Crypto Trading Psychology: Overcoming Fear And Greed

Psychology is an important factor in all trading, and especially crypto trading given the higher price volatility. It is therefore crucial to understand how it impacts behavior in order to limit irrational trading and monetary loss. As a general guide, you should never act impulsively and irrationally when trading since it could undermine your trading strategy and negatively impact investment performance. So, how can an effective crypto trading psychology be implemented? First of all, always follow a clear and methodical plan, adhering strictly to your predefined trading strategy. Now we will go on and analyze in detail how psychology affects traders’ behavior, and understand the best strategies to always act rationally following the strategy plan.

The Importance of Psychology in Crypto Trading

Crypto is known for extreme price volatility, with daily oscillations of more than 30% considered to be not that unusual. Such large price moves can trigger strong emotional reactions among traders because as you can quite imagine seeing your portfolio drop 30% in a day is quite uncomfortable even for expert and experienced investors. However, since high volatility is extremely common in cryptocurrencies, after a big pump or dump sizable price reversals often occur. For investors who display patience and do not react to short-term price moves – even sizeable ones – these reversals serve to mitigate investment losses relative to investors who panic sold/bought. It often pays to be calm and patient and not highly sensitive to short-term price action. Let’s consider 3 scenarios to understand better how crypto trading psychology can affect traders’ performances. Let’s consider you’re holding 0.1 BTC valued at $6.000 (at a valuation of $60.000 per Bitcoin).

Scenario A) HODLing

BTC loses 33.3% in a day, and the valuation of your Bitcoin assets (0.1 BTC) drops from $6.000 to $4.000. On paper, you’ve lost $2.000 in a day, but you decide to hodl and in 10 days the price returns to $60.000: Your portfolio returns to the initial valuation without any human action.

Scenario B) Efficient Trading

BTC lost 33.3% in a day, but you inserted a stop-loss order at -10% of the original valuation, so you automatically sold your BTC portfolio at a 10% loss, losing $600 but keeping $5.400 in liquidity. After the 33.3% drop, you buy BTC again with your $5.400, and you’re actually buying more BTC than you had previously: After the stop loss order and the drop, with $5.400, you can buy 0.135 BTC, increasing your BTC assets from 0.1 to 0.135 BTC. Considering the same case of Scenario A, after 10 days, the price of BTC reaches $60.000 once again, and you actually make a good profit, with 0.135 BTC valued at $8.100. Using stop-loss orders and trading at the right timing, even if the market drops, once it rebounds, you manage to actually generate a very good profit, increasing your asset value from $6.000 to $8.100, exploiting a price drop.

Scenario C) Panic Selling

Now, let’s consider the same scenario once again, but suppose you didn’t set a stop loss order, you feel extreme fear seeing the value of your asset rapidly drop, and you start thinking that it could dump even further, questioning the value and reliability of BTC as a store of value. Caught up in an irrational and impulsive fear, you decide to manually sell BTC after the 33.3% drop, losing $2.000 of your original assets. After selling, you decide to wait and see what direction the market takes, but, as in other cases, the market recovers and within 10 days is back to $60,000, and you decide to re-enter the market, caught up in the euphoria. Well, in this last scenario, if you buy BTC back once it has recovered, you can afford only 0.66 BTC, since you panic sold at the lowest price over a specific period.

Why did we do these calculations and scenarios? Because different psychologies and strategies bring consistently different results:

• Scenario A: By hodling, the value of your asset remains the same after the recovery.
• Initial value: $6.000 | Final value: $6.000
• Scenario B: By trading (with experience and skills), the value of your asset grows by 35% after the recovery.
• Initial value: $6.000 | Final value: $8.100
• Scenario C: By panic selling in the worst moment, the value of your asset decreases by 33.3% after the recovery.
• Initial value: $6.000 | Final value: $4.000

As you can imagine, new traders are usually part of Scenario C, in which they lose money due to fear and panic selling. However, it mainly happens because new traders lack the necessary knowledge and experience to understand and have sufficient confidence to manage these dynamics effectively, but everyone can become a profitable trader by learning, making mistakes, and accumulating experience and skills.

Understanding Fear in Crypto Trading

Fear in trading manifests as the anxiety of losing money, affecting your choices, and consequently altering your crypto trading strategy. The reaction is driven by the instinct to avoid losses, a psychological bias known as loss aversion. In fact, recent studies have demonstrated that the pain of losing money is twice as powerful as the pleasure of obtaining the same percentage of gains. A common manifestation of fear is FUD (Fear, uncertainty, and doubt), and people who make FUD often spread negative and pessimistic news on social media and communities, further spreading fear among other people and communities, triggering a ripple effect and exacerbating the market response.

When gripped by fear, traders are more likely to make decisions that are counterproductive to their long-term goals. For instance, panic selling is a common reaction, where traders sell off assets at a loss in response to a sudden market dip, fearing further declines. This not only locks in losses but also often leads to missed opportunities when the market eventually recovers. Another way fear affects decision-making is by causing traders to avoid taking necessary risks, leading to overly cautious behavior that limits potential gains.

Understanding Greed in Crypto Trading

Unlike fear, greed leads traders to the opposite effect, driving them to take larger risks in the search for even greater profits. This emotional status is commonly called FOMO (Fear of Missing Out), and traders, driven by the recent success of others, “ape into” trades to avoid being left behind, often entering the market already late and likely losing money. “If everyone is speaking about a crypto investment, for example, at bars, locals, meetings, etc., it’s already late to invest in that asset”: It’s a common statement in finance, meaning that by the time a cryptocurrency (or any other investment) becomes a popular topic of conversation among the general public, the opportunity to make significant gains from that investment has likely passed. 

Additionally, greed can cause overtrading, where traders enter multiple positions without sufficient fundamental and technical analysis, usually overlooking the predefined crypto trading strategy they’re using. It usually leads to increased trading fees, poor entry and exit points, and, ultimately, losses. Moreover, greed and overtrading can trigger users to ignore risk management best practices, such as stop-losses or diversification, and make them highly vulnerable to significant losses if they don’t correctly read the price trend.

Strategies to Overcome Fear and Greed in Crypto Trading

Now that you understand how crypto trading psychology works, you should understand that the only way to avoid irrational and impulsive trades is by applying and following a well-defined crypto trading strategy that aligns with your risk tolerance, goals, capital, and time availability. Consequently, you must accept a mindset shift and implement risk management practices, avoiding FOMO and becoming a disciplined trader.

How to Overcome Fear and Greed?

Accept volatility

It is intrinsic to the crypto market, and you must accept price swings as a natural part of the crypto market, remain calm, and avoid reacting emotionally to market fluctuations. Additionally, volatility is not always a bad thing since it can present opportunities for profits, as demonstrated in Scenario B in the previous paragraphs.

Long-term perspective

Another useful strategy to change your mindset and act rationally is to think about the long-term results. You don’t have to perform a +10% daily to obtain good results, but consider that even a small percentage of profit (like also 0.1% daily) can bring exceptional results in the long term thanks to the compounding effect.

Risk management

It is crucial to limit losses and control fear since it means deciding your exposure and inherent risks before entering the market. Traders use tools like stop-loss orders to control the maximum loss they can support, limiting the risks. Another common strategy for sound risk management is diversification, spreading the risks among various assets instead of a single one, reducing the risks of heavy losses if a specific cryptocurrency underperforms the market.

Research and education

Knowledge is your best friend in crypto trading. DYOR (Do your own research) is a powerful antidote to fear and allows you to stay updated with market trends and regulatory news, aiming to not miss some relevant information that can cause significant price swings. Additionally, it builds confidence and reduces the anxiety associated with market uncertainty and volatility. 

Emotional detachment

This is a skill that is difficult to apprehend. It involves viewing trading as a strategic game rather than a daily personal finance battle, allowing you to separate your trading emotions from your personal life emotions, reducing stress and anxiety while improving your responses to price swings.

Setting clear goals

Combat greed by setting clear goals for your trades and identifying exit points before executing the trade. By adhering strictly to pre-set exit strategies, whether it’s a profit target or a trailing stop, you can lock in gains and avoid the pitfalls of greed. Remember, a small profit is always better than a big loss.

Follow a clear crypto trading strategy

Always trade based on a studied and predefined crypto trading strategy that suits your risk tolerance, goals, capital, and time availability. Include clear entry and exit strategies, risk management practices, and maximum daily trades in your strategy. In this way, you can silence the irrational part of your instinct to rationally follow your plan based on predefined rules that you created based on your specific needs and goals.

In conclusion, at Trakx, we highly recommend learning, studying, and testing before investing money in cryptocurrencies, as well as implementing sound risk management practices to limit the potential losses while seizing the opportunity of the crypto market. To become profitable, you need knowledge, skills, and experience, and we will always be here to provide you with detailed crypto and trading guides. Additionally, we provide advanced crypto index funds that allow traders to implement advanced strategies and sound risk management with ease, automatically rebalancing the crypto baskets every month.