Psychology of Trading: How to Manage Emotions in Crypto Markets

The general level of anxiety has increased too. The number of people reporting feeling anxious has risen by 1.6% from 2008 to 2018. If there is something that you should not do when feeling anxious all the time, it is most likely investing! Some people get around this issue by using an AI crypto bot or any other form of automation just to remove themselves from the decision-making.

According to some scientific research, the general levels of anxiety have risen even more since 2018 thanks to the pandemic and increasing living costs across the world. Many people participating in the crypto market often make financial decisions while being stressed or afraid to lose money. Even without the issue of loss aversion which we will discuss in detail later on, the catastrophic influence of emotions can ruin you financially. Trading psychology is a largely unexplored field with most of the suggestions and advice coming from self-taught experts and financiers.

The absence of qualified psychologists and psychiatrists studying investors and their trading mentality is problematic, to say the least. Undeniably, emotions play a huge role and should be under control. However, receiving effective tips on how to keep them checked is incredibly rare. Let’s talk about the importance of psychology in trading and various ways to keep calm when the market tries to break your composure.

What is trading psychology?

We generally refer to a variety of emotions and mental conditions as well as character traits that affect decision-making when talking about the psychology of a trader. In 2012, Steve Peter wrote an intriguing book called The Chimp Paradox where he focuses on the primal aspect of investing by pointing out that we are still driven by simple concepts like hunger, fear, the desire to reproduce, etc. Other authors like Jared Tendler offer a more practical narrative while also saying that primal instincts dictate our decisions in everything, including money-making.

Some concepts are more interesting and deep than others. However, the general idea is that our mental state is hugely impactful and often determines the outcomes of all investment activities making it imperative for crypto enthusiasts to keep their heads cool when trying to decide the next move in the market. The vast majority of books focus on managing emotions in trading which is quite important yet misses some aspects of contemporary investing that have proliferated throughout the last decade.

Many practical tips and tricks suggested by experienced authors are applicable to a wide array of investment activities. The problem is that many people do not know how to use some techniques that are accompanied by examples of investing in stocks or bonds when trying to make money on something like yield farming or staking.

In these cases, trading psychology tips for crypto work just as well but require you to adapt them to the situations at hand. Let’s talk about some of the most interesting ideas in no particular order.

The psychology in crypto trading

When Bitcoin became a thing about fifteen years ago, people did not know what would eventually happen to the novel asset. Thousands of now-millionaires bought BTC early and sold only portions of their holdings. They do not regret their decisions. However, even more people wasted their coins on something like pizza (11,000 BTC for two pizzas in 2010) or simply sold their tokens too early. Others did not even think about buying.

When altcoins started appearing in every corner of the emerging blockchain domain, people rushed to buy them hoping to see the same flight to the moon as in the case of Bitcoin.  The vast majority of these new tokens either failed spectacularly or turned out to be scams and rug pulls. For example, Terra Luna, one of the first stablecoins, managed to lose over $45 billion in a matter of weeks.

The fear of missing out, abbreviated to FOMO in the crypto community, is a force of nature that simply drives people to new exciting investment opportunities even if they don’t make sense or look too good to be true. It is one of several concepts that are used to describe some aspects of investors’ psychology in this market.

Below are some others:

• FUD or fear, uncertainty, and doubt. Often used by enthusiasts as an insult thrown at critics who try to downplay the advantages of DeFi protocols or new assets like NFTs. It is also a neat way to describe the indecisiveness of investors who miss out on valuable opportunities because of are too scared to act. In many senses, it is the opposite of FOMO.
• BTD or Buy The Dip. This advice is often thrown around in communities on Reddit or Discord. The problem with this particular slogan is that it makes it sound like you can easily guess when the market bottoms. Obviously, even the best analysts struggle to predict price action movements correctly. BTD as a principle leads many investors to feel overconfident and enter the market with bad timing.
• Cryptosis is another meme-worthy phenomenon. It is a “condition” when a person wants to know everything there is to know about blockchain, decentralization, cryptocurrencies, etc. This joke, just like any other, is funny because it is true to at least some degree. Many enthusiasts become obsessed with learning believing that excess knowledge will give them an edge. In reality, there is a limit to how much you can learn and practically apply during investment activities.

This terminology is widely used by people who are into crypto and DeFi. In 2024, you won’t encounter these words everywhere, but experienced veterans still use them. These are memes and insider jokes that appeared due to the observable nature of behavioral finance in trading. Investors are predictable and often clump together in groups that resemble echo chambers. This flock mentality is the foundational aspect of many viable analytical strategies like analyzing market sentiment or using the fear/greed index.

To avoid becoming one of those easily identifiable individuals, it is important to develop discipline and avoid succumbing to biases and opinions from influencers. The easiest way for many investors to act strictly according to a predefined strategy is by using a trading bot or engaging in less demanding investment activities like staking or liquidity mining.

Emotional trading in crypto markets

Many psychologists working in the field of finance became popular because they can expertly describe feelings experienced by many investors. The relatability of some concepts seems frighteningly surprising to many. Let’s discuss some interesting behaviors that often affect those who want to make money by investing in financial instruments:

• Revenge trading. In some cases, you may feel an urge to get back at the market and get back what you have already lost. You may enter an opposite position or double down while trying to increase the size of an order. Decisions driven by anger and bitterness often lead to catastrophic failures. One must remember that the market is not an entity with an agenda. You cannot avenge your hurt feelings and lost funds.
• Tilting is something that happens to the best of us. A series of unfortunate deals can have a compounding effect and result in an outburst of rage or hopelessness. In both cases, you will make rash decisions, expose the portfolio to excess risks, or continue working in unfavorable conditions instead of cooling off and returning to the market when it calms down just like you did after a good night's sleep.
• Loss aversion is a phenomenon described in detail by scientists Kahneman and Tversky in 1992. Investors are often more afraid of losing $100 than getting $100. This particular mindset can be very harmful in financial management since risk increases proportionally to potential rewards. Someone who is too afraid to make a move will never become rich.
• The inability to accept losses is a problem that haunts too many investors. Newcomers feel this after losing money following a series of particularly lucky trades. This phenomenon is excellently described in the book Best Loser Wins by Tom Houggard where he argues that it is crucially important to learn how to deal with losses and find ways to stabilize your mentality to win in the long term.
• Overconfidence is the real problem for thousands of novices. The Dunning-Kruger effect is a known phenomenon describing how people with less knowledge believe that they are more knowledgeable about a certain subject than they are. In essence, they lack the necessary expertise to realize its absence. Many newcomers believe that they know everything after extensively watching YouTube and learning on social media platforms.
• Anchoring is another big issue in trading mentality. It refers to the practice of tying the value of your holdings to a certain reference like entry prices or target profitability goals. For example, you may stake ETH with a goal of exiting after receiving 5% in rewards. During this time, the price may have dipped several times and your stake is now worth 10% less. Instead of liquidating an unfavorable position right away, you might stick around until you get these 5% in ETH and lose 10% in USD value.
• Self-attribution is also something that many investors do when assessing their performances. In this case, one might believe that all gains made during an investment period are results of superior personal expertise and appropriate decision-making while all losses are caused by unfavorable market conditions and bad luck in general. In reality, all profits and losses might have been due to luck. It is hugely important to critically think of yourself when trying to identify the effectiveness of your investment activities.

How to Manage Emotions in Trading

Experts have been observing markets and their participants for centuries. It is enough time to develop incredibly effective methods of controlling emotions and avoiding making bad decisions due to operating in bad mental states. Surprisingly, we still do not have reliable cognitive behavioral techniques for traders since we are all different and have unique biases, fears, and mental blocks.

One of the simplest ways to assess your ability to operate under all possible circumstances is by simulating investment activity through the use of crypto paper trading or demo accounts. The problem here is that the mental load and stress will be significantly lower because you won’t worry about virtual money at all.

This ability to completely remove yourself from experiencing negative outcomes is the reason why many novices make millions on demo accounts and lose everything when engaging with the market using real money. They won’t take risks or stick to losing positions hoping that they will recover. On the contrary, using virtual tokens will be much easier and allow an investor to go all-in whenever they have a slight gut feeling that they’ll succeed.

Here are some tips for those who want to have strong emotional control in crypto markets:

• Be disciplined. It is important to make investments in an orderly fashion. Many investors often fail to remain composure precisely because they don’t have a plan. Before making your first order, make sure to focus on creating a solid strategy. Stick to the rules of your investment system and do not make decisions that go against it. Some people use iterative approaches and vigorously test their ideas before committing. For example, you can use TradingView automated trading systems and check their effectiveness using the strategy tester. Alternatively, going to vendors like WunderTrading to use their backtesting capabilities is a good idea.
• Avoid high-stress situations. The emotional gap is an enemy of solid decision-making. It happens when you try to determine what to do under severe stress or when not fully recovered from anger, regret, or doubt. Any strong emotion, even a positive one, can distract you or lead to irrational behavior. You should never open market positions during peak emotional conditions. Fear, anger, greed, happiness, and many other feelings can affect your judgment and lead to losses where you would otherwise not lose anything.
• Prepare yourself. Some people do yoga. Others simply make a cup of tea and try to get cozy in their favorite chair. The important thing is to get inside your comfort zone to focus solely on analyzing the market and trying to find the best course of action without thinking about a bad conversation at work or feeling hungry. Creating a good state of mind and ensuring that your body does not suffer either is hugely important for any decision-making let alone financial. Setting up specific routines like going to a gym or running every day can also be helpful.
• Do not visualize your goals. Many influencers and coaches are saying that you should focus on vividly imagining your goals arguing that doing so will make it easier to achieve them. There is a reason why so many of these coaches are selling courses instead of making money from investing. When you make financial decisions with a certain goal in mind, it is very similar to anchoring. You won’t be investing efficiently. Instead, you will enter and exit positions based on arbitrarily chosen metrics that may not have any relevance to your particular circumstances.
• Always be critical of yourself. We have already said that overconfidence and self-attribution are extremely dangerous mental biases that are present in many investors. Usually, inexperienced novices fall victim to these issues and make unreasonable decisions simply because they don’t know better. The easiest way to avoid this problem is to simply criticize every single decision that you make and scrutinize its argumentation. Be careful with this approach as it can lead to overthinking which is also a very unhelpful thing to do.
• Don’t give in to emotions. Take a short pause after each trade regardless of its outcome. If you made a killing and earned a fortune, it may lead to overconfident investing or encourage you to make the next trade immediately even when you don’t have a good entry point. After making a bad trade, you may want to get back at the market or simply return losses by doubling down. In both scenarios, giving yourself some time to rest and think about what happened is a much better idea.

Trading mindset strategies for beginners

Many newcomers come to the industry unprepared. They lack the necessary knowledge about novel digital assets, DeFi protocols, and blockchain technology. They are also completely out of their league when it comes to discipline. According to surveys, up to 60% of cryptocurrency holders do not know anything about blockchain technology or DeFi protocols. Roughly 65% of all newcomers to the market do not have any prior experience with financial instruments and investing.

It is important to filter any information that you receive and try to focus on achieving mental stability. Here are some good tips for novices:

• Do not watch YouTubers and Instagram influencers. These people are often strongly biased and promote projects that they are personally invested in. You will also be hyped up by stories about overnight millionaires and the ease with which dedicated hustlers make money by arbitraging coins or farming exorbitant yields. Having lower expectations is much better for your long-term performance.
• Avoid risky assets. Until you start understanding how to tell pump and dump schemes from legit projects, it is better to stay away from memecoins, suspicious decentralized exchanges, and hype protocols like ORCA that focus on catching virality instead of offering reliable investment opportunities to their users. You should also be very cautious with governance tokens that can be hard to get rid of in certain market conditions.
• Learn all you can but avoid catching cryptosis. Focusing too much on reading about different DeFi protocols and their digital infrastructures can lead to a false sense of security. Even the most promising projects can collapse overnight. On paper, the technological foundations of Terra Luna looked fine until it suddenly didn’t. Even the best analysts could not foresee the catastrophic failure of FTX, a CEX that was hyped up by everyone and their mom. Be careful not to “overstudy”.
• Use automated systems. An ATS can remove human factors from the equation during the execution phases. You will still need to find a good source of signals or develop a reliable technical analysis strategy, but all communications and instant decisions based on predefined parameters will be made automatically without your direct oversight. Platforms like WunderTrading offer excellent bot-building features allowing users to create unique systems.
• Do not make sell too early or too late. You can use a plethora of techniques to acquire assets. DCA buying works well among many others. However, exiting a market position is a skill that requires honing. Many newcomers sell when they see green numbers on their screens. They also fall into the sunk-cost mindset and want to wait until prices recover before exiting a losing position. Instead, use personally tested technical analysis techniques to find the best moments to buy and sell.

These tips will help novices avoid many psychological issues by simply removing causes like the absence of a good plan, baseless decisions to sell or buy, and executing strategies while being influenced by fear or anger. Achieving mental discipline in trading is incredibly important and should be cultivated as quickly as possible!

The main takeaway

Beginners often do not know why they behave in certain ways simply because of their lack of experience. Some veterans have made their fair share of mistakes and lost a lot before learning how to remain cool and simply follow a plan. Being aware of various psychological issues that can hinder the effectiveness of your investment operations helps to reduce the chance of unknowingly falling into a mental trap and repeating mistakes.