10 ways to improve your trading psychology to become profitable in derivatives

The landscape of financial markets is multifaceted, with trading and investing as two distinct pillars, each demanding specialized strategies. This article delves into the pivotal role of derivatives in tempering and guiding traders' psychology. The insights presented herein are poised to equip traders with enhanced psychological management tools. 

The Indian financial market has been witnessing an unprecedented surge in trading activities, particularly in derivatives. Securities and Exchange Board of India (SEBI) data reveals a remarkable uptick in the number of individual traders engaging in equity derivatives between FY19 and FY22. The National Stock Exchange (NSE) emerges as the dominant player, commanding an approximate 98 per cent market share in derivatives trading. 

Contrastingly, SEBI’s report paints a concerning picture, with 89 per cent of retail traders in equity futures and options (F&O) registering losses in FY22. Notably, the age bracket of 30-40 years, often characterized by heightened personal and professional aspirations, accounted for the majority (39 per cent) of participation. This demographic data accentuates the criticality of sound trading psychology. 

Derivatives trading is an intricate interplay of technical and fundamental analyses, underpinned by a keen understanding of market psychology. The psychological aspect is often the linchpin, dictating how traders assimilate and react to market fluctuations. Subsequent sections will elucidate strategies to fortify trading psychology, paving the way for informed and profitable engagement in derivatives trading.

Develop a trading plan: A trading plan is a set of rules that you follow when entering and exiting trades. It should include your risk management strategy, entry and exit criteria, and trade size. According to a survey conducted by FXCM, 70 per cent of traders who had a trading plan reported being profitable, compared to only 30 per cent of those who did not have a plan. Therefore, by having a clear trading plan, you can reduce the emotional impact of trading, which can lead to more consistent results. 

Mitigate Risk Effectively: Employ the '1 out of 5' principle. Segment your trading capital into a minimum of five portions, and ensure that no more than 20 per cent of the allocated trading capital is employed in a single trade. This approach facilitates prudent trade management, curtails excessive risk, and preserves capital for subsequent trading opportunities. It is imperative to recognize that risk management is integral to any trading strategy. By constraining losses and capitalizing on profits, traders can diminish the emotional ramifications of trading. Implement stop-loss orders to automatically withdraw from a trade in the event of adverse market movements. Utilize position sizing to regulate exposure to any individual trade or asset 

Stay disciplined and shut the noise: Sticking to your trading plan and managing your risk requires discipline. Emotional reactions to market movements can lead to impulsive decisions that can hurt your performance. By maintaining discipline and following your plan, you can reduce the impact of emotions on your trading. If anything distracts your disciplined routine, just simply, shut it without a second thought. 

Keep learning and be focused on Implementation: The markets are constantly evolving, and staying up-to-date with the latest trends, news, and developments is critical to success. Attend seminars, read books, and participate in online forums to stay informed about the markets and trading strategies. 

Employ Emotion Management Techniques: Trading is often accompanied by a gamut of emotions, which, if unchecked, can impair judgement and precipitate ill-advised decisions. A study by the University of Cambridge substantiates that emotional biases can considerably influence traders' decisions, often culminating in financial losses. It is imperative to employ emotion management techniques such as taking intermittent breaks, engaging in mindfulness or meditation, and circumventing impetuous decisions predicated on emotions. 

Maintain a Systematic Record of Trading Activities: Diligent tracking is indispensable in trading. It is essential to discern the efficacy of various strategies, which can only be achieved through systematic record-keeping. Maintaining a trading journal, wherein each trade along with the underlying rationale is documented, facilitates performance evaluation. For instance, comparing trading outcomes during the morning hours versus the latter half of the day, or assessing the effectiveness of different trading indicators such as Exponential Moving Averages (EMA), Fibonacci retracements, or candlestick patterns, can provide invaluable insights. Through meticulous data analysis, traders can identify efficacious strategies and concentrate on result-oriented setups without dispersion of focus.

Reward to protect your earned profits: While doing a job or business we expect our hard earned money to come as soon as possible then why not in trading. In fact, in the trading business you can reward yourself everyday just after the trade. With this not only will you stay motivated to follow discipline but you will protect your profits too. So, make it a habit whenever you are earning profits, take daily payouts and see the magic at the end of the month. 

Avoid Unwanted Gyaan: Keep exploring new things around the trading a but avoid overdoing it because too much information leads to  a lot of confusion and a confused mind can't take factual deduction in trading. Always be available for new learnings but do not try it with real money until you have cross checked the results. Do thorough study before  implementing any strategy and  Strat with a small amount to check where it's suitable for you or not. Try to master a few strategies and setup only and keep practicing on it until it is giving requited results to you. 

Avoid Hope, Keep Realistic Expectation from Market: If you think that stock market is not the right place, better you try something else. Here in this market you keep your expectations at the right place. For instance, if you are doing 10 trades, 1 trade can make your capital 10x but remaining 9 has probability of being zero because it is options trading and there is expiry date for every contact here. So, keep your expectation within the time probability. Do not trade the hopes here, just trade the price and your set-ups. 

Explore the other instruments too: Index option trading is getting more popularity but it is not the only instrument that you can trade in. You have futures, stock options, commodity futures and commodity options and currency futures and options. Keep an eye on that too and try to explore it and experiment (of course with small capital), which will help you to identify the best instrument according to your own persona. You need to understand that everything is not for everyone.

Conclusion - Derivatives trading is a highly popular and growing market in India. However, it requires a fine combination of technical and fundamental analysis, as well as sound knowledge of market, price psychology and your favourable and non - favourable characteristics so that you can work on the main cause to get effective results.  These strategies can help reduce emotional bias and lead to more consistent results in the long run. 

Views are personal. The author is a research analyst and co-founder, Stock Market Today.