, and every trader needs to know what makes trading different from gambling.
Gamblers don’t need to put a lot of effort or thought into their actions. They simply place a bet and they have virtually no control over the outcome.
Trading is different in this respect. Traders are well aware that every trade poses a risk and they might lose money, but they can somewhat control the outcome. They can place stop orders or exit the trade earlier than they originally planned in order to cap their losses. They can play a waiting game to see if the market moves in a more profitable direction. Traders have more agency over their trades and can influence their profit, provided they act rationally and think carefully before making a move.
Even though gamblers can be successful, gambling is essentially a game of probabilities. It doesn’t require much skill, foresight or knowledge.
Traders, on the other hand, need to possess a high level of skill, intelligence and understanding of how markets work in order to make the most profitable trades. It takes time, effort and dedication to learn all the information that is required for trading, and even more hard work to learn to use this knowledge in real life.
No matter how many times gamblers manage to win, it is the casino that benefits the most from their actions in the long term. The casino knows when to let gamblers win in order to ensure they will come back and spend more of their money on gambling. This phenomenon is called negative expected value, meaning that the losses of a gambler will always outweigh the wins.
In trading, it is very much possible to reach positive expected value if a trader creates a sound trading strategy and develops a comprehensive risk management plan. This is the reason there are so many traders who have made trading their career and are able to make steady income from their trading profits.
Negative Aspects of Gambling Psychology
- Overtrading. Overtrading is another behavior that is caused by the gambling mentality. It happens when traders get too focused on profits and try to place too many trades without thinking it through. But by doing so, they run the risk of losing the money they invested in these trades. They usually can’t keep up with all the trades and end up with more losses than they might have had before.
- Impulsive decisions. Gambling psychology makes traders forgo rational thinking. They want to make money as quickly as possible and not waste any time on researching their potential trades. However, this impulsivity is likely to bring them more losses.
- Lack of strategy and risk management. Traders with the gambling mentality think building a solid strategy is useless. They want to get as much money from each trade as possible. They don’t put Take Profit or Stop orders, hoping to get big wins out of each trade. But this erratic behavior is never rewarded in the end.
- Chasing losses. The gambling mentality makes traders continue placing more trades in hopes of recouping the previously sustained losses. But this only increases the chance of more failures since their actions usually lack strategy and research.
How to Overcome Gambling Psychology in Trading?
Gambling psychology mainly affects new traders who have a very basic understanding of how financial markets work. So the best way to get rid of it is to educate oneself about the most common strategies, patterns, risk management tools etc. It is also very useful to narrow down on one area of interest (forex, stocks, crypto) and improve your skills there rather than trying to learn about everything at once. There are many tutorials and resources with tips on how to handle their emotions and how to get into the right trader’s psychology. You can also learn by practicing trading in small amounts to understand how the market actually works. Once you have enough knowledge, you can finally build your own strategy and develop a risk management plan to keep your trades consistent and profitable.
The gambling mentality is a dangerous state of mind for traders to have as it causes them to make impulsive and irrational decisions. To avoid it, traders need to make an effort to build up a trading strategy and stick to it even when they feel the urge to trade more or bigger positions. Trading is not a gambling game, so it requires careful research, focus and dedication from traders to secure steady profit.