Individuals invest to make money, and they can become disillusioned when they don’t see a profit. Recent analysis by Bloomberg Intelligence attributes traders’ losses from “meme” stocks and riskier assets to heightened market volatility. But, according to new insights from trading platform Capital.com, there’s another reason why so many DIY trades fail—and the answer lies in human psychology.

Its research highlights that traders who fail to use risk mitigation strategies to protect their positions are paying the price in their losses. In the 18 months to July 2021, some 60% of Capital.com traders globally were not using stop-loss strategies, of which only 44% were making a profit. Among those traders who did use stop-losses, 49% of them adjusted the value before the original stop price was triggered.

David Jones, Chief Market Strategist at Capital.com, says this reflects the psychological traps many traders fall into. With 25 years’ experience trading, Jones says the data demonstrates something he has always thought to be true: Traders’ egos often get in the way.

“Most people don’t use stop-losses. We can draw a lot from the psychology of this,” he says. “Much of it revolves around the idea of ego and not being willing to admit you are wrong. When it goes wrong, you have to come out of it. This is the biggest pitfall for traders as long as trading has taken place.”

Easily influenced

The research has unearthed other notable trader trends. For instance, the vast majority of Capital.com trades (75%) are closed within 24 hours—and nearly half (45%) are closed within 60 minutes. Meanwhile, losing positions are closed 1.4 times more often within five minutes than winning ones.

According to the data science team at Capital.com, hanging on to losing trades

for too long and exiting successful positions quickly to lock in profit is often linked to disposition bias, a common psychological trait which tends to affect novice traders.

“We see that both newcomers and experts usually tend to behave inefficiently in terms of psychological biases,” says Arty Rusetski, Head of Data Science and AI at Capital.com. “However, newcomers more often ignore basic risk management rules, which often leads to loss of their funds.”

“Disposition bias can cause investors to sell assets that have increased in value, while keeping assets that have dropped in value. It influences us to retreat our original trading strategy, which usually leads to risk management mistakes and larger, unexpected losses.”

The evidence of this kind of trading behavior highlights the psychological risks traders face, with Jones likening an effective risk management strategy to the challenge of losing weight; on the surface, it should be a simple case of staying faithful to a diet and exercise regime. However, human psychology makes this process difficult, and the same can be said for trading, he argues.

“You have rules, and you have to stick to these rules,” he says. “But because psychology plays such a big part, it’s hard to do.”

Psychological biases that can present themselves when people trade include overconfidence bias—the sensation of believing the hype around an investment—and memory bias, when a trader gives too much credence to recent events.

Either of these can distract traders or allow them to be unduly influenced by news or current affairs, says Jones. He cites the recent gas crisis, when emergency talks between energy providers may have prompted some traders to buy into natural gas, even as the price of the commodity had recently fallen.

“This is a great example where people were following the news story, rather than what’s going on in the market,” says Jones. “Usually, by the time something hits what we call ‘mainstream news,’ rather than financial news, the move has already happened.”

Social media also has an impact.

“If everyone’s talking about it, if all your friends are talking about it, then surely it’s going to be great? It’s these sorts of things that can falsely influence traders and cause short-term price movements,” says Jones.

The impact of psychology can result in under-reaction just as much as overreaction. Tarik Chebib, Capital.com’s Group Chief Revenue Officer, says he often sees traders struggling to adapt to the barrage of information they encounter. This can cause “analysis paralysis,” leading traders to feel stuck and unable to make decisions.

“The more noise you accept to interfere with your trading, the more you are prone to fall into analysis paralysis,” says Chebib. “I would love traders to understand that it isn’t just about the entry—when to get into a position—and they need to focus much more on the live position.”

These psychological pitfalls are not limited to new traders, and the team at Capital.com sees expert traders often making the same impulsive mistakes in their decision-making. However, Chebib says that those newer to trading are more likely to find the real-world environment of markets a challenge to settle into.

No substitutes

Chebib and Jones often see traders display different behavior when operating demo accounts compared to when they are “live” and making decisions in real markets using their own money. Entering this real-world environment can have a significant impact on their risk appetite and entire decision-making process.

Chebib says the change in attitude could simply be due to having real assets in play. “When they get to a live account and their own hard-earned money is on the line, they realize it is not as easy as it was on the demo account. Decision-making changes drastically.”

But moving beyond the safety of a demo account and into the real world is crucial, says Chebib. After two weeks in a demo account, a diligent trader should have developed an understanding of their chosen platform and begin to appreciate the functionality of markets.

The real education can only begin with real money at stake for traders, says Chebib. “You cannot simulate what it feels like when real money is on the line, what it feels like when a market is going against you, when you are joyful and when greed kicks in, when you are up. There is a learning process, as with everything.”

To help traders identify when they may be falling into psychological traps, Capital.com is developing a dedicated AI solution to monitor their activity. This will result in in-app messages, push notifications and emails prompting traders to carefully consider what they are doing and the decisions ahead of them. The solution will help traders identify their strengths and weaknesses and fill in their knowledge gaps. Ultimately, it is designed to help people become more effective traders.

“Our AI program will identify the key drivers of investor behavior, which are personality type, emotional status and behavioral biases. Our aim is to educate, but we recognize that each of us learns in our own way. By utilizing cutting-edge AI technology to understand client behavior, we can ensure that each individual is served educational content in a format and style that is likely going to work best for them,” says Rusetski.

Why Psychological Biases Could Be the Enemy of Successful DIY Trading