It is no wonder that traders-beginners, having got to the stock exchange, are guided by ordinary human common logic in taking decisions. This logic is clear and straightforward. The cause entails the effect, and the effect is generated by the reason, and if to know all the reasons, the effects will be obvious; come up and use. And really, every price move has quite specific causes, it is generated by market participants, each of them has the reasons to act just the way he acts.

However, the number of participants at the market is actually quite large, and the reasons by which they act so, whether or no remain at times not quite clear even for them. All this leads that the price is moved by an enormous amount of various factors and tracing even the most significant is not always possible. So there will be no difference if we consider that price moves are accidental to a great extent.

And if so, the market is a probabilistic process and common logic (or common sense) is not always applicable there. In order to take optimal decisions completely another logic is needed here – probabilistic one. After all, each time when common logic runs into the probabilistic process, whether it is a casino game, cards or stock exchange, it starts glitching. And when logic weakens, it can’t resist psychological tensions inherent all people, moreover increased by situation importance; in fact it is gambling. Faith for the better, hope for the favorable end of events, fear of losses, aspiration for wishful thinking – all this begins influencing strongly the mechanism of decision taking. The great number of psychological traps appears, when quite nonoptimal and unprofitable decisions are taken, which look quite justified from the common logic point of view.

For example, you tossed a coin 5 times, and 5 times in a row it fell heads down. How will it fall next time? Common sense can tell you that since the coin falls heads down all the time, next time it will fall heads down also. Or one can say that it is quite impossible that a coin falls heads down 6 times and next time it will certainly fall tails down. In fact, mathematical probability that it will fall heads down remains 50%-50%.

It looks simply with an example with a coin, but at the market there are enough such accidental moments. What actually accidental is, the reason aspires to decompose into causes and effects, to discover regularities, to set an order. However when the reason doesn’t succeed in doing this, senses and emotions enter the game.

Another serious psychological trap, which inexperienced traders constantly run into at the stock exchange, is rejection of own losses, leading that losses go out of control and expand. When an open position begins to yield a loss, the trader gets entrapped by own fear. He still remembers as few minutes ago the price was much better, it seems to him that one needs only to close the position, fixing a loss, as the price will turn and return to former levels. Here is an example how it works:
1. Looks not bad for a purchase. Growth seems forcible and sure. We buy!
2. The price rises. The trader hopes for rise continuation, glad at an appearing income. No one thinks of the worst!
3. The price still rises. An income pleases more and more, the prospects of growth start to seem more promising, it seems it will never end, it is just the beginning, and, “by the way, how would be better to spend all this income? It is even better than I’ve expected!”.
4. The price begins to fall. “Small correction, easy to wait through. Why should one sell shares that rise so good?”
5. The price still falls. “Damn, the correction drags on… If I had sold them in a point 2, I would have earned not bad. Agree to the half income? Khm… No. Let’s wait further, don’t surrender to panic. Discipline is foremost!”
6. The price continues to fall. “Now it is already late to sell… If I sell them now, I’ll get the loss! Loss after I could have earned so much! No…it is late to sell. There is no choice but wait and hope. Can’t they always fall, can they?”
7. The price falls further. “Oh, God… There should be brandy somewhere…”
8. And further. “Damn it! I sell. It is impossible to sustain this…”

So, instead of income we get a forcible loss. What has been done wrong, in fact in every particular moment a decision to hold shares further seems to the trader logical and solely correct?

The problem is that only one decision has been taken amicably – to buy shares. The decision to sell shares has been put off, and as a result the trader got into a psychological trap, when, torn by conflicting emotions, he couldn’t have abandoned the position at all.

Inexperienced trader in the process of trade is constantly affected by two strong senses – fear of losses’ bearing and fear of income losing. Moreover, quality to believe what one desires inherent everyone plays a wicked trick with the trader, doing more pleasant variants of course of events in his eyes the most obvious. If the shares’ price rises, the trader is inclined to assure himself that it will happen henceforth. If the shares’ price began to fall, the trader is inclined to save the position, expecting returning of the price; he is afraid closing the unprofitable position, having fixed an already made loss. As a result many traders have the same problem – untimely closing (however, opening also) of positions, when decisions are taken not upon second thoughts, but under the action of emotions. This problem converts any income into losses, and losses into greater losses with ease.

However, sometimes exists the very opposite problem, when the trader fixes the profit too quickly, losing the greater part of possible income. All depends on what overpowers – fear or greediness. In any case, decisions, taken on a strong emotional background, are often nonoptimal or even harmful.

Exists simple solution of these two problems – one can decide beforehand at which situation the position will be closed and than, when this situation comes, work the taken earlier decision out hard and orderly, whatever market and intuition prompt. There are already ready mechanisms for realization of such approach – “take profit” and “stop loss” applications, present in the totality of facilities of most stock exchange terminals. Having opened the position, you can propose both applications beforehand, thus having foreseen any development of situation at the market. In case if the price of bought by you shares grows by reaching a level indicated in the application “take profit”, the position will be closed and the got income will be fixed. In case if the market goes against your position, the shares’ price will fall below the level, indicated in the application “stop loss”, the position will be closed also. Thus, the loss will not grow higher above defined value.

There is one more psychological trap, rather widespread among the great masses of traders. There is a popular method of “reduction” of losses from a red ink deal which is called “averaging”. For example, if earlier position was opened in long, and than the price began to fall, it is suggested to increase the position, buying shares at cutted price. As a result the average price at the total position appears less than the price of primary deal. Psychologically is a very convenient method, allowing to reduce “pain”from losses by one motion – simply buying more shares.

Actually, instead of one unprofitable position, which is certainly must be already prepared for closing, one gets the second in addition, opened at the falling market (i.e. against motion, that is very risky in itself), the only reason of its opening is the fact that earlier we had foolishness to make a mistake with an entry. Of course, consistent averaging at the consistently falling market leads to the growing increase of losses. Nevertheless, the method has its supporters.