Learn how emotions affect decision-making and price movements in the stock market.

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This section explains trading psychology - one of the most important aspects of being a successful trader. The best traders are emotionally detached from their holdings and execute their decisions objectively.

When trading, you must remember that there is no such thing as a "holy grail" stock. All stocks will move up and down, depending on interactions between supply and demand, as well as fear and greed.

The Dow Theory of trading, developed over a century ago, states that stocks are perfectly valued at any given time. However, price manipulations and fear/greed interactions can artifically drive stock prices away from their true valuations.

When stocks start to drop, stockholders sometimes become fearful and begin selling off their shares, even if no change in fundamentals has occured. Similarly, people sometimes buy stocks near the top of the rally because they do not want to miss out on profits.

Trading psychology attempts to take irrational emotions out of trading decisions to create better profits. Even the most skilled technical and fundamental traders are sometimes wrong. In fact, some traders are wrong over 70% of the time, yet still make money in the end due to trading psychology and their ability to stick with their systems.

Nonetheless, trading psychology remains one of the most easily ignored and least understood trading subjects. Below are some common mistakes and remedies to trading psychology errors:

1. "Cherry Picking" - Most people have no real system for selecting stocks and simply follow hot stock tips or stocks they hear about on the news. Unfortunately, if you have already heard about a stock through the news or public knowledge, then it is often too late. A lot of people already own the stock, leaving fewer buyers to drive the stock price upwards. The remedy to this dangerous approach is to develop a system for stock picking and do your own research.

2. No exit point for trade - Another very common mistake beginning traders make is not knowing when they are planning on selling a stock. Stock prices do not continue in one direction indefinitely.

Entering a position is easy, but many traders have difficulty closing out the trade. When the stock price moves contrary to investor expectations, the investor often holds onto the position hoping that the stock price will reverse. Also, when the stock pick is a winner, the investor will often hold on to the position in hopes that it will continue to make more profit. Such emotional decision-making often causes investors to lose money.

Although it is impossible to tell exactly where a stock price will reverse direction, technical analysis provides some clues that will allow traders to make good guesses in some cases. Good risk management also allows traders to mimize losses and safeguard profits when the trend turns unexpectedly against their positions.

Recommendations: Before you enter a trade, define two exit points - one below your entry price and one above. You should always consider the possibility that you were wrong about a stock and set up a stop loss to minimize losses. Traders should set a profit target as a goal, although most traders will re-evaluate their position at this point and decide if a higher target should be set.

3. Relying on "professional" advice - Many people rely on "professionals" to pick winning stocks for them. Sadly, many "professionals" have limited knowledge of the forces that move prices.

An interesting study that I read about showed that in some instances, different people subscribed to the same trading advisory services often had very different trading results. Although the advice they received was the same, their results differed because of the way they acted on that advice.

Sometimes, a dip in stock price might have caused one person to sell a stock prematurely. Other times, perhaps the stock tip was wrong, as even the best stock pickers are sometimes wrong. Yet emotional intervention can cause investors to hold onto losing positions in hopes of breaking even in the long run.

Many advisories, unfortunately, do not tell you what to do if their recommendation is wrong, or what to do if the stock does not reach the target price.

Recommendation: Learn as much as you can about technical / fundamental analysis and risk management and develop your own trading system that allows you trade without using emotions to make important decisions.