Recency Effect refers to a psychological situation which makes people recall and behave as per recent events. Though it may sound perfectly normal, it can have certain ramifications if not checked. If a trader emphasizes a lot on the results of their last trade, they might end up losing the rationale and perspective. In trading, it is common to be influenced by our last trades which could lead to many irrational decisions. Visit mex
The Recency Effect is the reason why so many traders end up giving back their profits. It happens because the recency effect allows traders to believe that their trading abilities are infallible.
Are you really confident of your next trade?
As someone who is just getting started in the market, winning the first few trades could boost your morale to a great extent even though you’re clueless about what led to the wins. If one is to say that the market conditions at the time of your trades were favourable and so you won, it implies that the same action would not yield profit when the market changes its course.
Yet a trader who may not have the education, understanding and trading skill would be under the impression that they can make things work and are overconfident about their trades because of their latest wins. Now, this is a commonly occurring event which a majority of traders might face.
You will be able to get over the recency effect by taking into account the fact that trading is something that relies on probabilities. To put it simply, we trade probabilities and not certainties which implies that each trade in the market is unique and free from the last trade you placed. The failure or success of the previous one would have no impact on the performance of your next trade. If you’re focusing too much on your latest trades, you’re setting yourself up for failure.
Why is taking your profits important?
Is it not rewarding to have liquid funds or hard cash at your disposal? The feeling of having access to funds that you can use can positively affect your emotional and psychological being which is definitely welcome after you spend hours staring at numbers on a screen.
What do we mean?
If we choose to not not use the money we trade with, specifically the profits, we end up not caring about the cash because it becomes something that’s intangible.
When we stop caring about it, it turns out to be really easy to give back the profits. If you look at it in the physical world scenario, imagine holding onto $500 cash that another trader tried to take away from you. You would definitely snap at them or maybe even hit them. But the same $500, when that shows up on your computer screen, it’s hard to tell that someone is taking your money away. You don’t really feel the loss and end up adding more funds to your account.
Here’s the solution:
If you trade on a monthly basis and earn roughly $10, make sure you withdraw at least a part of that profit. Keep that money on your trading desk. Understand that the money you’re seeing online is very real and you would not want to give it up. How do you not give up the money? By taking measures to keep that capital safe. Trading defensively is how you would stay in the game when it comes to trading.
Neglecting risk management
As we lay more emphasis on our latest wins, our confidence and our morale is boosted. Thus, we’re encouraged to increase the size and quantities of our trades which results in returning the profit. For instance, take the case of an amateur trader who is not skilled enough and lacks a sound understanding of the market. Chances are that their luck played out a few times and they won some of their initial consecutive trades. As a result, they were just too sure, almost overconfident about their trading abilities and thus chose to add more capital for their trades. However, if the market changes its course, that trading strategy might not work anymore.
Such experiences are common and mostly every trader has gone through them once in a while. What our takeaway should be from this is that overconfidence combined with poor risk management techniques could lead to devastating losses. You could be very confident about a trade but your action needs to be aligned with your risk management strategy.
You could avoid being over-confident due to the recency effect of your trades by looking at trading in terms of probabilities. In the market, there would definitely be someone who is taking the opposite position as you. You also should take into account what the person trading against you might be thinking because well, everyone has their money at stake so you can’t be the smartest one in the room, right?
Conclusion When you unnecessarily return the profits to the market, it can be quite frustrating. It might make you emotional or angry which could lead to poor decision making, thereby creating more room for grievous errors. You might end up emptying your account because of one bad trade. By warning you of the possible loopholes, we hope that you’ll be able to dodge a scenario where you don’t lose the profits earned. If that happens after all the efforts you put in, it can be extremely difficult to gain the confidence lost which can take a toll on your mental wellbeing. Overconfidence is one thing that can really take a trader down because then they make decisions driven by emotions and not rationale–it’s human nature to do so after you’ve experienced a few wins. The key to success is to stay humble and not lose sight of reality. Every trade is independent and your last trade is likely to have zero impact on your next trade. Hot-headedness and the desire to make the market change is futile because you can only control yourself in the market. Multibankfx – scalping policy