Following is an excerpt from my book, Essentials of Foreign Exchange Trading (John Wiley & Sons, 2009) regarding emotional trading in the forex market:

“There are many examples of emotional trading that both novice traders and experienced traders alike succumb to on frequent occasions. For one, many traders fall into the trap of trading aggressively, or even angrily, after either a string of losses or one particularly devastating loss. This is often caused by a desire to get back at the market with a vengeance. The trader’s underlying sentiment is that the market is the adversary, and that aggressive trading can somehow make back the lost equity, teaching the market a lesson in the process. Clearly, this is irrational behavior that invariably leads to even further devastation of the trading account. Discipline to accept losses gracefully and to continue adhering to the trading plan is the primary weapon against falling into this kind of a psychological trap.

A related trap that is found often in foreign exchange trading occurs when traders experience a winning streak and begin believing that they have mastered the market. Oftentimes, these traders will start thinking that they are unstoppable and that the principles of prudent trading somehow do not apply to them. Greed and recklessness then enter the picture. When this occurs, prior winnings generally turn into subsequent losses, and these traders then become compelled to play catch-up by attempting to make back the winnings. This results in a vicious cycle that eats away quickly at any account, if trading discipline is not re-introduced before it becomes too late.

Another example of emotional trading occurs when traders are alerted to a runaway price move after a large portion of the move has already occurred. The emotion that surfaces is one of fear—fear of missing out on the trade of the decade. Traders in this position that have not mastered the discipline to refrain from acting upon reckless emotions, will often jump into the trade blindly in an attempt to chase the market. They do this even if the entry turns out to be at the worst possible time, like buying at a top, where price has already exhausted itself after a significant upmove. Trading in this manner, without discipline, is a sure method of racking up frequent and substantial losses.”

- Excerpted from Essentials of Foreign Exchange Trading (John Wiley & Sons, 2009) by James Chen, CTA, CMT. Please click here for more information on this book.

* Follow my intraday forex updates on Twitter: http://twitter.com/JamesChenFX