The Forex Market: A Mirror to the Trader’s Soul and the Psychology of Trading Success

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I. Forex Traders Psychology and Performance

The forex market is undoubtedly the largest playground for speculators, as its liquidity and volatility (amplified by leverage financing) far exceed those of other speculative instruments. At the same time, this market magnifies many of the forex trader’s flaws. Forex trading acts like a mirror, revealing all the weaknesses hidden within you.

Why so? In everyday life, the negative consequences of poor decisions often go unnoticed. For instance, a life choice that was wrong could have been better with a wiser decision, yet you may feel self-satisfied due to some minor successes at the moment.

In daily life and work, the outcomes of our actions are not so easily observed and realized, leading us to believe we seldom make mistakes. This is because, compared to trading, we tend to have a more positive and forgiving view of ourselves.

However, the financial markets are entirely different. They serve as an unambiguous mirror, and an efficient feedback mechanism, making it easy to observe one’s mistakes and see the results of actions more clearly. This naturally reveals the “true self” that we don’t see in everyday life and work—a self that is not as excellent as we often think, as our weaknesses are easily concealed outside of trading. Some may say they are quite successful in their daily work and interactions, but they should realize they could be even more successful.

The financial markets do not allow for any missing link in the overall chain—even if a link can be weaker. Once you lack in any aspect, you will be unable to establish a consistent record of excellent performance.

In the financial markets, it’s normal for incorrect actions to lead to profits, but it’s not easy to sustain this; likewise, correct actions leading to losses are also normal, but it’s impossible to sustain them. Any forex trader who profits must operate according to all the procedural steps of trading, and the most outstanding forex traders are above average in every step.

In real life, missing certain aspects will definitely affect your relationships and emotions, even if you don’t realize it. The same goes for work, but in trading, if you lack in any aspect, you will inevitably be in a state of overall loss in the long run.

Why do we miss these aspects, or why do we overlook the critical steps in trading? It’s because there are flaws in our own concepts. Concepts are like projectors; if they are flawed, the projected image, i.e., the trading behavior and results, will inevitably be a failure.

The enchantment of the financial markets lies in two points: first, they allow you to clearly see the results of your actions; second, the results you see in the short term may not indicate that your actions are correct, while the cumulative results over the long term tend to provide accurate feedback on your actions.

The financial markets produce “random reinforcement” rather than “consistent reinforcement,” to be precise, “random reinforcement” in the short term and locally, and “consistent reinforcement” overall and in the long term. The so-called “random reinforcement” means “correct actions may not yield correct results, and incorrect actions may not yield incorrect results,” while “consistent reinforcement” means “correct actions will definitely yield correct results, and incorrect actions will definitely yield incorrect results.” Reinforcement is an important concept and tool in the learning theory of behavioural psychology, which Skinner studied extensively, and it is also the process by which the financial markets affect forex traders’ learning abilities.

II. Consistent Reinforcement Helps to Rapidly Improve Skills

Tolman and Honzik (1930) designed a maze composed of 14 units with a complex T-shaped channel. In each unit, there are blocked terminals (locked doors) and passable terminals (open doors). When a rat enters this maze, if it chooses incorrectly, it will hit a dead end at the locked door, making a mistake once; if it chooses the open door, it can enter the next unit. Thus, it goes through 14 units and finally reaches the end. In each unit, the rat’s task is to choose the open door and move into the next unit.

Tolman and Honzik divided the rats navigating the maze into three groups: one group received food rewards every day, called the “food-rewarded group”; another group never received food rewards, called the “non-food-rewarded group”; the third group was the experimental group, which was treated the same as the non-food-rewarded group for the first 11 days, receiving no food rewards, but from the 12th day on, they received food rewards like the food-rewarded group.

After the experiment began, compared to the non-food-rewarded group, the food-rewarded group significantly reduced the number of mistakes (i.e., hitting dead ends) and the time taken to navigate the maze, while the non-food-rewarded group’s subjects made fewer mistakes and took less time to a small extent.

In the first 11 days of the experiment, the experimental group’s rats, because they were treated the same as the non-food-rewarded group, made mistakes and took time to decrease very slowly. From the 12th day on, the experimental group received the same treatment as the food-rewarded group. Their learning performance improved dramatically, and the number of mistakes and the time taken decreased sharply, almost catching up with and surpassing the food-rewarded group’s learning performance.

Faced with this phenomenon exhibited by the experimental group, Tolman believed that the rats in the experimental group were still learning every day without food rewards. They became familiar with the passable paths of the maze during the process, forming a “cognitive map” of the maze in their minds, and creating a cognitive expectation of the path.

However, this learning effect was not manifested without rewards. Hence, this type of learning is called latent learning. When the subjects of the experimental group received food reinforcement, the effect of this latent learning was immediately manifested.

According to Tolman’s view, the results of the latent learning experiment not only provided strong evidence against the hypothesis that “there is no associative learning without reinforcement,” but also showed that what is important for the rats navigating the maze is to learn the cognition of the channels, to form a “cognitive map” of the path, rather than the rats’ overt responses during the learning process. The animal’s overt response is regulated by internal cognitive variables, which mediate the animal’s overt behaviour. The effect of learning is not all manifested externally, but importantly, it causes changes in internal cognitive expectations.

However, the reinforcement provided by the financial markets is not consistent reinforcement, at least locally it is random reinforcement. Therefore, its impact on the learning subject is much more complex than the aforementioned rat experiment, requiring much higher cognitive abilities and vision.

Humans have a tendency to be shortsighted, and easily influenced by recent results, and this is precisely what the forex market’s “trick” is. The forex market’s “random reinforcement” in the short term either leads forex traders into incorrect behavior or prevents them from recognizing correct behavior.

To escape the forex market’s “fog,” we need to be able to determine a complete and certain trading framework and process, so that our concepts and actions can be evaluated in the long term and overall. This way, we can break free from the constraints of “random reinforcement” and ultimately achieve lasting success in trading. Once you consciously operate according to a complete process, you can overcome human weaknesses and the interference of forex market random reinforcement.

III. Summary

In summary, our trading faces two types of interference: the first is our biases, with the biggest bias being “we tend to think that profitable positions should be closed quickly, and losing positions should be held on to.” This is the so-called “cutting profits short and letting losses run” tendency psychological effect. This effect is also one of the themes of behavioural economics.

The second interference is characteristic of random reinforcement in the forex market in the short term, which makes us unable to distinguish effective from ineffective behaviour in the short term. By following a complete process, we can overcome any psychological biases and random reinforcement in trading.

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